House Financial Services Subcommittee on Capital Markets and Government Sponsored Enterprises Hearing
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Introduction
Chairman Garrett, Ranking Member Maloney and members of the Subcommittee on Capital Markets and
My name is
Founded in
Like any powerful tool, however, securitization must be used carefully, and thoughtful regulation is an important part of that. Yet if regulation is taken too far, it could render large portions of the securitization market either operationally or economically non-viable, leading to a reduction of available credit and/or increases in borrowing costs.
Ultimately, the level of regulation will determine the affordability of credit for
While
As we assess these regulatory initiatives, each of which has merit in its own right, we are concerned about the combined, long-term impact they could have on the ability of
Our concern about this combined impact is also borne of the recognition that any single regulatory initiative, in isolation, can potentially have an outsized negative impact on the securitization market. One of the clearest examples of this is the effect of the Volcker Rule on collateralized loan obligations (or "CLOs") and, relatedly, the commercial loan market that relies on CLOs to provide affordable financing to U.S. borrowers. Another such example is the impact felt by the CLO marketplace from the proposed credit risk retention rules. My testimony today will focus on both examples and proposed solutions to counteract these negative effects.
If we do not foster a healthy and stable CLO market for all participants, then companies that create jobs, make capital investments to grow their businesses and provide goods and services will suffer. Companies such as:
.
.
. HCR ManorCare of
.
Importantly, CLO issuance in January, 2014, was down approximately
However, the CLO market has seen a slight upturn in February, and many in the market believe this positive result is due to the bi-partisan work of the Committee and the commitment by the federal agencies to resolve the unintended consequences of the Volcker Rule
Yet,
It is just as important to note that the long-term viability of the CLO market will not be solely determined by the implementation of the Volcker Rule. The pending credit-risk retention rulemaking is also of critical importance. If implemented as re-proposed, market forecasters predict that CLO issuance and the amount of credit provided to businesses could be reduced by 75 percent or more.
We appreciate the bi-partisan work of the Committee and the federal agencies to work toward both a short-term solution for the Volcker Rule and a long-term solution for risk retention., Without significant changes to these regulatory initiatives, we are deeply concerned about the sustainability of the CLO industry.
Therefore, it is imperative that the momentum that this Committee has provided - on both sides of the aisle - is maintained. Thank you for your work on these important issues.
Overview of CLOs
What are CLOs?
CLOs are investment funds that invest in commercial loans--that is, senior secured loans (including middle market loans) made to U.S. companies. Companies may use these loans to finance expansion projects, such as building new utility plants and energy pipelines, to support working capital and general operations, such as paying employee salaries and supplier invoices, and for refinancing existing debt. Commercial loans are therefore a critical source of credit for U.S. businesses - credit that is necessary for job creation and economic growth. The credit provided by CLOs to the commercial loan market generally serves to stabilize and lower interest rates for businesses that might not otherwise have access to capital markets financing. In fact, CLOs represent the largest non-bank segment of the commercial loan market, having invested in approximately
The companies that access the funding provided by CLOs can be found in every state of the Union and operate across all kinds of industries, including: restaurants, utilities, healthcare providers, rental car companies, communications and broadcasting companies, manufacturers, and supermarkets and food services companies. It is no exaggeration to say that the access to credit provided by CLOs affects nearly everyone in your Congressional districts who is working hard to create jobs and spur the U.S. economy.
As a technical matter, CLOs are structured as securitizations. They issue securities that are dependent upon repayment from portfolios of financial assets. n3 It is important to note that the CLO structure and associated markets have a proven track record, having demonstrated their stability and resiliency before, during and after the recent financial crisis. This strength is largely driven by five differentiating features:
1. Diversification. A CLO portfolio is primarily comprised of senior secured commercial loans, usually a minimum of 90 percent, and those loans are well-diversified across different industry sectors. Consequently, CLOs are not reliant on the performance of any particular company or industry.
