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Holdings of collateralized loan obligations plateau as Volcker undergoes rewrite

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Holdings of collateralized loan obligations plateau as Volcker undergoes rewrite

Collateralized loan obligation holdings at U.S. banks and thrifts remained flat in 2017 and the beginning of 2018, as market forces continued to apply pressure on a security that also faces regulatory headwinds from the Volcker rule.

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Data from the past nine years show that CLO holdings increased threefold while banking regulators scrambled to interpret and write a Dodd-Frank regulation placing limitations on proprietary trading. Although the rule originally had a compliance date in 2014, regulators gave the industry an extra three years to comply, during which the industry tapered off its CLO holdings.

But industry participants insist that CLO holdings have flattened out because of forces at work in the markets, not in the regulatory space.

Total U.S. issuance for CLOs has increased as of late, alongside tighter spreads, implying that nonbank financial companies have been driving the most interest in the securities.

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Stuart, Fla.-based Seacoast Banking Corp. of Florida is among the few banks that have increased their stakes in CLOs during 2017, from $129.6 million in the first-quarter of 2017 to $292.4 million in the linked quarter of 2018. Just over 21% of the company's total securities are in CLOs. Seacoast CFO Chuck Shaffer said in an interview that the company liked the idea of a floating-rate security in a rising rate environment.

But Shaffer acknowledged that the bank has also paused its CLO purchases. He said the company has not purchased a CLO in 2018 as part of an overall strategy to shrink its securities portfolio and focus on organic lending.

"In the last six to maybe nine months we've seen spreads tighten to a point where it's not attractive to us currently," Shaffer said.

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The flattening interest in CLOs comes as the main banking regulators rethink the Volcker rule, which affected the CLO market by restricting banks from having ownership stakes in any covered funds. This meant that any CLOs with a debt component in the underlying asset mix would be prohibited.

To circumvent the new requirements, the banking industry turned to Volcker-compliant CLOs that did not include bonds.

Regulators are now asking the industry for suggestions on how they can refine its definition of a "covered fund," which some believe should be narrowed to private equity funds and hedge funds, not securitizations.

Chip MacDonald, a partner at Jones Day, said in an interview that he expects the Fed to reconsider the treatment of CLOs as part of this review. MacDonald said CLOs and other securitizations should be exempt from Volcker, criticizing the Fed for forcing the industry into "spending a lot of money trying to restructure around [the rule]."

Elliot Ganz, executive vice president and general counsel for the Loan Syndications and Trading Association, said CLOs were clipped by the Volcker rule for including "immaterial" levels of debt. Ganz said that prior to Dodd-Frank, CLOs had up to 5% to 10% of their underlying assets in bonds, disputing the idea that CLOs functioned as speculative instruments instead of market-making suppliers of liquidity.

The Federal Reserve Board's request for public comment specifically asks for feedback on whether the agencies should permit a loan securitization vehicle to hold 5% or 10% of assets that are considered debt securities.

Ganz said the 5% to 10% range is perfect. He said the market has little appetite to stuff more debt into CLOs.

"You can have a law that says you can have as many bonds as you want; you won't see a CLO market, in my view, with [bond] bucket[s] more than 5%," Ganz said.

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SNL compiled the CLO data using what banks report under "Structured financial products supported predominantly by corporate and similar loans" in the Form Y-9C, which is a quarterly regulatory report generally filed by bank and savings and loan holding companies with more than $1 billion in assets. This data can be downloaded using SNL Office.

Data can also be accessed on the SNL website for a single company. For example, click here for Wells Fargo's held-to-maturity securities and here for Wells Fargo's available-for-sale securities.