April 10, 2019 - Like many others, we watched Treasury Secretary Mnuchin’s testimony before the House Financial Services Committee with great interest. Unlike most, we were less fascinated with “Gavelgate”, than we were with a discussion on leveraged lending and CLOs.

At 3:03:45 of the hearing – shortly before Gavelgate – Congressman Andy Barr asked Secretary Mnuchin several questions on leveraged lending and CLOs. Despite our limited transcription skills, we watched the debate and have reproduced it as faithfully as possible below. (But we encourage members to see for themselves.)

Congressman Barr: Leveraged lending is increasing; 75% is estimated through non-banks.  As I understand it, nearly 70% of US companies are non-investment grade. But aren’t leveraged loans simply loans to well-known non-investment grade companies like Dell, American Airlines, Burger King, Cablevision, Sprint and Hilton Hotels that permit these companies to grow thrive and hire American workers? And if these loans were shut off, wouldn’t it be very bad for the companies, and their employees along with broader US economy?

Secretary Mnuchin: That’s true. Leveraged lending is a very important part of the economy. We are working at FSOC and studying the leveraged lending issue – just because people have raised this – to make sure there are no problems.  But it is something we are on top of.

Congressman Barr: If the economy does have a downturn, prices will drop, certain types of high yield debt will be difficult to refinance. But in a Nov 2018 speech, referring to elevated business bankruptcies and outsized losses, Fed Chairman Powell said ‘such losses are unlikely to pose a threat to the safety and soundness of institutions at the core of the system and are likely to fall on investment vehicles like CLOs with stable funding that present little threat of damaging fire sales’. Given that CLOs provide long –term capital not subject to the short-term redemptions or outflows that we’ve seen in retail and institutional credit products, do you believe, unlike some of the current rhetoric in Washington today,  that CLOs can represent a vital source of liquidity to below investment grade companies?

Secretary Mnuchin: I do indeed, and that is one of the reasons that we are comfortable. A lot of the capital has moved out of regulated banking sector into CLOs, which are permanent capital vehicles.

Congressman Barr: And they’ve performed very well over their 30-year history, including during the financial crisis.

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