2. Active Management. CLOs are actively managed by
3. Alignment of Interests. The interests of CLO managers are strongly aligned with the interests of CLO investors. In other words, CLO managers have "skin in the game." They do not profit from the sale of assets to the CLOs they manage at the time of sale; they receive the bulk of their compensation only when and if the CLO performs well over time; and if they breach their legal duties as set out in the CLO transaction documents, they can be removed as manager by the investors.
4. Self-Correcting Mechanisms. CLOs are designed to "self-correct" for any material deterioration in the credit quality of the portfolio of commercial loans. These mechanisms include tests that, if not satisfied, require that investors in the CLO's senior debt securities be repaid before the CLO manager receives most of its fees or any investors in the CLO's junior equity securities receive further payment, until compliance with the tests is restored.
5. Transparency. CLOs purchase commercial loans from third-party sellers in an active, transparent secondary market. The loans are issued by companies that are audited by reputable accounting firms; report financial performance information to loan investors on a regular basis; frequently are required to file regular financial reports with the
State of the CLO Industry
Historical Performance
CLOs performed very well before, during and since the financial crisis. As a result of the strong historical performance of the underlying leveraged loans, 5 year cumulative impairments on investment grade CLO debt securities since 1993 have been less than 0.8%. n4 Consequently, no CLO debt security initially rated higher than "A" by one of the primary credit rating agencies has suffered a principal loss. For debt securities initially rated "BBB" or higher the 5-year cumulative principal loss rate for securities issued between 1993 and 2012 is just 0.2%. n5 These loss rates compare favorably with certain fixed income securities such as corporate bonds, which have seen principal loss rates of approximately 0.7% during the period from 1992 to 2012. n6
CLOs have also provided strong returns to investors compared to other fixed income securities, as CLO debt securities with an average rating of "A" returned an average of 3.9% in 2013, compared to an average loss of 2.2% for all other fixed income securities during the same time period. n7
Current State of the
Issuance Compared to Historical
While CLO issuance has rebounded considerably from financial crisis levels, the uncertainty surrounding interpretation of the Volcker Rule appears to have contributed to putting a damper on recent CLO issuance activity. CLO issuance in
We note that issuance this month increased after seeing a 17-month low in January. This recent uptick has been attributed to the market's reaction to this Committee's bi-partisan support for a regulatory fix to the Volcker Rule.
Therefore, we appreciate the bi-partisan efforts of this Committee to address these issues, and we appreciate the continued momentum that this hearing has provided. Without the efforts of both
How Declines in
As noted earlier, CLOs are currently invested in approximately
As CLO issuance declines, the ability of these companies to obtain important financing at reasonable rates diminishes. And if CLO issuance declines by the 75 percent or more that is estimated, as a result of the proposed risk retention rule being implemented in its current form, then it is expected that a "refinancing wall" will occur between 2017 and 2020. Specifically, this means that there would be more loans that need to be refinanced than the commercial loan market, as currently composed, would be able to support. n11
CLOs also allow global investors, who lack the access to directly lend to U.S. companies, a method of providing this credit with the assistance of a U.S.-based asset manager and at the risk level they are most comfortable. Without CLOs available as a means of funding commercial and industrial loans, there is no certainty that the other current participants in the commercial lending market, such as banks and mutual funds, would be able to provide all of the additional funding necessary to support the refinancing wall that would hit U.S. borrowers. At the very least, even if alternate funding sources become available, then they will be more expensive than CLOs and will increase the costs of borrowing for the companies, making it harder for companies to meet payroll or grow without sacrificing jobs.
