February 2, 2017 - The election of Donald Trump has many members asking whether there will be legislative fixes to ease the regulatory burden on the loan market, with a particular focus on risk retention and leveraged lending guidance. In fact, it may take a while for either of those issues to change materially for the loan market. But we also would note that there’s another issue that bears watching: Tax Reform. We discuss each below.
- Risk Retention: Many members have called, asking whether risk retention will be rolled back soon in the new Administration. The short answer is “probably not”. Our Washington contacts observe that, recent missives notwithstanding, FinReg rollbacks are not in the first wave of Republican priorities. The current priorities are repeal and replacement of the Affordable Care Act, tax reform, immigration reform and the wall. The next wave likely includes FinReg fixes. The main vehicle for FinReg reform is the CHOICE Act, which, among many other things, removes risk retention for all asset classes except mortgages. When it ultimately makes it onto the floor of the House, the CHOICE Act is likely to pass; however, it may see a tougher ride in the Senate, according to a number of our Washington watchers. Meanwhile, the QCLO legislation is waiting in the wings, but the industry will defer to the CHOICE Act before doing anything. For these reasons, there may not be a near-term legislative fix for risk retention.
- Leveraged Lending Guidance: Based on our conversations, there is little expectation that the Guidance will be softened in the near term. The reality is that the professional staff at the banking agencies is not changing, and they seem happy with the impact the Leveraged Lending Guidance is having. As for future changes, President Trump will eventually appoint new heads to the OCC, Fed and FDIC, as well as a Vice-Chair for Supervision at the Fed. Once these appointments are confirmed, the tone at the top may begin to change, but there is little expectation there will be a rapid change beforehand. (LLG Postscript: TR-LPC reported that KKR, as sole lead, this week closed a $1.37 billion repricing for UFC. Readers may recall last year’s news that banks were chastised for underwriting the UFC loan, which was tagged as a “non-pass” credit by the banking regulators. Several months later – and regulatory opprobrium notwithstanding – the market decided the UFC loan was good enough to reprice. However, it was a non-pass credit and the banks presumably could not lead a repricing. In turn, KKR, which is not regulated by the banking agencies, did the repricing on its own.)
- Business Tax Reform: Last year, House Republicans published a “blueprint” for tax reform. Importantly, the proposal significantly reduces interest expense deductibility in favor of immediate expensing of business investments. In the blueprint, interest expense can be deducted from interest income, but there will be no tax deduction for interest expense greater than interest income. The Republican blueprint explains that this model “eliminates a tax-based incentive for businesses to increase their debt load beyond the amount dictated by normal business conditions. A business sector that is leveraged beyond what is economically rational is more risky than a business sector with a more efficient debt to-equity composition.” A KPMG report notes that this would reduce the advantage of leverage in the structuring of M&A transactions. This proposal – which will be subject to considerable wrangling in Washington – bears watching by the leveraged loan market.