CLO managers have received some Congressional backing for their efforts to curb the impact of forthcoming risk-retention standards.
A bipartisan U.S. House resolution was introduced Friday that would create a “qualified” exemption from upcoming risk-retention requirements that go into effect for new CLOs issued after December 2016. The bill creates a standard for designating a “qualified” CLO that would meet prescribed standards for asset quality, minimum capital structures and other criteria.
The bill, authored by U.S. Rep. Andy Barr (R-Ky.) and Rep. David Scott (D-Ga.), would allow the managers of “qualified” CLOs to hold a greatly reduced amount of capital – as much as one-tenth the level required by the existing final rule when it goes into effect.
The Barr-Scott bill closely maps the proposals the Loan Syndications & Trading Association and other securitization groups have pitched since the Federal Reserve began the rulemaking process on risk-retention standards required under the 2010 Dodd-Frank Act.
The bill would not completely gut risk-retention requirements for CLOs, but instead reduce the amount of capital to be held to 5% of the equity tranche of a CLO, rather than 5% of the face value of a portfolio as set out in the final risk-retention standard, according to a newsletter published Friday by the LSTA.
The difference between a piece of the equity tranche vs. the notional value would mean that a qualifying CLO valued at $500 million could have the retention standard lowered from $25 million to about $2.5 million, which is “still a very substantial amount of ‘skin in the game’ for thinly capitalized managers,” the LSTA stated.
The standards would include quality of assets, portfolio diversification, minimum capital structure, "alignment of interests," proper reporting and disclosure and manager regulation, according to the bill.
Barr announced plans at a CLO investor industry conference in April to pursue the qualified exemption standard for CLOs - modeled after a comparative "qualified" risk-retention exempition already granted to mortgage lenders on home loans they underwrite.
Barr noted at the time the exemption standards would include requirements for CLO investors (unaffiliated with the manager) to invest 90% or more of available cash in three or more loans, limit cov-lite exposure to 60% of assets, plus investing no more than 3.5% in any one loan or 15% in any one borrower.
There would also be interest coverage and total collateralization tests, and monthly reporting on assets and portfolio performance. CLO managers would also have to be registered investment advisors.
“By meeting these six best practices, requiring substantial subordinated CLO fees and requiring the manager to retain 5% of the CLO equity, the proposal meets both the letter and the spirit of the Dodd-Frank Act,” the newsletter stated.
The bill now goes to the House Financial Services Committee for markup phase before a full vote before the House if approved by the committee.
“Clearly, turning the bill into law will be an arduous task but one that would be extremely beneficial to the syndicated loan market – and the American companies that rely on loans for financing,” the newsletter stated.
Barr has been a go-to voice in the House for the syndicated loans industry, having in 2014 introduced another bipartisan bill that sought to extend the deadline for banks to bring their CLO holdings into compliance with Volker Rule standards (such as the exclusion of high-yield bonds from the portfolio).