Reasons for the Current State of the
Volcker Rule
Even though CLOs are "long-only" funds that invest primarily in loans to U.S. companies through a robust, transparent structure with a buy-and-hold strategy that does not contribute to mark-to-market volatility, most CLOs are effectively treated as hedge funds under the Final Rule n12. The Final Rule defines "covered fund" in a way that includes securitization issuers, such as CLOs, that rely on the exemption provided by Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act. Although the Final Rule excludes from the definition of covered fund "loan securitizations," or securitization issuers that hold only loans and certain servicing assets, risk-mitigating assets and cash equivalents n13, most CLOs in existence today do not qualify for the loan securitization exclusion, even though typically 90 percent or more of their portfolios are devoted to commercial loans. n14
One of the primary consequences of a CLO being treated as a covered fund under the Volcker Rule is that banks are not permitted to acquire or hold an "ownership interest" in that CLO, absent certain limited exceptions. The problem for the CLO market, and for the banks that invest in it, is that the Final Rule defines "ownership interest" in a way that includes not only the junior-most "equity" class of securities issued by a CLO (in other words, the class of securities that economically "owns" the CLO), but also the highly rated, senior secured classes of debt securities issued by a CLO and commonly purchased by banks of all sizes. As a result, over the next 17 months U.S. banks may have to divest up to
The Volcker Rule's Effect on Bank CLO Investments: A Case Study
The well-underwritten commercial loans held by CLOs, the various structural features of CLOs that provide significant protections to investors, the strong historical performance of CLOs (before, during and since the recent financial crisis) and the excellent risk-adjusted returns of CLOs, among other factors, have attracted a variety of institutional investors to CLOs.
In particular, a wide range of U.S. banks, including large, mid-size and community banks, have invested in CLOs--specifically, in the interest-bearing, secured note classes issued by CLOs that are rated "AAA" or "AA" by one or more rating agencies. n16 As mentioned, the amount of senior CLO debt securities currently held by U.S. banks is between
For example,
However, if there is no clarification to the Volcker Rule, then
We highlight
The Rulemaking Issue
The Final Rule effectively transforms the senior CLO debt securities held by banks into the equivalent of equity securities. It does this by re-characterizing as "equity-like" certain common features of CLO debt securities that are designed solely to safeguard the rights of those security holders as secured creditors of the CLOs in which they have invested. The Final Rule essentially says to banks, "You may have thought you were lending to CLOs, but you really own those CLOs." This was news to both banks and the actual owners of the CLOs.
The definition of "ownership interest" in the Final Rule contains specific language that is intended to capture securities and other interests that, while in the form of debt, exhibit substantially the same characteristics as equity. Most of this language describes features relating to economic control of the issuing entity or the right to receive a share of the entity's profits and losses. However, the definition also treats as "ownership interests" those interests that, on a current, future or contingent basis, have "the right to participate in the selection or removal" of an investment manager of a covered fund, "(excluding the rights of a creditor to exercise remedies upon the occurrence of an event of default or an acceleration event)." n19
As discussed in the Overview, there are a number of structural features that contribute to the robustness of CLOs. Among these are important creditors' rights given to holders of CLO debt securities that reflect their effective status as senior lenders to, rather than owners of, a CLO. Although most of these creditors' rights are vested in the senior-most outstanding or "controlling class" of debt securities, because CLO debt securities are paid in order of seniority, any class of CLO debt securities can become the controlling class after all classes senior to it have been paid in full.
One such important creditors' right is the ability to remove a CLO manager "for cause" and participate in the selection of its replacement. In typical CLO transaction documents, the events that could trigger the right to remove a CLO manager "for cause" include, among others, a willful breach by the CLO manager of its obligations under the transaction documents, the dissolution or insolvency of the CLO manager or fraud or criminal activity by the CLO manager in connection with its investment management business. n20 By their very nature, "for cause" events ultimately threaten the ability of a CLO to make promised payments of principal and interest to the holders of its debt securities. n21 Another important creditors' right is to vote on the replacement for a CLO manager that resigns. The resignation of a CLO manager is effectively a change-of-control event for the CLO, a circumstance under which traditional bank lenders often receive consent rights or the right to be repaid.
