[House Hearing, 113 Congress] [From the U.S. Government Publishing Office] THE DODD-FRANK ACT'S IMPACT ON ASSET-BACKED SECURITIES ======================================================================= HEARING BEFORE THE SUBCOMMITTEE ON CAPITAL MARKETS AND GOVERNMENT SPONSORED ENTERPRISES OF THE COMMITTEE ON FINANCIAL SERVICES U.S. HOUSE OF REPRESENTATIVES ONE HUNDRED THIRTEENTH CONGRESS SECOND SESSION __________ FEBRUARY 26, 2014 __________ Printed for the use of the Committee on Financial Services Serial No. 113-66 U.S. GOVERNMENT PRINTING OFFICE 88-528 WASHINGTON : 2014 ----------------------------------------------------------------------- For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; DC area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC, Washington, DC 20402-0001 HOUSE COMMITTEE ON FINANCIAL SERVICES JEB HENSARLING, Texas, Chairman GARY G. MILLER, California, Vice MAXINE WATERS, California, Ranking Chairman Member SPENCER BACHUS, Alabama, Chairman CAROLYN B. MALONEY, New York Emeritus NYDIA M. VELAZQUEZ, New York PETER T. KING, New York MELVIN L. WATT, North Carolina EDWARD R. ROYCE, California BRAD SHERMAN, California FRANK D. LUCAS, Oklahoma GREGORY W. MEEKS, New York SHELLEY MOORE CAPITO, West Virginia MICHAEL E. CAPUANO, Massachusetts SCOTT GARRETT, New Jersey RUBEN HINOJOSA, Texas RANDY NEUGEBAUER, Texas WM. LACY CLAY, Missouri PATRICK T. McHENRY, North Carolina CAROLYN McCARTHY, New York JOHN CAMPBELL, California STEPHEN F. LYNCH, Massachusetts MICHELE BACHMANN, Minnesota DAVID SCOTT, Georgia KEVIN McCARTHY, California AL GREEN, Texas STEVAN PEARCE, New Mexico EMANUEL CLEAVER, Missouri BILL POSEY, Florida GWEN MOORE, Wisconsin MICHAEL G. FITZPATRICK, KEITH ELLISON, Minnesota Pennsylvania ED PERLMUTTER, Colorado LYNN A. WESTMORELAND, Georgia JAMES A. HIMES, Connecticut BLAINE LUETKEMEYER, Missouri GARY C. PETERS, Michigan BILL HUIZENGA, Michigan JOHN C. CARNEY, Jr., Delaware SEAN P. DUFFY, Wisconsin TERRI A. SEWELL, Alabama ROBERT HURT, Virginia BILL FOSTER, Illinois MICHAEL G. GRIMM, New York DANIEL T. KILDEE, Michigan STEVE STIVERS, Ohio PATRICK MURPHY, Florida STEPHEN LEE FINCHER, Tennessee JOHN K. DELANEY, Maryland MARLIN A. STUTZMAN, Indiana KYRSTEN SINEMA, Arizona MICK MULVANEY, South Carolina JOYCE BEATTY, Ohio RANDY HULTGREN, Illinois DENNY HECK, Washington DENNIS A. ROSS, Florida ROBERT PITTENGER, North Carolina ANN WAGNER, Missouri ANDY BARR, Kentucky TOM COTTON, Arkansas KEITH J. ROTHFUS, Pennsylvania Shannon McGahn, Staff Director James H. Clinger, Chief Counsel Subcommittee on Capital Markets and Government Sponsored Enterprises SCOTT GARRETT, New Jersey, Chairman ROBERT HURT, Virginia, Vice CAROLYN B. MALONEY, New York, Chairman Ranking Member SPENCER BACHUS, Alabama BRAD SHERMAN, California PETER T. KING, New York RUBEN HINOJOSA, Texas EDWARD R. ROYCE, California STEPHEN F. LYNCH, Massachusetts FRANK D. LUCAS, Oklahoma GWEN MOORE, Wisconsin RANDY NEUGEBAUER, Texas ED PERLMUTTER, Colorado MICHELE BACHMANN, Minnesota DAVID SCOTT, Georgia KEVIN McCARTHY, California JAMES A. HIMES, Connecticut LYNN A. WESTMORELAND, Georgia GARY C. PETERS, Michigan BILL HUIZENGA, Michigan KEITH ELLISON, Minnesota MICHAEL G. GRIMM, New York MELVIN L. WATT, North Carolina STEVE STIVERS, Ohio BILL FOSTER, Illinois STEPHEN LEE FINCHER, Tennessee JOHN C. CARNEY, Jr., Delaware MICK MULVANEY, South Carolina TERRI A. SEWELL, Alabama RANDY HULTGREN, Illinois DANIEL T. KILDEE, Michigan DENNIS A. ROSS, Florida ANN WAGNER, Missouri C O N T E N T S ---------- Page Hearing held on: February 26, 2014............................................ 1 Appendix: February 26, 2014............................................ 29 WITNESSES Wednesday, February 26, 2014 Coffey, Meredith, Executive Vice President, Loan Syndications and Trading Association............................................ 8 Levitin, Adam J., Professor of Law, Georgetown University Law Center......................................................... 9 Quaadman, Tom, Vice President, Center for Capital Markets Competitiveness, U.S. Chamber of Commerce...................... 11 Vanderslice, Paul, Managing Director, Citigroup, on behalf of the CRE Finance Council............................................ 13 Weidner, Neil J., Partner, Cadwalader, Wickersham & Taft, on behalf of the Structured Finance Industry Group (SFIG)......... 15 APPENDIX Prepared statements: Coffey, Meredith............................................. 30 Levitin, Adam J.............................................. 46 Quaadman, Tom................................................ 65 Vanderslice, Paul............................................ 73 Weidner, Neil J.............................................. 168 Additional Material Submitted for the Record Garrett, Hon. Scott: Written statement of the National Association of REALTORS... 196 Barr, Hon. Andy: Written statement of First Federal Savings Bank.............. 197 Quaadman, Tom: Written responses to questions submitted by Representative Ross....................................................... 199 Vanderslice, Paul: Written responses to questions submitted by Representative Ross....................................................... 212 Written responses to questions submitted by Representative Mulvaney................................................... 213 Written responses to questions submitted by Representative Garrett.................................................... 