Bloomberg News

CLO Selloff Unlikely Due to Volcker Rule, Morgan Stanley Says

January 06, 2014

The implementation of the Volcker rule means banks may keep their collateralized loan obligations holdings, according to Morgan Stanley.

Banks, with have more than $60 billion invested in the least risky, or AAA rated portions, of CLOs, are unlikely to sell because of the range of options available to avoid violating the Volcker rule, Morgan Stanley analysts led by Vishwanath Tirupattur, wrote in a report today. The implementation of the rule will also lead to new CLOs limiting their portfolios to invest in loans to remain compliant with the rule, the report said.

The market for CLOs, whose sales climbed 49 percent last year, is under scrutiny as regulators plan new controls to curb risk taking. The Volcker rule, which was finalized last month, prohibits banks from having ownership interest in CLOs that invest in bonds and requires them to sell their stakes before the rule takes effect in 2015.

“Considering the range of options available, we think that it is unlikely that current large U.S. bank holders of CLO AAAs will be forced sellers,” Tirupattur wrote in the report.

Mitigating factors include making amendments to the CLO documentation to remove securities from the CLO’s holdings, voluntarily give up the right to participate in the selection or removal of CLO managers, and a “glimmer of hope that the regulatory review will result in a favorable outcome for current bank holders of CLO AAAs,” according to the report.

Full conformance with the rule is only required by July 21, 2015, with a potential for the deadline to be extended to July 21, 2017, a period during which the bank holdings would amortize at the rate of 25 percent to 30 percent per year, the report said.

CLOs are a type of collateralized debt obligation that pool high-yield, high-risk loans and slice them into securities of varying risk and return. These leveraged loans are rated below BBB- by Standard & Poor’s and less than Baa3 at Moody’s Investors Service.

Sales of the structured credit climbed to $82 billion last year, compared with $55.2 billion in 2012, according to data from Royal Bank of Scotland Group Plc.

To contact the reporter on this story: Sridhar Natarajan in New York at snatarajan15@bloomberg.net

To contact the editor responsible for this story: Faris Khan at fkhan33@bloomberg.net


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