There's a great deal of skepticism about the Trump administration's ability to affect regulatory relief. Yet some of the players most affected by rules enacted under Dodd-Frank are preparing for its potential repeal.
Since December, sponsors of new-issue securitizations have been required to keep 5% of the economic risk in deals. This has proven to be particularly onerous for sponsors of collateralized loan obligations, most of whom are asset managers will little balance sheet of their own. CLO managers have gone to great lengths to avoid triggering the requirement on deals that predate the rule.
Now they are realizing that a workaround sanctioned by the Securities and Exchange Commission comes with a big drawback: If Dodd-Frank is repealed, they would not be in a position to benefit.
The workaround allows CLOs issued prior to December 2014 to be refinanced without triggering the risk-retention requirement — but only under certain conditions, and only one time. It was spelled out in a no-action letter that Crescent Capital Group obtained from the SEC in 2015.
The problem: many of the $52.97 billion in refinance deals since December that relied on this exemption to lower the interest rate on outstanding notes put language in the deal amendments precluding them from refinancing more than once. So even if the risk-retention requirement goes away, eliminating any penalty for a second refinancing, they would not be in a position to do so.
The contract language is so clear-cut, a second refinancing isn’t possible even if the manager were willing to put the deal in compliance with risk retention.
"There's just one refi permitted under the Crescent letter," said a securities lawyer who works with CLO managers. "And the contracts being signed say 'no more refinancings.' Period. Full stop."
Another securities lawyer, Paul R. St. Lawrence of Cleary Gottlieb, said he started getting inquiries from clients shortly after the presidential election in November about the potential repealing risk retention, and what that meant for deals refinanced using the Crescent exception.
"Some equity investors and some managers were asking whether it might be possible if further refinancings could be done if either they became compliant with risk retention, or if the (Dodd-Frank) law longer applied," said St. Lawrence, a partner at the firm.
As a result, a number of CLO managers, reportedly including CVC Credit Partners and Seix Asset Management, have recently begun to use different language in both new-issue CLOs and refinancing that would allow the deals to be refinanced a second time — if risk retention is repealed.
There does not appear to be any movement to revise contracts in deals that have already taken advantage of the Crescent no action letter to refinance, according to several securities lawyers interviewed for this story.
CVC and Seix officials declined to comment.
Refinancings account for the bulk of activity in the CLO market so far this year. Deals issued in 2013 and 2014 are now exiting their non-callable periods (typically two years), but can still be actively managed. (Reinvestment periods are typically four years long.) Managers are taking advantage of tighter spreads available for replacement securities.
Some $49.5 billion of deals were either refinanced or had their interest rates reset in the first quarter, according to Thomson Reuters. In March, alone, 50 deals totaling $20.4 billion were refinanced, and nearly $10 billion in CLOs have so far been priced this month through April 10. Last year, Wells Fargo identified $152 billion in CLOs that could take advantage of the Crescent exemption to refinance this year without triggering risk retention.
The "no action" SEC letter applies to transactions in which only the interest rate on one or more existing classes of notes is changed within the first four years of a deal's life. No other terms, including capital structure, maturities, voting/consent rights and other conditions may be changed, according to legal analyses of the letter.
The SEC was responding to a legal quandary raised by Crescent's law firm, Cleary Gottlieb, as well as other managers and CLO industry groups like the Loan Syndications & Trading Association: if a CLO issued prior to December 2014 was exempt from the risk-retention rule, would the exemption be maintained if a CLO was refinanced through the issuance of new securities?
The answer appeared to be no, at least not without investor consent. So as part of a contractual "safety valve," the attorney speaking on background says, most new deals are being issued with language that would throw off the yoke of restricted multiple refinancing if the risk-retention rules were tossed aside, or if new interpretation by the SEC relaxed the guidelines for additional changes in refinancings.
Besides Congressional repeal of Dodd-Frank, other potential avenues for removing CLOs (refinanced or new issue) from risk-retention oversight include a dormant bill in the U.S. House of Representatives that could create a wide exemption for "qualified CLOs" that meet certain requirements.
Another path is through the LSTA's ongoing federal lawsuit against the SEC and other regulatory bodies seeking to overturn the application of the rules to CLOs in the first place.
A U.S. district court in Washington, D.C., dismissed the LSTA's lawsuit in December; the LSTA has appealed that ruling to the federal appeals court level.