216 THE DODD-FRANK ACT'S IMPACT ON ASSET-BACKED SECURITIES ---------- Wednesday, February 26, 2014 U.S. House of Representatives, Subcommittee on Capital Markets and Government Sponsored Enterprises, Committee on Financial Services, Washington, D.C. The subcommittee met, pursuant to notice, at 2:37 p.m., in room 2128, Rayburn House Office Building, Hon. Scott Garrett [chairman of the subcommittee] presiding. Members present: Representatives Garrett, Hurt, Huizenga, Stivers, Mulvaney; Maloney, Sherman, Lynch, Himes, Peters, Foster, and Kildee. Ex officio present: Representative Hensarling. Also present: Representative Barr. Chairman Garrett. Good afternoon, everyone. Today's hearing of the Subcommittee on Capital Markets and Government Sponsored Enterprises is hereby called to order. Today's hearing is entitled, ``The Dodd-Frank Act's Impact on Asset-Backed Securities.'' And we welcome the members of the panel. But before we hear from the panel, we will have opening statements. And I will yield myself 5 minutes. Today, we are here to examine, as I say, the impact of the Dodd-Frank Act on asset-backed securities (ABS). And we are privileged to have this panel of great witnesses. I would like to welcome all of our witnesses and thank them for agreeing to testify about the impact of this law on the $3 trillion ABS market. These securities are arguably the most important mechanism that American companies have to fund their operations, as well as the way nearly all homes and commercial properties are financed. In many ways, Dodd-Frank is a perfect example of several unfortunate trends in the way that Congress and the regulators choose to deal with our Nation's problems. However, increasingly, whenever something goes wrong the knee-jerk reaction of Congress and the regulators seems to be to demand that the Federal Government do something, anything about it. Obviously, the 2008 financial crisis was a calamity that we are still recovering from today. But as Representatives, we have a duty to understand what happened and see if there was a way the financial system could have been more stable. Unfortunately, we did not take the time to think through the various unintended consequences that could arise before passing Dodd-Frank, and so now we are dealing with the repercussions. So 4 years later, the evidence is mounting that Dodd-Frank is a disaster for many sectors of the financial system, especially for asset-backed securitization. While our focus today is mitigating the worst of these consequences, I hope we as legislators will learn some lessons from this experience. You see, successful government regulation is a difficult matter, especially when it touches on something as complicated and interconnected as our financial system. Passing bills without a more complete understanding of their impact, or for the sake of showing our constituents that we are doing something, is, in fact, a recipe for disaster. As the saying goes, ``Act in haste, repent at leisure.'' And so, we are here today about helicopter parents, who hover over their children making sure they never do anything dangerous. Today, we seem to have a Congress that functions like helicopter parents, and a regulatory system constantly worried that somewhere somebody might be putting their money at risk. The American people are not the Government's children. Investors don't need Congress or the Federal Reserve (Fed) or the Consumer Financial Protection Bureau (CFPB) to keep them safe. Risk-taking is the reason our markets exist, and without risk there can be no innovation, no improvement, and no prosperity. Sometimes, these risks pay off, and sometimes they don't. But win or lose, they serve a purpose in steering capital towards it most productive uses. Our financial markets are not a T-ball league. There is no way everyone can be a winner. We will inevitably be poorer as a society if we stifle such risk-taking or shift the negative consequences onto the taxpayers. With Dodd-Frank and practically every other major law passed since 2008, we have increased the regulatory burden on the private sector. That burden falls most heavily on small- and mid-sized businesses, who are the biggest drivers of innovation and job creation in our economy. Yet, we keep making it more expensive and more complicated and legally risky to start, or operate, a business. An outside observer might even conclude that we have decided that entrepreneurs and private markets were all a bad thing and we are passing laws designed to discourage them. At the same time, we give preferential treatment to government-backed financing. And so, over time, this different treatment will lead to fewer jobs, less innovation, a less stable economy, and greater losses to taxpayers. It will also lead to more command and control from Washington, and more crony capitalism, where the well-connected get all the benefits. So Dodd-Frank takes a lowest common denominator approach to all aspects of the economy and especially to the ABS market. In terms of risk retention, all types of ABS are treated the same, as if they were subprime market mortgages, backed securities, or synthetic CDOs--the worst of the worst. Perhaps the best example of this misguided approach to regulation is the treatment of collateralized loan obligations or (CLOs). CLOs are a type of ABS that are backed by syndicated loans to businesses, and they are a major source of financing to mid-sized companies that cannot cost-effectively issue corporate bonds. There are many different explanations for our financial crisis, but I have yet to hear someone claim the CLOs were responsible. And yet, the reproposed rules from Dodd-Frank risk retention gives the same broad-brush treatment to CLOs as it does to more risky types of securities. By all accounts, then, Dodd-Frank will effectively kill off the $300 billion CLO market by making it prohibitively expensive to arrange and manage a CLO. So, why are we destroying this vitally important asset class? It makes no sense at all. I can only assume that CLOs just got swept up with all the other three-letter acronyms for financial products. This market funds businesses of different sizes all across the country. For example, in my district we have a major car rental company--in my district is a company that uses CLOs to finance its operations. Yet here we are today, sorting out the unintended consequences of a poorly written law and trying to prevent a totally artificial collapse of a major piece of the ABS market. I am hopeful that we can work in a bipartisan manner to fix these regulatorily-created problems in this important market. And in the testimony today, I hope that our witnesses will provide us with concrete ways to correct these regulatory obstacles and ensure that these markets are still able to flourish. It is time