In almost all CLOs, a specified percentage of the controlling class has the right to remove the CLO manager "for cause" and the right to nominate or approve the replacement of a CLO manager who has been so removed or has resigned. Consequently, CLO debt securities are, under a literal reading of the Final Rule, interests that have "the right to participate in the selection or removal" of an investment manager of a covered fund--in other words, "ownership interests" in which banks may not invest. Incongruously, because these rights are structured to help prevent an event of default under the CLO transaction documents, the carve-out in the Final Rule's language for "rights of a creditor to exercise remedies upon the occurrence of an event of default or an acceleration event" does not appear to apply.
Restructuring as an Alternative to Bank Divestiture
As an alternative to divesting their CLO debt securities, banks theoretically could attempt to orchestrate the restructuring of the legacy CLOs that issued those securities so that the CLOs qualify for the loan securitization exclusion from the definition of "covered fund". For at least two reasons, however, restructurings of legacy CLOs on a widespread basis is unrealistic. First, CLO managers would need to sell existing holdings of bonds and other securities that are not permitted under the loan securitization exclusion. They may not be willing to do so, however, if the CLO would incur a loss. Moreover, CLO managers have fiduciary responsibilities to all of the investors in the CLOs that they manage. Sales of non-loan assets, while beneficial for banks as a means of qualifying for the loan securitization exclusion, might be economically disadvantageous to other, non-bank CLO investors. Second, even after such sales, CLO managers would need to promise not to make any new purchases of impermissible securities. Banks that have invested in CLOs likely would not be comfortable with any such promise unless it was formally memorialized in an amendment to the CLO's transaction documents. However, it can be very difficult to amend CLOs transaction documents because amendments frequently require the consent of a majority of each class of securities issued by the CLO and the cooperation of security holders whose interests are not always aligned.
One Immediate Effect of the Rulemaking Issue
Although banks have until at least
Risk Retention
Pursuant to Section 941 of the Dodd-Frank Act, six governmental agencies were tasked with developing rules to require securitizers to retain a portion of the risk of the assets they securitize. The agencies have released proposed rules which, if enacted "as-is," would permit a CLO to satisfy the agencies' risk retention requirements either by retaining a specific type of interest in the CLO by the CLO investment manager or by structuring CLOs to consist solely of "CLO-eligible loan tranches" and related servicing assets. In either case, these options for risk retention are unworkable for most of the current participants in the CLO market and, if they are the only options available, are expected to significantly decrease the number of participants in the CLO market, the amount of CLO issuance and, consequently, the availability of financing to U.S. companies. I will address the problems with each of these options in turn.
CLO Manager Retention
The current risk retention proposal will require CLO investment managers to retain an interest equal to 5 percent of the fair value of all CLO securities issued in each new CLO it manages unless the transaction is structured to consist solely of "CLO-eligible loan tranches" and related servicing assets. In addition, to the extent that the retained interest represents a horizontal interest in the CLO, the interest is required to be structured in way to prevent the retention holder from receiving cash at a faster rate than that at which principal is paid to investors in all other CLO securities, as based on projected cash flows.
CLO managers are similar to (and in fact, often also are) mutual fund managers and generally do not profit from selling assets to an investment vehicle, but instead rely on fees received for active management in connection with the performance of the vehicle. As a result, many of the managers in the CLO market are not capitalized in a manner that would permit them to hold interests in CLOs that they manage at the level that the agencies are proposing. The agencies expressed understanding in their re-proposal that requiring collateral managers to be the sole sponsors of CLOs and to satisfy risk retention would reduce the number of CLO issuances and competition among CLO managers.
Also, the requirement to restrict payments received by the holder of a retention interest is unnecessary as CLO equity tranches are already fully subordinated to payments to CLO debt securities. Since CLOs distribute interest and principal received on the underlying loans separately, principal proceeds on the underlying loans are never paid to a CLO equity tranche before all of the CLO debt securities have been paid in full. Furthermore, CLOs typically provide that interest payments will be diverted to pay principal of CLO debt securities when certain overcollateralization or interest coverage tests are not met. As a result of these features, losses fall on CLO equity tranches before affecting any CLO debt security.
