LSTA warns of Senate bill's possibly severe impact on loan market

By Angela McDaniels

Tacoma, Wash., May 28 - The Loan Syndications and Trading Association said the risk retention plank of the Senate's recently passed Financial Regulatory Reform Bill could have a severe impact on the syndicated loan market.

The proposed Senate legislation would "require any securitizer to retain an economic interest in a portion of the credit risk for any asset that the securitizer, through the issuance of an asset-backed security, transfers, sells, or conveys to a third party," the association noted in a report.

LSTA said the proposed retention level is 5%, and the securitizer would likely be either the structuring bank or the collateralized loan obligation itself. That 5% risk retention could be shared with an originator that sells the asset into a securitization.

"The ramifications of the Senate bill could range from unfortunate to devastating for the revival of the CLO market," LSTA said in the report. "If the CLO structuring bank is required to retain the risk, the economics of arranging CLOs may simply become untenable. In turn, new CLO formation might be hamstrung. Alternatively, if CLOs are the risk retainers, this may reduce - but might not completely halt - CLO formation."

House bill

The Senate's proposed legislation is narrower than the bill passed by the House of Representatives in December.

According to the LSTA report, the House bill would require "any creditor that makes a loan to retain an economic interest in a material portion of the credit risk of any such loan that the creditor transfers, sells, or conveys to a third party, including for the purpose of including such loan in a pool of loans backing an issuance of asset backed securities."

The final version of the House bill requires creditors to retain 5% of the risk of the loan unhedged, the association noted.

LSTA said that the use of the word "creditors" - not originators or underwriters - means the requirement could presumably be applied to all the lenders in a syndicate, not just the lead banks, and that a rule strictly applied in this fashion could theoretically limit lender groups to 20 institutions, each holding 5% of the credit risk.

"This could have serious consequences since many large syndicated loans ... are designed to be held by far more than 20 lenders," the association said in the report.

'Glimmers of light'

LSTA said that while both bills are "potentially sweeping in their import, there are a few glimmers of light."

First, the bills have become "less onerous" over time. The association said both the House and Senate reduced the risk retention requirement to 5% from 10%.

Second, both bills give regulators authority to interpret the rules, and third, the regulators also have powers to reduce the risk retention or remove it entirely for less-risky assets or asset classes, the association said.

In addition, the Senate exempted some asset classes like qualifying residential mortgages and commercial mortgages.

"This illustrates an understanding that not all asset classes are created equal - or present equal risk - and thus not all should be treated the same," LSTA said. "So even though syndicated loans have not been specifically exempted, there is precedent to argue they should be."

Next steps

The House and Senate bills must be reconciled in the Conference Committee process, which is expected to begin the week of June 7.

In the Senate bill, regulators are given 270 days to prescribe risk-retention rules and then up to two years to implement the new regulations. In the House bill, the regulators must prescribe regulations within 180 days.

In the meantime, the association said it will continue its "educational process" with lawmakers and regulators explaining, among other things, the importance of CLOs for providing credit to speculative-grade companies and the ramifications of potentially limiting bank groups to just 20 lenders.

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