Regulation and the Loan Market
Two (of Many) Issues
Loan Market Subject to Inadvertent (and Very
“Advertent”) Regulation
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CLOs
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Risk Retention
Volcker
FDIC Assessments
FATCA
BEPs?
Loans
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Participations
FDIC Assessments
FATCA
Leveraged Lending Guidance
And many more…
In Hopes of Being Just Mildly Depressing,
Let’s Limit Ourselves to Two Major Issues
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Two key issues
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Leveraged Lending Guidance
Risk Retention
What the rules say…and what they may mean for the loan
market….
Leveraged Lending Guidance
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Background
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Banks should not originate* loans to companies that cannot show the ability to
repay all their senior secured debt or half their total debt in 5-7 years from base
cash flows
Leverage > 6x raises concerns
Is this a way for regulators to squeeze leverage from the system; reduce
bubbles/perceived systemic risk?
Last year, people said banks weren’t complying
But the market is changing…
*Originate means originate, refinance or modify; it’s not clear the leeway banks
have in refinancing or amending “special mention” loans that are performing well
Loan Issuance, Leverage Levels are Down …
Is This Permanent?
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There are fewer deals with leverage of 6x or more…
There are fewer deals period…
Source: S&P Capital IQ/LCD
Bookrunners Have Been Changing…is This
Permanent?
LBO Bookrunner League Tables
3.5
3.0
1Q14
1Q15
2.5
2.0
1.5
1.0
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Bookrunners have been changing for LBO deals
Non-bank market share is up to 22% for 1Q15
Source: Thomson Reuters LPC
CIT
BMO
BAML
JPM
Goldman
MS
GE Cap
Jefferies
Nomura
DB
Macquarie
CS
RBC
Citi
Barclays
RBS
Mizuho
Fifth Third
BAML
Macquarie
BMO
RBC
DB
Jefferies
Goldman
UBS
MS
Barclays
0.0
JPM
0.5
CS
LBO Loan Bookrunner Vol. ($Bils.)
4.0
Will LLG Make Special Mention Loans Harder to
Refinance?
Maturity Distribution of Special Mention Loans
Likey classified assets ($BIls.)
18
16
CC
14
CCC-
12
CCC+
10
B- (weighted)
8
6
4
2
0
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2015
2016
2017
2018
2019
Year Loan Matures
2020
2021
2022
Refinancings count as originations
What happens to Special Mention loans once it comes time for them to refinance (or amend)?
Will Special Mention loans be less liquid?
Source: LSTA, S&P/LSTA Leveraged Loan Index
7
Leveraged Lending Guidance
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Issues for the Industry to Consider
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Is this temporary or permanent?
If permanent, are we facing a long-term problem or implementation pains?
What happens if new issue shrinks by 50% due to LLG?
If the non-bank originators lead 33% of the new deals, what does this do to
secondary market liquidity?
Will LLG dislocate the market in several years when companies need to refinance?
Risk Retention
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Final risk retention rules require CLO managers (or a majority-owned
affiliate thereof) to retain 5% of the CLO’s notes (vertical, horizontal or
“L” shaped)
For a $500 million CLO, this would be $25 million
Goes “live” on Dec. 24, 2016 (but folks need to figure out their compliance
strategy ASAP)
Market is trying to develop solutions like Capitalized Manager Vehicles or
Majority Owned Affiliates
Many large CLO managers and those affiliated with banks, insurance
companies and PE firms are expected to continue to issue CLOs – albeit
perhaps not as many
However, it could constrain issuance from smaller, independent managers
CLOs Have Been A Success Story
U.S. CLO Issuance Has Been Strong
16
14
10
8
6
4
2
0
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Jan-11
Mar-11
May-11
Jul-11
Sep-11
Nov-11
Jan-12
Mar-12
May-12
Jul-12
Sep-12
Nov-12
Jan-13
Mar-13
May-13
Jul-13
Sep-13
Nov-13
Jan-14
Mar-14
May-14
Jul-14
Sep-14
Nov-14
Jan-15
Mar-15
Iss. ($Bils.)
12
U.S. CLO issuance has rebounded following the financial crisis
CLO outstandings have grown
And this is a good thing! CLOs provide long-term financing to U.S. companies and stabilize the
secondary loan market
Source: Thomson Reuters LPC
Smaller Managers Play a Major Role: At YE2014, Half
of CLO Managers Had Issued 3 or Fewer 2.0 CLOs
30
100%
# of managers
25
Count of Managers
90%
Cumulative Share
80%
70%
20
60%
15
50%
40%
10
30%
20%
5
10%
0
1 Deal
2 Deals
3 Deals
3-5 Deals
6-9 Deals
10-12 Deals
Over 12 Deals
# of post-Crisis CLOs
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Smaller managers comprise half the U.S. CLO market
While many managers with fewer CLOs might have other forms of management, they might be
vulnerable to a decline in their CLO business
What happens to the manager base? What does this do to the loan market?
Source: Wells Fargo
0%
The Perfect Storm: Today’s CLOs are Scheduled to
Exit Reinvestment as Loan Refinancing Needs Peak
CLO Demand May Ebb When Loans Need to be Refinanced
300
Volume ($Bils.)
250
Loan Maturities
Today's CLOs in Reinvest
200
150
100
50
0
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2015
2016
2017
2018
2019
2020
2021
2022
Today’s CLOs will mostly be out of their reinvestment period by 2017/2018
Institutional loan maturities will be ramping up at this point
Where will we be in the credit cycle/interest rate cycle at this point?
*This looks at the contractual maturity of the loan and the contractual end or reinvestment. More realistically, companies will need to
refinance earlier, and CLOs can reinvest a bit longer.
Source: Wells Fargo, S&P/LSTA Leveraged Loan Index
Broader Issue: CLOs, Loan Mutual Funds Provide 6080% of Institutional Loan Demand
100%
90%
CLOs
Loan mutual funds
80%
70%
60%
50%
40%
30%
20%
10%
0%
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2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
To the extent that much of this investor base is squeezed, who replaces it?
What happens to companies that have outstanding (special mention?) loans that have to refinance in several
years when… banks will have a hard time refinancing them and CLOs may be buying materially less?
Source: S&P Capital IQ/LCD
So, What Happens…?
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Market is working on solutions
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Legal Approach
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Capitalizing the manager with new partners…Capitalized Manager Vehicles, Majority
Owned Affiliates
Figuring out financing options
Challenging the Agencies’ Rulemaking in Court
Legislative Approach
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Some lawmakers are seeking commonsense fixes to issues like risk retention on Open
Market CLOs