Perhaps even more importantly, restricting cash flows paid to the holders of CLO equity tranches will make them less attractive to investors. As almost of all of the credit risk of a CLO is found in the bottom 20 percent of the capital structure and CLO equity tranches represent roughly half of that bottom 20 percent, investors expect to receive a higher return in exchange for taking on the risk of potential losses. All of that higher return comes in the form of excess interest generated by the underlying loans. If interest cash flows are withheld, investors in CLO equity tranches may not be appropriately compensated for bearing the credit risk of the transaction and may be unwilling to invest in CLOs going forward. A reduction in the number of CLO equity investors in the market would further reduce CLO issuance and shrink the availability of credit available to U.S. companies.
CLO-eligible Loan Tranches
Alternatively, the agencies proposed that a CLO manager would not have to retain an interest in a CLO it manages if the CLO consisted solely of "CLO-eligible loan tranches" acquired in the open market and related servicing assets. "CLO-eligible loan tranches" were defined by the agencies as loans where the lead arranger for the loan agrees to hold 5 percent of the loan purchased by the CLO for the life of the loan without the ability to hedge its exposure. Unfortunately, 10 banks are the lead arrangers for nearly 85 percent of all syndications of broadly syndicated loans, with 3 banks acting as lead arranger for nearly 49 percent of all syndications. n22 With such a small universe of lead arrangers, requiring the lead arrangers to retain 5 percent of every tranche of a loan syndication that a CLO wanted to have qualified as a "CLO-eligible loan tranche" would potentially require an enormous increase in those banks' risk-based capital. In addition, retaining these loan tranches would require the banks holding them to pay a higher premium for depository insurance. These additional costs, if not prohibitive to the banks, would be passed along to borrowers, further increasing the costs of borrowing and negatively affecting the ability of U.S. companies to finance growth. Additionally, the requirement that the banks hold a portion of these loan tranches until maturity without being permitted to hedge is a credit strategy opposed by both bank regulators and common prudential risk management practices. Given all of these concerns, banks have indicated that they are unlikely to originate a substantial amount of loans that would satisfy the proposed requirements of a "CLO-eligible loan tranche".
Solutions for the Volcker Rule
In the event that the agencies decline to provide this guidance,
Solutions for Risk Retention
As demonstrated earlier, the currently proposed options for asset-backed securities risk retention are unworkable for CLOs and are expected to greatly reduce CLO issuance and its beneficial effect on the commercial loan market. In its comment letter to the agencies,
Moreover, in a second comment letter developed with the LSTA and SIFMA,
Third Party Retention
1. Third Party Retention Holders and Eligible Retention Interests.
2. Asset Pool Composition and Third Party Review. In order for an open market CLO to be eligible to utilize the third-party purchaser retention option, such CLO's asset pool would be required to be comprised primarily of commercial loans and servicing assets. The agencies have asserted that risk retention should be held by collateral managers when no other party is the sponsor of the CLO as the agencies consider the collateral managers to be the parties that determine the credit risk profile of the securitized assets in a CLO. Although CLO managers do select the specific assets to be included in a CLO asset pool, they do so in accordance with set parameters laid out in the transaction documents for each CLO. Due to the revolving nature of a CLO asset pool and the number assets in the typical CLO asset pool, it is not practical, nor commercially desirable by other CLO investors, for a third-party retention holder to approve each asset selected by the CLO manager before it is acquired by a CLO issuer. However, we believe that it is possible for a third-party retention holder to materially influence the selection of the assets in an open market CLO in a manner that will satisfy the agencies' goal of improving the quality of the assets in securitization asset pools without reviewing and approving each asset. As a proxy for reviewing each asset, each third-party retention holder would be required to conduct a review of, and approve certain key terms (the "Transaction Portfolio Terms") governing the quality of the assets the CLO will be permitted to purchase and the composition of the CLO's portfolio. Once the Transaction Portfolio Terms have been approved, the CLO manager will be permitted to trade portfolio assets without additional approvals from the third-party retention providers so long as trades are made in accordance with the Transaction Portfolio Terms. After the third-party retention holders have approved the initial Transaction Portfolio Terms, no material change to any of the Transaction Portfolio Terms may be effected without the prior written consent of each third-party retention provider. Additionally, to satisfy our proposed third-party retention holder option, the CLO issuer will be required to have acquired or entered into binding commitments to acquire by the CLO's closing date at least 50 percent of the initial target par amount CLO portfolio assets. This will help ensure that the third-party retention holders are able to gauge the CLO manager's ability to comply with the Transaction Portfolio Terms prior to the closing of the CLO.