that we stop being the helicopter Congress and start treating financial markets participants like the adults that they are. And with that, I yield back, and now yield to the gentlelady from New York. Mrs. Maloney. Okay, thank you so much, Mr. Chairman. And I thank all my colleagues and I welcome all our panelists. Thank you all for being here. I think it is worthwhile to examine Dodd-Frank's impact on the securitization markets, because these are complicated markets that are constantly evolving. These markets are also very important to our economy. They provide financing for families buying a home, businesses that want to expand, and students who want to get an education. However, we also need to keep in mind that some of these securities were at the center of the financial crisis that cost our economy a staggering $16 trillion. Too often, the incentives of the lender, sponsor, and investor were badly misaligned, with disastrous consequences. We need to prevent these toxic securities from coming back, without unduly disrupting the availability of credit. Dodd-Frank required the banks sponsoring the asset-backed security to have some kind of skin in the game which gives them an incentive to monitor the quality of the loans being securitized. It is important to remember that this was not a novel idea. In some markets, investors in asset-backed securities had been requiring this for years. Dodd-Frank also aimed to bring greater transparency to securitization markets by requiring disclosure of detailed loan-level information so that investors know what they are buying. The regulators, in implementing Dodd-Frank, have attempted to strike a careful balance, and I applaud them for their thoughtful approach. The regulators have been willing to make changes to the rule when unintended problems come up, like they did when the Volcker Rule inadvertently harmed community banks that owned certain CDOs, for example. The regulators are now considering another tweak to the Volcker Rule that would provide targeted relief to CLOs. And both Chair Yellen and Governor Tarullo at our last hearing said that this issue is at ``the top of the list,'' for regulators. I am pleased that regulators are willing to make these kinds of adjustments, but I also hope that the regulators will be just as quick to adjust their rules to close loopholes that the markets find and to prevent bad actors from evading the rules. I very much look forward to hearing from our witnesses on the real-world impact of these rules. And I reserve the balance of my time for any other Member who would like to speak on this after your side. Or go ahead. Mr. Sherman, I yield to you for the rest of my 5 minutes. Thank you. Mr. Sherman. I thank you for yielding. At these hearings, we need to focus on whether we have reached the proper definition of what securities and other assets need to be divested, whether we have the right time frame for such divestiture to take place, and maybe we will explore whether the bank renouncing certain ownership assets, certain indices of ownership, certain rights they have under some of these agreements, give them an opportunity to continue to hold them. As to the chairman's discussion of helicopter parents, we have entities that are too-big-to-fail. We had better helicopter over them. Because if they go down, they will take the whole family with them. The way to deal with them is to break them up. Too-big-to-fail is too-big-to-exist. To tell them that they should engage in any kind of risky activity and we won't get involved would be an appropriate statement if we hadn't lived through 2008 and experienced what this Congress does when those that are too-big-to-fail are failing. So if we are going to allow too-big-to-fail entities to exist, we are going to have to hover over them with a helicopter. I think the best solution is that too-big-to-fail is too-big-to-exist, and that way we can really end this excessive government involvement. Finally, one of our witnesses, Mr. Levitin, will point out that Section 939F of Dodd-Frank, the Franken-Sherman Amendment, has simply not been implemented. And this goes to the heart of why we had the meltdown. The credit ratings agencies were giving triple-A to alt-A, and any pension manager who didn't invest in them was an underperformer. And until we deal with the credit rating agencies, and the fact that the umpire is paid by one of the teams, we are going to have meltdowns in one area or another. And unless I get the chairman to cosponsor our bill to end too- big-to-fail, those meltdowns are going to involve the taxpayer. I yield back. Chairman Garrett. The gentleman yields back. I have not yet decided to cosponsor your bill to end too-big-to-fail because I know that this committee passed Dodd-Frank, which we were told already ended too-big-to-fail in this country. With that, I will now yield to the vice chairman of the subcommittee, Mr. Hurt, for 2\1/2\ minutes. Mr. Hurt. Thank you for holding today's subcommittee hearing on the impact of Dodd-Frank on asset-backed securities. I thank the witnesses for being here, and I look forward to your testimony. In the wake of Dodd-Frank, we have continued to see costly unintended consequences arise from regulations that were poorly devised and implemented. These regulatory impacts represent real costs to consumers, both families and small businesses on Main Streets in every congressional district. With the recently-finalized Volcker Rule, we began to see these consequences almost immediately after it was released, as community banks were faced with taking large write-downs. While the joint regulators eventually corrected this error, there are still several other Volcker-related issues yet to be resolved, most notably with respect to CLOs and asset-backed securities. In Virginia's 5th District, my District, many companies rely on the CLO market to finance their operations, including a financial information firm headquartered in Charlottesville, with over 2,600 employees, and an auto parts manufacturer in Southside. These companies, however, like so many others across the country face increased