IFR Magazine – June 08, 2019

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during the credit crisis and the small size of the
asset class compared with the broader economy.
The US$1.2trn leveraged loan market has
more than doubled in size since the credit crisis,
buttressed by years of low interest rates and
increasing demand for floating-rate loans.
Companies have been able to take advantage
by borrowing higher levels of debt compared
with their earnings than in the past while offering
fewer lender protections in return, drawing the ire
of legislators and some regulators.
“We must consider the possibility that [loans]
may prove systemic,” Meeks said in his opening
remarks.
Concerns about loose loan underwriting
standards was a common refrain throughout the
hearing, with a focus on covenant-lite financings,
a feature regulators previously described as
aggressive.
Almost 75% of broadly syndicated loans
arranged in the first quarter was covenant-lite
compared with 58.9% of loans issued in the same
period in 2013, according to data compiled by LPC.
The witnesses were asked about the Office of
Financial Research (OFR), which was established
as part of Dodd-Frank in 2010, to coordinate
and sponsor research to support regulation
of financial markets. The OFR said in its
appropriations and annual performance report
that its estimated fiscal year 2018 funding was to
be 25% below its 2017 fiscal year operating level.

“Central to managing risk was the

establishment of the OFR, which is tasked with

monitoring risk in the system, wherever the risk

might originate or lie, quantify the risk, map

the interconnectedness of the risk and inform

[Financial Stability Oversight Council] FSOC in its

monitoring of systemic risk,” Meeks said.

A discussion draft sponsored by

Representative Bill Foster, a Democrat from

Illinois, would protect the independent funding of

the OFR, giving the director sole discretion for its

annual budget.

Erik Gerding, a professor at the University of

Colorado Law School, said during the hearing that

the OFR was in “danger of being hollowed out

either by decisions by the Secretary of Treasury to

reduce its funding or staffing losses”. He called

the OFR the “under appreciated” accomplishment

of Dodd-Frank, the massive regulatory reform

package that sprang from the credit crisis.

“The OFR needs an independent source

of funding,” he said in written testimony. “We

cannot wait until it is time to man the lifeboats to

fully fund the iceberg patrol.”

STRONG DEFENCE

US Representative Andy Barr, a Republican

from Kentucky who previously introduced a

bill that proposed a qualified CLO to deal with

Dodd-Frank risk-retention rules, put up a strong

defence of the funds.

He asked panelists about performance of CLOs

during the credit crisis and stressed that the two

most senior slices of the funds did not suffer any

losses and just 53 of more than 9,000 tranches

suffered any impairments.

Barr’s 2015 qualified CLO proposal advocated

that if a fund met a set of tests including asset

quality and portfolio diversification standards,

managers could purchase and retain 5% of the

equity slice of a CLO as opposed to the 5% of the

fund required under Dodd-Frank risk-retention

rules.

Last year, a US Appeals Court ruled in favour

of the US loan trade group, the LSTA, which sued

the Federal Reserve and Securities and Exchange

Commission to exempt CLOs from risk retention.

Ahead of Tuesday’s hearing the LSTA stressed

that while an appetite for more credit risk in

the loan market has increased, it is too soon to

determine if investment losses will be similar to

the credit crisis.

“We encourage lawmakers and regulators to

do their due diligence; any comprehensive inquiry

into the leveraged loan market will demonstrate

[it] has provided opportunity for stable growth of

companies and expansion of the economy,” Elliot

Ganz, general counsel at the LSTA, said. “We

have done extensive research into systemic risk of

leveraged lending and have concluded that [it] is

not a threat to US or global financial stability.”

Kristen Haunss