3. CLO Managers.
4. Retention Period.
Expand the Definition for Qualified Commercial Loans
"Qualified CLOs"
As was laid out in our joint letter with the LSTA and SIFMA to the agencies on
1. Asset Quality Protections. In order to ensure the quality of the collateral in a "Qualified CLO", each "Qualified CLO" would be required to, among other things, hold at least 90 percent of its assets in senior secured loans and cash equivalents, not own ABS interests or derivatives (other than for hedging purposes), not purchase defaulted assets, margin stock or equity convertible securities, acquire loans held or acquired by at least three other investors or lenders not affiliated with the CLO manager and own loans whose borrowers are subject to an annual audit from an independent accredited accounting firm. n25.
2. Portfolio Protections. In order to ensure that CLO investors are not unduly exposed to loan pools that are concentrated in riskier areas of the global economy or certain specific borrowers, each "Qualified CLO" would be required to limit its investments such that no more than 3.5 percent of its assets relate to a single borrower, no more than 15 percent of its assets relate to a single industry and no more than 20 percent of its assets may relate to non-U.S. borrowers (and no more than 10% may relate to borrowers outside the U.S. and
3. Structural Features. In order to ensure that the CLO debt securities are adequately protected by means of structural features, a "Qualified CLO" would be required to have an equity tranche equal to at least 8 percent of the CLO's assets, as well as overcollateralization and interest coverage tests that, if failed, will require interest and principal proceeds to be used to repay CLO debt securities. n27
4. Alignment of Interests of CLO managers and Investors. A "Qualified CLO" would be required to be structured to acquire assets in the open market rather than from the balance sheet of the CLO manager or an affiliate, make a majority of the CLO manager's fees be subordinated to payments due on rated CLO debt securities, limit the ability of the CLO manager to sell assets on a discretionary basis, require the CLO manager and/or certain of its affiliates and/or employees to hold a 5% unhedged interest in the CLO's equity tranche and to limit distributions on the retention interest for the first two years of the CLO. n28
5. Regulatory Oversight. A "Qualified CLO" must have a manager that is a registered investment adviser under the Investment Adviser Act of 1940. n29
6. Transparency and Disclosure. Each "Qualified CLO" will be required to provide certain monthly reporting to all CLO security holders. n30
We believe that our proposal for a "Qualified CLO" could be an alternative solution for the problems described earlier. Perhaps most notably, this proposed retention interest would appropriately align the interests of the CLO manager with those of investors and more correctly size the risk retention interest to more closely correspond with 5 percent of the credit risk of the CLO.
We also note that the proposed asset quality protections will help ensure the quality of CLO collateral and the safety of CLO debt securities as an investment for banks and help protect the soundness of our banking system.
Congressional Request
Given the importance of the CLO market in financing U.S. businesses and the need to ensure that CLO issuance does not meaningfully decline as a result of the agencies' rule making under Section 941 of Dodd-Frank, we respectfully request that the Financial Services Committee review our recommended solutions to the problems presented by the currently proposed rules.
Comments on Proposed Legislative Fix
As such,
As such, we have attached in Appendix A a list technical issues that will need to be addressed by the agencies in order for a CLO solution to Volcker to become operational. At the same time, we would not recommend that they become part of any legislative fix, as they are technical in nature.