costs as the CLO market reacts to the Volcker Rule's treatment of CLOs as covered funds. I think most would be hard-pressed to characterize financing the operations of these Virginia companies as ``hedge fund-style high-risk trading.'' Yet according to one of the Volcker Rule's Senate sponsors, the purpose of the provision was to put a firewall between banks in exactly these activities. While that may have been the original intent, we now see how a flawed rule, written in a flawed process, can extend well beyond its original confines and impact our communities. I appreciate the bipartisan group of Members who want to correct this misapplication of the Volcker Rule, and I look forward to its resolution. And I look forward to the testimony of the witnesses. Thank you, Mr. Chairman. I yield back the balance of my time. Chairman Garrett. Mr. Peters is now recognized for 3 minutes. Mr. Peters. Thank you, Mr. Chairman, and thank you to our witnesses for being here today. And certainly, I would like to thank Chairman Garrett and Ranking Member Maloney for convening this important hearing. I was first elected in 2008, which was during the height of the financial crisis. And our Nation at the time was shedding 800,000 jobs per month, and many small businesses in my home State of Michigan found themselves unable to access the capital and credit that they needed to continue operations, let alone grow and create jobs. During my time in Congress, my top priority has been ensuring that small businesses have the tools they need to grow, especially access to capital. There certainly is no silver bullet, and our Nation's entrepreneurs rely on innovative programs like those implemented by the States, with the support of funding from the State Small Business Credit Initiative, or backed by the SBA as well as community banks, credit unions, funding from the markets through initial public offerings, venture capital, private equity firms, and many others. Collateralized Loan Obligations, or CLOs, are part of the spectrum of financing that keeps Michigan businesses moving forward. Michigan industries that currently rely on CLOs show the diversity of Michigan's economy and include not just auto manufacturing and parts suppliers, but media and communications firms, textile and apparel manufacturers, retail and supermarkets, and utilities, as well as gaming and hospitality. We need to work together to ensure that Dodd-Frank implementation protects consumers and our economy as a whole without cutting off access to capital to small businesses. We also can't go backwards. We can't go back to allowing the use of government-insured money to make speculative bets on bets and then on further bets that threaten the entire financial system. We can't go back to shedding millions of middle-class jobs because of Wall Street overreach. Today, I hope our witnesses will address how we can find the balance in our markets we need to protect consumers, while maintaining liquidity and robust access to capital for our small businesses. I hope our witnesses touch on how small businesses make use of CLOs, the impact a disruption on the CLO market would have on them, and where these firms would find alternative financing in the event of such a disruption. Most importantly, I hope that our panel and my colleagues focus on solutions. Thank you, and I yield back. Chairman Garrett. Thank you. Mr. Barr is recognized for 2\1/2\ minutes Mr. Barr. I would like to thank the chairman for hosting this hearing today, and for the opportunity to analyze the discussion draft that I have put forth to fix an overreach by regulators in implementing the Dodd-Frank law. Based on concerns expressed by committee members on both sides of the aisle in a February 5th hearing with the regulators, as well as a subsequent letter sent to the regulators by over a dozen Democratic members of this committee, I am extremely hopeful that we can work together in a thoughtful and bipartisan way to fix the chilling effect the Volcker Rule will have in providing financing to American companies through Collateralized Loan Obligations, better known as CLOs. I am interested in getting this issue right because this is about jobs, business growth, and economic development in communities throughout the country. For example, CLO financing has been instrumental in building an infrastructure to bring cell phone service to rural areas. It has been used by companies in my district like Tempur-Pedic to raise funds fund to grow their business. In Kentucky, CLO financing has even helped companies which mine coal and provide health care. Finally, the importance of fixing the Volcker Rule for legacy CLOs, those issued before December 31, 2013, has been made clear to me by a community bank in Kentucky which considers its investment in CLO debt securities as an important part of the bank's investment portfolio. According to this community bank, if it is forced by the Volcker Rule to liquidate its investments in CLOs and take losses, ``the consequences could potentially translate to hiring freezes and/ or layoffs for our employees and higher rates to our customers.'' With Volcker, I am concerned that the medicine being prescribed, which would involve banks forced to sell billions of dollars of CLO paper in a fire-sale scenario, and the loss of credit availability for a wide swath of American companies, would be far more damaging to the credit markets than the perceived illness which the medicine is designed to fix, which would be the highly hypothetical scenario of banks ever suffering losses from holding triple-A CLO paper, which performed very well during the financial crisis. During the February 5th hearing in this committee with the Volcker regulators, I asked Federal Reserve Governor Tarullo about grandfathering existing CLO investments. I was pleased that he responded by saying that he will look at this as the first issue on the agenda. As such, I am hopeful that today's hearing will help clarify this issue and what is at stake so that we can fix this unintended discrimination against CLOs as soon as possible. Thank you, Mr. Chairman, and I yield