|Total Bank CLO holdings:||$70bn[i]|
|JPM CLO Holdings:||$29bn (41% of total bank CLO holdings)[ii]|
|Citigroup CLO Holdings:||$16bn (23%)[iii]|
|Wells Fargo CLO Holdings:||$5bn (7%)[iv]|
- CLOs are investment funds that consist of “leveraged loans”, (huge, low-rated, corporate loans) which can be swapped in and out by the manager throughout the life of the fund. Investing in a CLO is functionally identical to investing in a hedge fund that invests in this kind of loan.
- CLOs held by banks were – and continue to be – proprietary positions. Beneficial capital treatment of CLOs meant that banks could borrow cheaply and hold high-yielding CLOs on their books, capturing the difference as profit.
- The specific features of CLOs (when it will mature, the kinds of investments it can make, the rights and protections for each class of investor, etc.) are not publicly disclosed and are non-standardized, so it is impossible to know how many CLOs exist with any given feature.
- Importantly, it isn’t clear which CLOs, or how many, would be affected by any change in the rule.
- CLOs are NOT backed by loans to small business or individuals. CLOs are backed by “leveraged loans”, or large junk-rated corporate loans typically used to fund corporate buyouts.
- CLOs are NOT owned broadly by community banks.
- CLOs have performed exceptionally well throughout the crisis and continue to be highly liquid and attractive securities.[v]
- CLOs backed entirely by loans are excluded from the rule. Some CLOs are backed entirely by loans, others are backed by some mix of loans and other assets (bonds, derivatives, other securitizations). CLOs backed only by loans are explicitly excluded from the Volcker Rule and it does not prohibit banks from owning them in any way.
CLOs that are backed by a mix of loans and non-loans are generally covered by the Volcker Rule because they are identical to hedge funds – therefore banks have strict limits on how many they can own.
- Many CLO holdings are not considered “ownership interest” under the Volcker Rule. Even those CLOs that do not qualify for the loans exclusion may not be subject to the Volcker Rule if they don’t represent ‘ownership’ in the fund. The Volcker Rule considers “ownership” any position that has any feature of traditional securities ownership such as: the right to vote on the removal of the manager, or the participation in upside gains and downside risks of the investments. Traditional “debt” investments, like corporate bonds, do not contain any of these features and debt holdings are not considered “ownership” under the rule.
Certain CLOs may contractually provide investors with rights or protections that cause their investments to be considered “ownership interest” under the Volcker Rule. It is impossible to know how many CLOs have such features, since the documents are non-standard and not publicly available. CLOs without such features are not subject to the Volcker Rule.
- Many CLOs will mature before the Volcker Rule Divestment period is over, so banks will not have to sell them to comply with the rule. CLOs are generally structured as 10-year investments, and many existing CLOs will mature before July 21, 2019 (the maximum possible divestment date, including available extensions).
- Existing CLOs can potentially be restructured in order to be Volcker Rule compliant. Those CLOs that do not qualify for the exclusion, and are considered ‘ownership interest’ can still be brought into compliance with the rule if the stakeholders agree to amend the contract.
- New CLOs can be easily structured such that they do not fall under the Volcker Rule – and they are already being structured this way[vi]. Therefore, CLO issuance will not be affected in any way by the rule.
- Ultimately, very few CLOs may fall under the Volcker Rule’s ban on proprietary trading. Those CLOs that: are not already excluded from the rule, are considered ownership interests under the rule, will not expire before the divestment deadline, and cannot be restructured into compliance, must be sold. These are the only CLOs that banks will have to sell because of the Volcker Rule.
- The market for CLOs is very strong. The CLO market has been consistently liquid and outperformed most other securitizations throughout the crisis. Issuance rose 49% last year and demand remains strong.[vii]
- Banks would likely post profits on CLOs they need to sell in order to be compliant with the Volcker Rule. Because these securities are held on banks’ books at par value, due to accounting rules, they would likely realize significant gains if they were forced to sell these securities at current market prices.