Fitch: Volcker Amendments Good for Some CLOs, Hard on Others
Collateralized loan obligations (CLOs) that amend sooner than others may improve managers’ relationships with their key investors, make their debt and equity more attractive sooner and, as the deadline for compliance approaches, more liquid in the broader market. However, amendments will be difficult for some CLOs that have been heavily sold into the secondary market or where bond investments are important to the CLO manager’s investment thesis, Fitch Ratings says.
There are various ways to Volckerize a CLO transaction, but by far the most common is to remove a CLO’s ability to invest in bonds. We do not consider this to impact the creditworthiness of the transaction as the indentures continue to allow for some exposure to unsecured collateral in the form of second-lien loans. And we believe it could benefit investors by increasing the liquidity of their holdings.
The Volcker Rule will prohibit banks from having an ownership interest in CLOs that invest in bonds. The definition of an ownership interest covers not only CLOs’ equity, but also their senior securities due to the ability of banks to remove managers for cause. In addition to investment holdings, banks’ inventory for the purposes of market making may also be restricted by the Volcker Rule, which would hamper liquidity on noncompliant CLOs. In total, U.S. banks currently hold approximately $70 billion of CLO debt that may eventually fall foul of the Volcker Rule.
Last week the Office of the Comptroller of the Currency published procedures for examiners to determine whether or not banks have business activities or investments that are subject to the Volcker Rule. The OCC promised that more detailed procedures are forthcoming. In our view, this could help speed amendment activity as it could spawn and agreed-upon set of changes the market will identify and rely on.
Amending a CLO to make it Volcker-compliant will typically require the approval of the majority of both the equity and senior debt holders. The most onerous structures require positive consent (active approval), as opposed to lack of dissention. Where debt and/or equity tranches are widely held across the investor community, the logistics of obtaining positive consent from a majority may become more of a challenge.
Transactions issued since the Volcker Rule was passed in December 2013 have been structured to be compliant at closing. The transactions most at risk are the post-crisis CLOs issued before the Volcker Rule was passed. We expect the majority of pre-crisis CLOs will have matured or been called before the July 2017 implementation date.