back. Chairman Garrett. Thank you. The gentleman yields back. The gentleman from Massachusetts, for 2 minutes. Mr. Lynch. Thank you, Mr. Chairman. I am very happy that we have an opportunity to discuss the improvements made to the Dodd-Frank Act asset-backed securities legislation, the financial products that were at the very core of the financial crisis. I know this hearing was intended to address Dodd- Frank's effect on asset-backed securities in general, but I want to express very serious concerns about the draft legislation circulated by my friend from Kentucky. Let me just say at the outset that I have enormous respect for the gentleman from Kentucky, and I do believe there is a real opportunity for some much-needed bipartisanship on the issues of voting rights for senior debt securities of CLOs and also the way Dodd-Frank addresses risk retention on CLOs. As a matter of fact, I signed, along with 16 of my Democratic colleagues, a letter to the regulators making clear that the voting rights provision in CLO contracts should not, on their own, create an ownership interest under the Volcker Rule and urging the regulators to provide limited relief to address this issue. So I am sympathetic to the concerns from holders of these securities who are worried that they may have to divest them unless they get some relief. We are on the same page on that. But the discussion draft goes far beyond the limited relief that we requested. It completely exempts CLOs issued before December 31, 2013. And in discussions I have had with my staff, along with holders of these CLOs, they made very clear to us that it was not necessary to grandfather all CLOs issued before the Volcker Rule was finalized. They only needed the targeted relief we argued for in our letter. So it is unnecessary, and reckless, I think, to expand the scope of relief for CLOs beyond what the holders of these CLOs have requested. And I am very concerned that expanding this limited relief will open up the Volcker Rule to gaming by the industry. This committee should be very, very cautious about rolling back regulations that are critical to Dodd-Frank reforms before regulators' ink is even dry on those reforms. Thank you, Mr. Chairman. I yield back. Chairman Garrett. The gentleman yields back. I believe that concludes all of our opening statements at this time. We will now turn to our panel. We thank you again for coming. A number of you have been here before. And for those of you who have not, and for those of you who have and may have forgotten, I always ask that you make sure you turn your microphone on, and that you pull the microphone as close as you can, because some of us just can't hear anymore. And without objection, your entire written statements will be made a part of the record. We just ask you to summarize it during these 5 minutes. I now recognize Ms. Meredith Coffey, executive vice president of the Loan Syndications and Trading Association. Thank you for being with us, and you are recognized for 5 minutes. STATEMENT OF MEREDITH COFFEY, EXECUTIVE VICE PRESIDENT, LOAN SYNDICATIONS AND TRADING ASSOCIATION Ms. Coffey. Thank you, and good afternoon, Chairman Garrett and Ranking Member Maloney, and members of the subcommittee. My name is Meredith Coffey, and I am executive vice president of the Loans Syndications and Trading Association (LSTA). Now, importantly, the LSTA does not represent the CLO market. Instead, the LSTA represents the $3 trillion corporate loan market. And our concern is how regulation could severely diminish securitization, particularly CLOs, and how this could significantly hurt the corporate loan market. Critically, this would hurt U.S. companies' access to loans they need to expand, to build factories, to build cellular networks, and engage in M&A as they grow and build--create jobs. We are grateful to be here today to testify on how important securitization is to lending and to U.S. companies. And, importantly, how regulation, if it is poorly implemented, could decimate this important market. Now, as background, U.S. CLOs provide approximately $300 billion of financing to U.S. non-investment-grade companies. These companies include health care companies like community health and HCA; food companies like Del Monte and Dunkin Donuts; technology companies that are big, like Dell Computer, and small, like Netsmart Technologies; and many, many more. In fact, roughly 1,000 companies receive financing from CLOs and these companies employ more than 5 million people. It is a very important source of financing. Unfortunately for these companies, CLOs face existential threats. The risk retention rules alone threaten to reduce the CLO market by 60 to 90 percent. If the CLO market is reduced so dramatically, companies that rely on CLOs could see a substantial shortfall in financing. Now, it may be these companies can seek other sources of financing. But if so, it will come with a far higher price tag. If companies could replace lost CLO capacity it would cost them $2.5 to $3.8 billion per year to replace the capacity. So the choice for U.S. companies, really, would be to do without financing or face markedly higher financing costs. Neither bodes well for economic growth and job creation. And not only are CLOs an important source of financing for 1,000 U.S. companies, they have also proven to be safe investments. In the last 20 years, the cumulative default rate for CLOs was 0.41 percent. Not one of the 4,000 triple-A and double-A rated CLO notes defaulted, not one. This compares extremely well to almost all other asset classes, even investment-grade corporate bonds. So what are the threats to CLOs and what are possible solutions? The first major threat is that the final Volcker Rule arbitrarily converts investment-grade CLO debt securities into the equivalent of equity through an expansive definition of ownership interest. In turn, banks would no longer be permitted to hold investment-grade CLO debt. The ramifications are huge. U.S. banks hold $70 billion to $80 billion of investment- grade CLO notes. Moreover, foreign banks hold another estimated $60 billion. If banks