Treasury & Other CLO Issues

October 12, 2017 - In addition to risk retention (discussed in detail here), last Friday’s Treasury Report on Capital Markets also identified several other regulatory issues for securitizations and offered recommendations. Wells Fargo’s Lagniappe discussed the Treasury’s proposals for capital charges and High Quality Liquid Assets (“HQLA”), and what their (possibly modest) effects on CLOs might be.

First, on capital requirements, the minimum risk weighting for securitizations for U.S. banks is 20%. However, the Basel Committee has reduced the minimum risk weight to 15% and the European Banking Authority also has recommended a reduced minimum capital charge for some qualified senior tranches, Lagniappe notes. Treasury recommended that the U.S. banking regulators align with the Basel recommendations, that securitization capital charges be aligned with the capital for the underlying assets, that the Simplified Supervisory Formula Approach’s (SSFA) “p-factor” not be raised (which would penalize securitizations), that the FRTB’s impact on secondary market activity be reviewed, and that the SSFA recognize that credit enhancement exists when a bank holds a securitization at a discount to par. What is the impact on CLOs? Wells suggests that lower capital charges theoretically could lead to marginally lower AAA spreads, but other bank challenges – like FDIC Assessments – could mute any tightening.

Second, on HQLA, Lagniappe notes that U.S. banks are required to hold a sufficient amount of high quality liquid assets to withstand outflows during a 30-day stress period.  HQLA is divided into two major categories (Level 1 (most liquid) and Level 2) and two subcategories (Levels 2a and 2b). Level 2 assets and Level 2b assets can only be 40% and 15% of HQLA, respectively. In addition Level 2a and Level 2b assets have haircuts of 15% and 50%, respectively. So, on to CLOs. Banks currently get no credit for CMBS, ABS and CLOs as HQLAs. While the report recommends that high quality securitizations with a strong track record could receive consideration as Level 2B assets, Wells Fargo thinks it is unlikely that CLOs will be included in any definition of HQLA.

So, the big takeaway from Wells Fargo is that, for CLOs at least, the most significant potential changes from the second Treasury Report would be in the risk retention category.

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