A dramatic last-minute drop is occurring in a corner of the market for collateralized loan obligations ahead of a deadline for U.S. banks to get rid of some of their holdings.

Yield premiums on top-rated slices of certain types of CLOs — which bundle junk-rated corporate debt into new securities with varying risks — are widening "significantly," according to a report from Deutsche Bank AG. The reason is U.S. banks no longer will be able to hold these particular CLOs under provisions of the so-called Volcker Rule that take effect on July 21.

"Market participants seem to have realized that July follows June and that the deadline for positions not in place in December 2013 is upon banks," Deutsche Bank analyst Bjarni Torfason wrote Wednesday.

As a result, yields over benchmark rates on AAA rated CLOs issued before the financial crisis climbed to a range of 1.2 percentage points to 1.5 percentage points, up from a range of 0.8 of a percentage point to 1.15 percentage points in early May, according to Deutsche Bank. Other parts of the CLO market remain "relatively stable," Torfason wrote.

The types of CLOs that the Volcker Rule targets include those that use bonds, and not just loans, as collateral. Investment managers have responded by structuring new CLOs to comply with the rule, limiting its impact on issuance.

For non-bank investors, the wider spreads on certain CLOs offer a "decent opportunity although the supply of such non- compliant paper in the secondary market has yet to develop into a trend," Bank of America Corp. analysts including Chris Flanagan, Ryan Asato and Collin Chan wrote last week in a report.

The Volcker Rule, which focuses on reducing risky short- term trading by banks and is part of the sweeping financial overhaul mandated under the Dodd-Frank Act, is impacting the markets for CLOs and other collateralized debt obligations because of its provisions meant to limit the lenders' investments in private equity funds and similar vehicles.

The Federal Reserve said in April 2014 that it would provide two additional one-year extensions beyond next month for CLOs held by banks as of the end of the previous year. The Loan Syndications and Trading Association said at the time that U.S. banks held $70 billion of AAA and AA rated CLOs and that they shouldn't have to sell the holdings at all, adding that the step could impair the market and cause "material losses" for the lenders.


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