were forced to sell, which they would be, this would materially disrupt the market. In fact, CLO issuance in January dropped nearly 90 percent from year-earlier levels, primarily due to concerns around the Volcker Rule. It has recovered somewhat in February. But do be aware, this is because the market participants took comfort that lawmakers, particularly members of this committee, are working to resolve this problem. We appreciate how seriously the committee takes this issue and the bipartisan efforts to ensure American businesses continue to get the financing they need. The legislation that Representative Barr introduced would provide a prospective solution and would provide business borrowers with certainty. And the letter that Representatives Waters and Maloney, and 15 other lawmakers sent, has been instrumental in focusing the regulators on fixing this problem. We greatly appreciate your effort and your focus on this issue. But the Volcker Rule is not the only existential threat that CLOs face. Risk retention threatens to shutter the CLO market, as well. The Dodd-Frank Act requires securitizers to retain 5 percent of the credit risk of any ABS. Even though CLOs have no securitizer, as defined in Dodd-Frank, the agencies have said the CLO manager is the sponsor and thus must purchase and retain 5 percent of any new CLO. So for a new $500 million CLO, a manager must find $25 million to purchase notes from that CLO. Why doesn't this work? Unlike banks, most CLO managers are thinly-capitalized asset managers. They simply do not have the capital to invest $25 million to manage each new CLO. And because of this, risk retention would dramatically reduce the market. While the agency's proposed rules do not work for CLOs, we have offered a workable alternative. A qualified CLO, which would be subject to many of the restrictions and protections, and for which managers could purchase and retain 5 percent of the equity of the CLO. This should be feasible for agencies and it should permit most of the CLO market to survive. Thank you again for inviting me to testify, and I would be delighted to expand on any of these issues. [The prepared statement of Ms. Coffey can be found on page 30 of the appendix.] Chairman Garrett. Great. Thank you very much for your testimony. Professor Levitin, greetings. And you are recognized for 5 minutes. STATEMENT OF ADAM J. LEVITIN, PROFESSOR OF LAW, GEORGETOWN UNIVERSITY LAW CENTER Mr. Levitin. It is good to be here again. Good afternoon, Chairman Garrett, Ranking Member Maloney, and members of the subcommittee. Thank you for inviting me to testify. I am here today as an academic who studies structured finance. I have no personal financial interest in these matters, and I am not speaking on behalf of any organization. A key point we should not lose track of in this hearing is that structured financial products caused the financial crisis of 2008. Mortgage securitizations and CDOs were at the very heart of the crisis, and one of the pillars of the Dodd-Frank Act are provisions reforming the structured finance market. Unfortunately, Federal regulators have been unacceptably slow in implementing the Dodd-Frank Act's structured finance provisions. Several key rules have not been finalized or, in some cases, not even proposed. In particular, the SEC has failed to fulfill its statutory duties under the Franken-Sherman and Merkley-Levin Amendments. The SEC does not seem to have internalized that its mission is not just investor protection, but also systemic stability. Although some rulemakings have been delinquent, regulators have finalized one of the most important rulemakings: Regulation VV, which implements the Volcker Rule. The Volcker Rule prohibits banks from having ownership interests in certain investment funds. The Volcker Rule does this in order to prevent Federal Deposit Insurance from leaking out and covering speculative investment activity. Bank ownership interests in investment funds can give rise to implicit recourse to banks' balance sheets, and thus to the Deposit Insurance guarantee. This is a problem we have witnessed repeatedly in the structured finance context for various asset classes. Over the past 25 years, banks have repeatedly rescued their credit card securitization vehicles. And in 2007, banks brought sponsored hedge funds and structured investment vehicles back on their balance sheets. As long as banks have ownership interests in investment funds, and investment funds include any type of structured product--it is always done through a fund-- there will always be the specter of an implicit guarantee. Accordingly, Regulation VV correctly defines ownership interest broadly to include not just formal equity ownership but also functional indicia of ownership: the ability to control an investment fund or to share in its profits or losses. This is just what the accounting rules require. The Regulation VV ownership prohibition does not apply, however, to funds that invest solely in loans. This has resulted in some questions about the status of Collateralized Loan Obligations, or CLOs. Let's be clear about what a CLO is. A CLO is a securitization of interests in high-yield corporate loans. CLOs do not typically hold whole loans. Instead, they contain syndication pieces that are parts of multi-million or, quite often, multi-billion dollar high-yield corporate loans. CLOs are not financing small business. They are financing large business. They are providing an important piece of the financing for large business, but they are not providing all of it. Like all securitizations, CLOs involve closed-end investment funds. CLOs are also generally actively managed. As closed-end, actively-managed, structured investment funds, CLOs are indistinguishable from CDOs, the very instrument that was at the heart of the financial crisis. The only difference one can point to is that CLOs' assets are concentrated in corporate loans rather than in other assets. Structurally, however, there is no difference between a CLO and a CDO, and the CLOs' markets solid performance in the past is not a guarantee of its future performance. Regulation