It transpired at IMN's well-attended CLO conference last week that the Federal Reserve’s two year extension for banks to make their CLO holdings comply with the Volcker rule only applies to CLOs held by banks now. If the paper trades, it will no longer benefit from the extension, and banks may not be able to keep hold of their CLOs.
Market participants are now rightly worried that this willimpair secondary market liquidity, a further worry for bank investors that were already concerned about having to sell their bonds into a declining market.
At the panel he chaired on Volcker at the conference, Elliot Ganz, executive vice president and general counsel at the Loan Standards and Trading Association, pointed out that the Fed’s extension does not officially take place until August, meaning there is potentially time to get a deal on grandfathering of legacy CLOs by then.
But Sairah Burki, director of Policy at the Structured Finance Industry Group, said she felt there was not much momentum for further changes either from regulators or on Capitol Hill. Despite Congressman Andy Barr’s Volcker relief bill heading to the full house, few expect it to make it into legislation.
The CLO market must surely now wake up to two uncomfortable truths: that relief on this issue is not forthcoming, and that this affects banks now.
Accounting woes
The only way to avoid this is for banks to be refinanced out of existing CLOs, or for CLO managers to amend documentation to make their deals Volcker-compliant. Some managers, like ING, have done this; others, like Octagon Credit Investors, have not.
At the conference, plenty of industry participants pointed out that Volcker compliance was a bank problem, not a manager problem, that it is up to banks to find a solution. But it affects all CLO buyers, and therefore all managers too.
It is not safe to assume that banks will use their allowance for investing in covered funds — set at 3% of tier one capital — to hold CLOs. And while the triple-A buyer base is deeper than it has been for some time, banks, with their low cost of funding, are the natural holders of AAA CLO paper. If they are forced to sell, yields will rise, and equity will suffer.
Compromise
This lack of clarity makes deal amendments even more pressing, because it progresses the search a form of standard language to give investors confidence that when CLOs are "Volckerised", they actually do become Volcker-compliant.
One bank investor who spoke to GlobalCapital recently received a legal opinion on a Volckerised deal which cast doubt upon whether it was indeed Volcker-compliant. While legal opinions on this issue should be taken with a spoonful of salt — as one lawyer said, they are “not deliverable” — the fact that this uncertainty exists is another sign that Volckerisation is not going to be an easy process.
The process needs to gain momentum, and quickly, otherwise the new issue market will suffer, and all the new investors that left last week’s conference with optimistic forecasts ringing in their ears will have nothing to buy.