The leveraged loan market is hoping to dodge yet another bullet from the Dodd-Frank Act.
The industry caught a break when the final version of Volcker Rule excluded syndicated loans from restrictions on market making by banks. But it’s still concerned that the way regulators are proposing to implement the Volcker Rule will harm CLOs, which are big buyers of syndicated loans.
The Loan Syndication and Trading Association (LSTA) submitted a comment letter on Tuesday saying the proposed rules would treat CLOs as if they were hedge funds or private equity funds. The Volcker Rule, which is designed to limit risk taking by U.S. banks, prohibits banks from underwriting or owning hedge funds, private equity funds, and other “covered funds.” While Congress included language in the Dodd-Frank Act that expressly prohibits regulators from using the Volcker Rule to restrict banks’ ability to sell or securitize loans, the LSTA feels this doesn’t go far enough.
In its comment letter, the trade group asked regulators to broaden the definition of “loan securitization” in the proposed rules to include all types of “securitization of loans,” both CLOs in existence at time final rules are adopted and those created after that date.
The LSTA also asked regulators to explicitly exclude loan securitizations from the definition of a “covered fund.”
The trade group also wants to ensure CLOs are able to invest in assets besides syndicated loans without tripping other kinds of restrictions, namely a requirement that sponsors of securitizations retain some of the risk in these deals. The industry has been lobbying regulators to exclude CLOs from risk retention requirements on asset-backed securities, arguing that CLOs managers buy the collateral for these deals on the open market, rather than use them to shift risky assets off their balance sheets.
Still, there a number of reasons a CLO might hold other kinds of asset besides loans; sometimes they receive equity in exchange for the debt via a bankruptcy or restructuring, for example. So the LSTA is suggesting that regulators define new CLOs as being: comprised of at least 90% of senior, secured syndicated loans and temporary investments, with all holdings limited to senior, secured syndicated loans, other corporate credit obligations, temporary investments, and government obligations used to "credit enhance" securities issued by a new CLO, hedge transactions, and workout interests.
Still another concern for the loan industry is the potential impact of the Volcker Rule on the making of bridge loans. The legislation prohibits banks from engaging in proprietary trading, and while Congress carved out an exception for loans, it did not do so for bridge loan facilities, short-term financing meant to backstop borrowers until they can access the high yield bond market or other, more permanent financing.
The LSTA said bridge loan facilities typically provide the lender with the right to require that the borrower incur such permanent financings for such purpose, thereby enabling the lender to reduce its credit exposure to the borrower.
“This right is a longstanding market feature and is often central to the commercial terms and conditions upon which a lender may be willing to provide a bridge loan facility,” it said in the comment letter. “Any uncertainty around this issue will increase the credit risk associated with this legitimate and longstanding source of funding for borrowers worldwide and will unduly burden, or render impracticable, this method of capital formation.”
The trade group asked regulators to clarify that acquiring and reselling securities received in lieu of or to refinance bridge loan facilities are permitted underwriting activities. It also asked regulators to measure “near-term demands of clients” in connection with permitted underwriting activity at the initial extension of the bridge commitment.