Prime brokerage “not an option” for CLO financing
05 August 2013 New York
Image: Shutterstock
New risk retention rules will dramatically shrink the collateralised loan obligation market, and prime brokers will not help the situation, said The Loan Syndications and Trading Association in a letter to US regulators.
The association submitted a comment letter to US regulators responsible for developing and implementing new risk retention regulations.
It featured a survey that showed managers, representing more than two thirds of the US CLO market, estimating the number of CLO’s they manage dropping from 500 to approximately 70, if the rules are implemented as currently written.
The rules would require managers to retain 5 percent of the fair value of a CLO.
“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,” said Meredith Coffey, executive vice president of the LSTA.
“[Half of] the respondents said they couldn’t or wouldn’t issue a new CLO. Over 80 percent said the rules would shrink the market by 75 percent or more.”
“We only have to look at the experience in Europe, where CLO issuance has collapsed, to see what risk retention does to a market,” said Bram Smith, executive director of the LSTA.
The LSTA submitted the survey findings to the Federal Reserve, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission, the Federal Housing Authority and the Department of Housing and Urban Development.
Findings were compiled from 35 CLO managers who collectively manage $228 billion in 509 CLO’s.
The survey also showed that financing the retention is not a reasonable solution. Of the 35 CLO managers that responded, 20 said they could not raise funding. Of the 12 that said they could raise funding, just two said that they would raise funding.
“Moreover, even if a CLO manager was willing to finance the retention, it does not appear that such financing would be forthcoming,” said a statement from the association.
The LSTA spoke with bankers representing over half the prime brokerage market and a number of the term lenders. Neither route appeared to be a realistic alternative for CLO managers to raise financing to retain five percent of a new CLO.
Generally the term lenders said they would lend between 50 percent and 75 percent of the value of the AAA or AA rated notes—and nothing further down the capital structure.
“In turn, this means that—even if the CLO manager could access term financing—it would still have to provide over half the required retention out of its own pocket. Critically, this loan would be recourse to the CLO manager, meaning that their business could be at risk if just one CLO deteriorated,” said the statement.
It added that the prime brokerage option is even less feasible, citing results which found prime brokers indicating that they lend short-term against a percentage of highly liquid securities.
“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. Because CLO securities are not sufficiently liquid and because the risk retention rules themselves would not permit them to be rehypothecated, the prime brokerage option simply is not an option.”
“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,” said Elliot Ganz, general counsel of the LSTA.
“Moreover, the survey indicated that the prime brokerage option was basically a non-starter.”
The association submitted a comment letter to US regulators responsible for developing and implementing new risk retention regulations.
It featured a survey that showed managers, representing more than two thirds of the US CLO market, estimating the number of CLO’s they manage dropping from 500 to approximately 70, if the rules are implemented as currently written.
The rules would require managers to retain 5 percent of the fair value of a CLO.
“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,” said Meredith Coffey, executive vice president of the LSTA.
“[Half of] the respondents said they couldn’t or wouldn’t issue a new CLO. Over 80 percent said the rules would shrink the market by 75 percent or more.”
“We only have to look at the experience in Europe, where CLO issuance has collapsed, to see what risk retention does to a market,” said Bram Smith, executive director of the LSTA.
The LSTA submitted the survey findings to the Federal Reserve, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission, the Federal Housing Authority and the Department of Housing and Urban Development.
Findings were compiled from 35 CLO managers who collectively manage $228 billion in 509 CLO’s.
The survey also showed that financing the retention is not a reasonable solution. Of the 35 CLO managers that responded, 20 said they could not raise funding. Of the 12 that said they could raise funding, just two said that they would raise funding.
“Moreover, even if a CLO manager was willing to finance the retention, it does not appear that such financing would be forthcoming,” said a statement from the association.
The LSTA spoke with bankers representing over half the prime brokerage market and a number of the term lenders. Neither route appeared to be a realistic alternative for CLO managers to raise financing to retain five percent of a new CLO.
Generally the term lenders said they would lend between 50 percent and 75 percent of the value of the AAA or AA rated notes—and nothing further down the capital structure.
“In turn, this means that—even if the CLO manager could access term financing—it would still have to provide over half the required retention out of its own pocket. Critically, this loan would be recourse to the CLO manager, meaning that their business could be at risk if just one CLO deteriorated,” said the statement.
It added that the prime brokerage option is even less feasible, citing results which found prime brokers indicating that they lend short-term against a percentage of highly liquid securities.
“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. Because CLO securities are not sufficiently liquid and because the risk retention rules themselves would not permit them to be rehypothecated, the prime brokerage option simply is not an option.”
“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,” said Elliot Ganz, general counsel of the LSTA.
“Moreover, the survey indicated that the prime brokerage option was basically a non-starter.”
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