CLO market quiet; revised risk retention rule 'will substantially reduce' CLO managers

By Cristal Cody

Tupelo, Miss., Sept. 5 - Activity in the collateralized loan obligation market continued to be quiet on Thursday with market participants digesting the revised proposed 5% securitization risk retention requirement released in the previous week, sources said.

Primary activity is expected to pick up in the remainder of the month with deals in the pipeline from CLO managers H.I.G. Capital, LLC, Neuberger Berman Fixed Income LLC and others, according to market sources.

The revised risk retention requirement likely will impact CLO issuance once the rule takes effect, according to market sources.

"As we stated when analyzing the original proposal, we believe that the risk retention requirement will substantially reduce the universe of CLO managers," Dave Preston, an analyst at Wells Fargo Securities, LLC, said in a note. "Many CLO managers do not have capital available to contribute to 5% of a CLO. Smaller, more thinly capitalized asset managers may not be able to repeatedly purchase $20 million of a $400 million CLO."

The notice released on Aug. 28 by the Board of Governors of the Federal Reserve System, Department of Housing and Urban Development, Federal Deposit Insurance Corp., Federal Housing Finance Agency, Office of Comptroller of the Currency and the Securities and Exchange Commission revised a proposed rule the agencies issued in 2011 to implement the risk retention requirement in the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Risk retention would be based on fair value, and CLO managers would be required to retain 5% of the CLO balance.

The comment period on the proposed rule expires Oct. 30.

The requirement would become effective two years after the final rule is published with CLOs issued before the rule takes effect grandfathered.

The second notice of proposed rulemaking "appears to specifically reject the LSTA's [Loan Syndications and Trading Association] proposed solution that managers be allowed to satisfy risk retention requirements via unfunded class M notes backed by management fees," Preston said.

In a European CLO that priced in July, Credit Suisse Asset Management Ltd. sold a €37.75 million tranche of class M subordinated notes as part of the dual currency Cadogan Square CLO V BV deal.

Existing CLO management contracts and platforms also likely will see consolidation as a result of the risk retention requirement, Preston said.

Risk retention of 5% in a CLO equals about 40% to 50% of the equity tranche.

"We believe that as existing CLOs from smaller managers exit reinvestment, and these smaller managers are unable to issue new deals, these deals will likely end up transferred to larger managers," he said. "We believe that this will not benefit CLO investors, as their choice of manager would be greatly reduced to the small number of remaining large CLO managers."

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