new rules (promulgated per the requirements of the Dodd-Frank Act) for calculating deposit insurance assessments for insured depository institutions, including "large institutions
" and "highly complex institutions
," are set to become effective on April Fool's Day, 2013. No kidding. As institutions of this type are active investors in CLOs, particularly the “AAA”-rated tranche of CLOs, there has been significant consternation among market participants on the immediate and long-term effect of such new rules.
Dechert partners John Timperio and Gordon Miller have done an in-depth analysis on the new rules and their potential impact on the CLO market and, as outlined in a recent legal update, see the likely impact of such rules to be less adverse than some of the predictions of other commentators in the market.
Initially published on February 25, 2011, the new FDIC rules replace the existing supervisory ratings-based and capital-based methodology with an asset-based methodology, which assesses large institutions and highly complex institutions for the risk each applicable asset poses to the Deposit Insurance Fund using a “scorecard” that combines any such institution’s CAMELS ratings and certain forward-looking financial ratios, including the ratio of “higher risk assets” (including leveraged loans, nontraditional mortgage loans and subprime consumer loans), and “higher risk securitizations” of such higher risk assets (encompassing securitizations of such “higher risk assets”) to Tier 1 capital and certain reserves.
Such institutions have been required to include such “higher risk assets” in their calculation of their deposit insurance assessment rate during the transitional period that began when the FDIC published the final rule in 2011. However, in making such calculations these institutions have been permitted to identify leveraged loans and CLOs using each such institution’s existing internal methodologies or the criteria in existing supervisory guidance. As of April 1, such institutions will be required to use a new single standard, set forth in revisions to the final FDIC rules issued in anticipation of final implementation, to identify leveraged loans and CLOs. While such single standard may be more or less inclusive than the standards employed using their applicable transitional methodologies, it is likely that for many institutions the new single standard will result in an increase in the identification of leveraged loans and CLOs.
The impact of this new single standard for each applicable institution will be fact specific and particular to such institution’s asset mix. It will also be materially impacted by any material differences between the applicable methodologies employed by an institution during the transitional period and those methodologies required to be used under the terms of the final rule set to take effect on April 1. As each applicable institution assesses the new requirements in identifying “higher risk assets” and “higher risk securitizations”, some institutions that purchase CLO securities may temporarily withhold buying such securities while their internal regulatory experts evaluate the new rules of the road. However, it is possible that other institutions may be incentivized to buy CLO securities if such institution was maxed out under the concentration criteria for “higher risk assets” such that purchasing additional CLO securities would not negatively impact their deposit insurance assessment rate.
For the broader CLO market, the new required FDIC standards may result in an uptick in the pricing of leveraged loans and CLO securities for transactions effectuated after April 1. However, as the market digests the new rules and market participants more clearly understand the rules of the road going forward, it is likely that the impact of these FDIC rules will not result in a significant slowdown in CLO issuance, a material increase in the pricing of CLO securities or any material attrition in the CLO investor base.