Conclusion
Securitization continues to be an essential source of funding for the economy, and
The financial crisis taught us that securitization must be carefully structured, and thoughtful regulation through Dodd-Frank Act implementation is an important part of that structuring process.
However, if regulation is taken too far, it will render large portions of the securitization market either operationally or economically unworkable.
Our regulatory concerns focus on the combined effects of current regulatory proposals, which encompass much more than Dodd-Frank, such as shadow banking reform and proposals for implementing Basel III (including liquidity coverage and net stable funding ratios).
At the same time, any single regulatory initiative, while having merits in its own right, can also have a severe and negative impact on the securitization market if not crafted appropriately. The most immediate example of such a negative impact is the effect felt throughout the CLO marketplace by the Volcker Rule and proposed risk retention rules. Without changes to the proposed regulatory framework, companies providing up to 7.5 million jobs could be negatively affected, as CLO issuance is expected to decline by 75 percent or more.
We thank the Chairman, Ranking Member, Congressman Barr and the Members of this Committee for the bi-partisan work with the agencies to resolve the unintended consequences of the Volcker Rule. The CLO market has seen a slight upturn in February. However,
If we do not find solutions that work for both the regulators and the marketplace, then companies who create jobs, make capital investments to grow their businesses and provide goods and services will suffer--businesses such as
As such,
Thank you, and I look forward to your questions.
n1 http://research1.ml.com/C?q=wezDxGw7YSk.
n2 Id.
n3 CLOs usually issue multiple classes of secured debt and a single class of unsecured equity, with the most senior class of secured debt (which bears the least risk of loss) at the top of the CLO capital structure and the most subordinated equity class (which bears the most risk of loss) at the bottom of the CLO capital structure. By issuing their securities in multiple classes or "tranches," CLOs are able to attract investors with varying risk/reward appetites.
n4
n5
n6 Id.
n7 http://research1.ml.com/C?q=BVkyYbIBgLg.
n8 http://research1.ml.com/C?q=wezDxGw7YSk.
n9 Id.
n10 This figure is derived from
n11 See The CLO Salmagundi: Risk Retention Consequences,
n12 Final Rule, Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships with, Hedge Funds and Private Equity Funds (
n13 Section __.10(c)(8)(i) of the Final Rule.
n14 CLOs that have already issued their securities and commenced operations are commonly referred to as "legacy CLOs." Legacy CLOs typically permit a small portion (usually in the 7.5% to 10% range) of their portfolios to consist of bonds, for the purposes of diversity and realizing extra income. Bonds and other securities, however, generally are not permitted under the loan securitization exclusion.
n15 In addition to the
n16 Such notes typically comprise the senior-most (commonly referred to as the "controlling class") or next senior-most classes of CLO debt securities and represent a majority of a CLO's capital structure.
n17
n18 First Federal Savings Bank Letter (
n19
n20 In the event of a CLO manager's removal, the controlling class typically shares with the equity class of securities the right to propose a replacement. If specified percentages of the two classes are unable to agree on a replacement, a court can be petitioned to appoint a successor.
n21 In CLO transaction documents, the equity class of securities issued by a CLO receives no such promise of repayment in respect of amounts invested by its holders. Rather, CLO equity is entitled only to receive excess interest and principal collections that are not needed to pay amounts due to holders of CLO debt securities or certain service providers to the CLO, such as the CLO manager and trustee.
n22 Dealogic (
n23 See LSTA,
n24 Id. at 6.
n25 Id. at 6-7.
n26 Id. at 7.
n27 Id. at 7-8.
n28 Id. at 8.
n29 Id. at 9.
n30 Id. at 9.
Read this original document at: http://financialservices.house.gov/UploadedFiles/HHRG-113-BA16-WState-NWeidner-20140226.pdf
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House Financial Services Subcommittee on Capital Markets and Government Sponsored Enterprises Hearing
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