LSTA survey paints grim CLO outlook under new risk retention rules

By Susanna Moon

Chicago, Aug. 2 - The Loan Syndications and Trading Association said its new survey of CLO managers point to a dismal outlook for market issuance if new risk retention rules are adopted as proposed.

The new rules would require managers to retain 5% of the fair value of a CLO.

If adopted, CLO managers expect the number of CLOs they manage to dwindle to about 70 as a result of the new rules, from about 500 now, according to a press release by LSTA.

The trade organization said it included the survey in a comment letter sent to federal regulators, including the Federal Reserve, Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp., the Securities and Exchange Commission, the Federal Housing Authority and the Department of Housing and Urban Development, the release noted.

The survey is of CLO managers responsible for managing more than two thirds of the U.S. CLO market, or 35 CLO managers who collectively manage $228 billion, or 509, CLOs.

"The rules - which would require a manager to purchase and retain $25 million of notes for every $500 million CLO - would be devastating for the largest as well as the smallest managers," Meredith Coffey, executive vice president of the LSTA, said in the press release.

"Fully half the respondents said they couldn't or wouldn't issue a new CLO. Over 80% said the rules would shrink the market by 75% or more," Coffey said.

Added Bram Smith, executive director of the LSTA: "We only have to look at the experience in Europe, where CLO issuance has collapsed, to see what risk retention does to a market."

The CLO managers in the survey also said financing the retention would not work. Of the 35 CLO managers, 20 said they could not raise funding. And of the 12 that said they could raise funding, just two said that they would raise funding.

Banker feedback

In talking with bankers, neither route appeared to be a realistic alternative for CLO managers to raise financing to retain 5% of a new CLO, the release noted.

The LSTA said it spoke with bankers representing more than half the prime brokerage market and a number of the term lenders.

Generally, the term lenders said they would lend between 50% and 75% of the value of the AAA or AA rated notes - and nothing further down the capital structure, according to the LSTA.

The prime brokerage option is even less feasible, the LSTA said. Prime brokers said they lend short-term against a percentage of highly liquid securities and not only would these securities be subject to the aforementioned haircuts, but they would also face daily margin calls.

In addition, there must be a liquid secondary market where these securities can be traded immediately, and the security must be of a type that the prime lender can lend (rehypothecate) overnight, the LSTA noted.

"While an occasional large, top-quality, diversified asset manager might be able to access some amount of term financing, it is simply not an option for the typical CLO manager," Elliot Ganz, general counsel of the LSTA, said in the press release.

"Moreover, the survey indicated that the prime brokerage option was basically a non-starter."

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