VV will necessitate banks to divest ownership interests in some unknown number of legacy CLOs whose assets are not restricted solely to loans. But this is no different than any other divestment required by Reg VV. And given the liquidity of the CLO market and the relatively long divestment window, the divestment should not result in a fire sale. To the extent that legacy CLOs are a concern, and I do not believe that we have an empirical basis for making that conclusion, there are surgical fixes available that do not require legislation. Going forward, Reg VV will not have an impact on the CLO market. The CLO market has already figured out several transactional solutions to enable continued bank investment in the asset class. And as Ms. Coffey noted, the CLO issuance is actually up this month, after having been down in January. The other major rulemaking that I wish to briefly mention is the credit risk retention proposal under Section 941. And I just want to frame it in maybe a different way than it is usually thought of. I think it is generally accepted that there is a--there can be conflicts of interest between securitization sponsors and securitization investors. We have two basic routes in which we can address this. We can either try and deal with it ex ante by making securitization sponsors essentially partners in the securitization, making them buy a piece of the securitization. And that means that they are going to have to have some capital for that, which is going to be a problem. Or we can try and deal with this on the back end by having effective representation and warranty enforcement. I am not especially optimistic that we are ever going to get effective back-end enforcement. Therefore, I think we need to be thinking about how we can make risk retention work. Thank you. [The prepared statement of Professor Levitin can be found on page 46 of the appendix.] Chairman Garrett. Thank you. From the U.S. Chamber, welcome back, Mr. Quaadman. You are recognized for 5 minutes. STATEMENT OF TOM QUAADMAN, VICE PRESIDENT, CENTER FOR CAPITAL MARKETS COMPETITIVENESS, U.S. CHAMBER OF COMMERCE Mr. Quaadman. Thank you, Mr. Chairman, and thank you, Ranking Member Maloney. And I would also like to thank the members of the subcommittee for your continued leadership on issues of importance to Main Street businesses. I would also like to take a quick moment to thank Congressman Barr for developing legislation to address the CLO issue, as well as Ranking Member Maloney for spearheading the letter that was signed by many Members asking the regulators to fix the issues. The Chamber has been very concerned with the impacts of the Dodd-Frank Act on the ability of Main Street businesses to access capital. Our view has been, with all the different major regulatory pieces of Dodd-Frank and other regulatory initiatives, that they need to be looked at holistically to see how they work in conjunction with other rulemakings and other initiatives such as Basel III and even money market fund reforms. Shortly after the Volcker Rule was proposed in December 2011, we sent a letter to the regulators asking for such a holistic review to see how the Volcker Rule would impact the ability of businesses to enter the debt and equity markets and how it would interact with other regulations. And we also asked that the regulators conduct an economic analysis. With that letter, we included a survey that we had taken of small-, medium-, and large-sized businesses on the impacts and impediments and costs of the proposed Volcker Rule, at that time, with their ability to access different forms of capital. And one of the solutions that we proposed at that time was also that the regulators hold roundtables. About a month later, after that letter was sent in, Governor Tarullo from the Federal Reserve testified from this table to the full Financial Services Committee, saying that the regulators involved in the Volcker Rule did not understand the marketplace activities and what participants were doing in the markets. I am sorry to say, 2 years past that hearing--despite, I think, good faith efforts to change some of the substantive issues with the Volcker Rule--I don't think the level of understanding of the regulators on marketplace activities has necessarily changed. So as you have already heard, CLOs provide $300 billion in financing to small and medium-sized businesses as well as those businesses which can't find financing in other forms. And CLOs performed well during the financial crisis versus other securitizations. They are different in that the CLO managers have skin in the game, and there is an alignment of interests with the investor communities. However, as we have seen, the CLOs have been impacted by the risk retention rules as well as by the Volcker Rule. These impacts are no longer theoretical. In January, Bloomberg reported that CLO issuances in the United States are down by at least 60 percent, and that CLO activity is now beginning to migrate over to Europe. So, there are solutions to the problems. As I said earlier, the regulators, in terms of the procedure in developing Dodd-Frank, played fast and loose with what their legal requirements were. However, we believe that the legislation proposed, or the discussion draft put forward by Congressman Barr does put a little bit of a stronger public policy statement to the regulators to get this problem fixed, though I do believe we have a unity of interests here to get the problem fixed. These issues are not partisan, and we would hope that both sides can agree to a solution. Additionally, as I said, we thought these issues should have been resolved during the rulemaking process itself. While we think it is a good first step that the agencies have formed an interagency working group in the development of the Volcker Rule implementation issues, we also believe that there should be a working group of market participants; financial institutions; small, medium, and large businesses; global businesses; institutional investors; and others that can work with the regulators to actually ``war game'' Volcker throughout the conformance