NEW YORK--(BUSINESS WIRE)--The provision of extra time to comply with the Volcker Rule's ban on holding some investments provides few opportunities to banks and collateralized loan obligations (CLOs), Fitch Ratings says. The U.S. Federal Reserve extended the deadline for banks to divest their CLO holdings to July 21, 2017.
In our view, the deadline extension could provide banks with more time to shop their investment portfolios and potentially diminish the losses that could result from the forced sale of their CLO holdings. It also provides more opportunities for the banks to restructure some of their holdings to be in compliance with Volcker. Small banks could benefit from the extension more as they have higher portions of their securities allocated than larger banks. While the largest banks, JP Morgan and Wells Fargo, have smaller percentages, they could incur large losses.
The extension lowers the potential of a downdraft in the CLO and leveraged loan markets like the one that forced the sales of the first generation of CLO senior tranches during the recession. In our view, CLOs created before the financial crisis are likely to be called or otherwise paid out before the forced sale. Those created during 2014 are Volcker compliant. However, the majority of CLOs structured between the beginning of 2010 and the end of 2013 will not be converted into Volcker compliant structures, as it is neither practical nor feasible to gain approval from all the parties.
Last month, the Office of the Comptroller of the Currency (OCC) published a study on the potential impact of this legislation, estimating a cost of $3.6 billion across all U.S. banks if their sales closed quickly. The Loan Syndications and Trading Association estimated the range between $1 billion (if investors demanded 2% all-in yield) to $16 billion (if investors demanded a 14% yield).
Fitch expects opportunistic investors to take up most of the CLO senior notes at prices much lower than par with expected losses for the tranche if forced sales occur. We expect this to have a negative impact on banks that made the initial investment in these CLOs as forced sales prices will likely be significantly lower than the expected credit losses on the notes. We also expect a potential disruption in the CLO secondary market to affect the CLO primary market as evidenced by the current spread widening amid a benign credit environment.
One alternative to the forced sale scenarios is the exemption granted to banks in January allowing them to continue to own collateralized debt obligations backed by trust-preferred securities. Estimates indicated that small banks could lose just $600 million on the forced sale of those securities.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.