September 26, 2016 - September 26, 2016 – A new issue was buzzing around the market last week: Whether the OCC would change rules that currently permit banks to invest in CLOs. Here’s the issue. On September 8th, the Fed, OCC and FDIC released a mandated report (“Section 620 Report”) to Congress and FSOC on investments that banks may engage in under current law. The OCC section – starting on p. 75 – is creating some agita for the CLO market. In particular, the OCC said that it plans to “issue a proposed rule that restricts national banks from holding as Type III securities asset-backed securities, which may be backed by bank-impermissible assets”. So, a key question is whether leveraged institutional loans – the collateral of CLOs – fall into the “impermissible” category. One might not naturally expect institutional loans to be in the impermissible category. After all, most of the institutional loans in CLOs also have revolvers that are held by banks. In addition, on page 100-101, the OCC notes that for federal savings associations, “[e]xamples of permissible investments include trust-preferred securities, collateralized bond obligations, and collateralized loan obligations”.
However, nothing is simple. Market participants have raised the question of whether CLOs that have bonds in them would be problematic. (Citi touched on this in a report last Thursday.) In addition, folks have wondered whether non-pass credits – which the Leveraged Lending Guidance discourages (but does not prohibit) banks from underwriting – would make a CLO investment impermissible.
It will take some more time to determine exactly where the OCC is going with this – and the LSTA plans to engage in the issue. The good news is there should be time either way. The OCC says it plans to “issue a proposed rule to prohibit federal banking entities from holding asset-backed securities that hold bank-impermissible assets”. To do this, the OCC must begin with a notice of proposed rulemaking, have an open comment period, review all the comments, publish a final rule – and hopefully provide a transition period in a worst case scenario. We will continue to review the Report. If you have questions, please contact email@example.com or firstname.lastname@example.org.