The terms of the final U.S. risk retention rule have been released, with little material change to the regulation with respect to CLOs, according to the LSTA.
This means that once the regulation goes into effect two years after it has been published in the Federal Register, CLO managers will have two methods by which to comply with the regulation, the manager as sponsor option or the arranger option.
Manager retention means the manager can retain 5% of the entire size of the CLO, vertically or horizontally.
The one piece of good news from the final rule is that the ‘cash throttle’ has been removed. This would have restricted the equity retention from receiving any payments before the notes began to amortise, which would have rendered retention via a horizontal piece unfeasible.
Loan arranger retention is where provided that the CLO buys 100% of eligible loan collateral, the manager would not have to retain 5% risk in the structure. Eligible collateral is defined as a loan tranche whereby the arranging bank retains 5% for the life of the loan. This is widely considered a non-option by market players given that banks are unlikely to agree to retain a portion of loans they underwrite for the purpose of the regulation.
The explicit third-party equity option has not been accepted, says the LSTA. Neither has the Qualified CLO concept or the expansion of the Qualifying Loan definition.
The FDIC votes on the regulation today, while the Federal Reserve will vote tomorrow.
All CLOs issued prior to the effective date are expected to be grandfathered.
Bram Smith, the LSTA’s executive director, today issued a statement expressing its disappointment with the final terms, which will “negatively impact American credit markets and make financing for U.S. companies more expensive and scarce.”
The statement continues, “Ironically, while the risk retention rule revealed today does not cover the vast majority of residential mortgages – one of the major sources of the financial crisis – the agencies have decided to proceed with a one-size-fits-all approach that unfairly harms CLOs, a historically safe financial product that in no way contributed to the financial crisis this rule aims to safeguard against in the future. In fact, CLOs performed exceedingly well throughout the financial crisis, and no investor has ever lost money on a senior CLO note.” – Sarah Husband