LSTA study cautions regulators on effects of risk retention rules

By Jennifer Chiou

New York, Dec. 18 - The Loan Syndications and Trading Association released a study conducted by Oliver Wyman that measures the impact of risk retention rules on corporate borrowers if those rules go into effect as proposed.

According to an LSTA release, the requirements for asset-backed securitizations under Dodd-Frank will likely severely limit the availability of collateralized loan obligations in the future.

In the study, Wyman reviews various scenarios from moderate to severe but, in general, finds risk retention would cost corporate borrowers about 150 basis points in higher interest costs.

The study found that these rules would effectively reduce the availability of credit and/or increase the cost of financing for American companies.

As a result, the study recommends that regulators proceed cautiously to implement risk retention in a way that does not disrupt the CLO market and bring undue harm to corporate borrowers.

Wyman said that CLOs currently provide $280 billion of credit to non-investment-grade corporate borrowers, roughly 45% of funded non-investment-grade term loans to U.S. companies.

As proposed, risk retention rules would likely reduce CLO formation by $170 billion to $250 billion, the study noted, adding that companies seeking to replace this source of financing would be forced to rely on more expensive sources of credit.

To replace CLOs, borrowers would likely see financing margins increase by more than one-third, an increase in annual interest costs equivalent to $3.2 billion in today's market, the release said.

"CLOs are an integral source of financing for U.S. companies and provide real economic value to investors," executive director of LSTA Bram Smith said.

"As proposed, risk retention will impede the availability of CLOs, which will severely limit the availability of credit for American companies and force corporate borrowers to rely on more expensive sources of funding - if the other funding is available at all."

Additionally, the study noted that CLOs do not fit within Dodd-Frank's securitization framework, which sought to redress conflicts of incentives and lack of transparency of underlying assets.

The study also found that CLOs have "proven to be incredibly safe, with a less than 1.5% impairment rate since 1996, and did not contribute to the financial crisis."

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