period in order to discover any unintended consequences. And then to also craft solutions to those unintended consequences. As we have seen with CLOs today, as we had the hearing a couple of weeks ago with trust-preferred bonds, we are sort of getting into a ``Whack-a-Mole'' situation, where issues keep popping up one after the other. The other situation I think we all want to avoid is that we all wake up on July 23, 2015, when the conformance period is ended, and markets are volatile and businesses don't have access to different products because these unintended consequences had not been worked out. We also believe the interagency working group, as well as this market participant working group, should report to the committee and the subcommittee regularly as to their progress. And I am happy to take any further questions you have. [The prepared statement of Mr. Quaadman can be found on page 65 of the appendix.] Chairman Garrett. The gentleman yields back, and I thank the gentleman. Mr. Vanderslice, you are now recognized. Welcome, first of all, to the panel. And you are now recognized for 5 minutes for your testimony. STATEMENT OF PAUL VANDERSLICE, MANAGING DIRECTOR, CITIGROUP, ON BEHALF OF THE CRE FINANCE COUNCIL Mr. Vanderslice. Thank you, Chairman Garrett and Ranking Member Maloney, for giving me the opportunity to testify today. I am co-head of the U.S. CMBS group, and head of the commercial mortgage distribution efforts for Citibank global markets. However, I am testifying today on behalf of the Commercial Real Estate Finance Council, or CREFC. CREFC members include multi- family and commercial lenders, loan and bond investors, and servicing firms of all types. I will focus my comments today on the recently reproposed risk retention rules and CMBS. CMBS is an integral component of commercial real estate lending because it expands the pool of available loan capital beyond what balance sheet lenders, mostly banks and insurance companies, can contribute. In 2013, CMBS provided almost 25 percent of all CRE financing. That is over $80 billion in loans that were made. CMBS also provides about 34 percent of all CRE loans made in tertiary markets, and 24 percent of the loans made in secondary markets. No other lending source comes close to servicing these markets to that extent. To give you a better sense of the significance of this industry, Mr. Chairman and Ranking Member Maloney, in your combined MSA alone, there are thousands of properties with outstanding CMBS loans totaling over $66 billion. And that is outstanding today. The proposed CMBS retention rules impose a burden on borrowers that is projected to appreciably increase their cost of funds. A strong consensus across all CREFC constituencies was reached on a set of recommendations to the risk retention rules as reproposed this past August. CREFC and its members are supportive of the goal of risk retention in the proposed rules. However, we believe strongly that the rule should provide optionality and flexibility for achieving these goals. Simply put, there is more than one means to an end. Allowing our industry this optionality and flexibility will allow risk retention to be achieved fully, but with the least possible amount of marketplace disruption. Today, I will focus on three key areas: single borrower-single credit transactions; b-piece structure; and qualified commercial real estate (QCRE) parameters. First, single borrower-single credit transactions (SBSC): There is a strong consensus across all CREFC constituencies to completely exempt single-borrower-single credit deals from the retention regime. SBSC deals involve only one loan, or a pool of cross-collateralized loans that essentially function as one loan. SBSC transparency is extremely high because granular loan details are reported to potential investors, and SBSC loss experience has been exceedingly low. Furthermore, because these transactions effectively contain only one loan, it is much easier for institutional investors to evaluate the credit of the transaction before investing, and they have broader access to data because the deals are typically done in the private market. Second, b-piece structure. For CMBS only, the proposed rules allow a third-party b-piece investor to buy the first- loss position to bear the retention obligation. The actual amount of retention required under the reproposed rules is quite significant, effectively 5 percent of the cash proceeds or 5 percent of the fair value of the bond sales, which is about double the capital investment currently made by b-piece buyers in deals that we are doing today. To address this, the regulations allow two BP buyers to buy the retention obligation and co-invest side-by-side. Although this helps to address access to capital, it creates a host of other issues for the b-piece investors. To address these issues, CREFC recommends allowing a senior subordinate structure for b-piece investors. This would still accomplish the retention regime objectives, but would be workable for the industry without materially increasing the cost of funds to the borrowers. Third, QCRE parameters. The proposed rules would exempt qualified commercial real estate (QCRE) loans from the retention regime if specified underwriting parameters are fulfilled. The QCRE goal is to reward conservative underwriting. There was a broad consensus among CREFC members, including among investors, that QCRE parameters should be modified by making certain changes to the proposed QCRE loan parameters. Based on historical data from all CMBS deals since 1997, our recommendations would expand the universe of QCRE- eligible loans from around 3 percent of CMBS loans to about 15 percent. Using the same data, the cumulative loss percentages for those qualifying loans would fall to less than 1 percent. This is all in contrast to the other qualifying asset exemptions under which the vast majority of assets will qualify. Mr. Chairman, we want to make risk retention work, not eliminate it. And we believe that the recommendations I have outlined today, and that CREFC has advanced in its comment letters, would help accomplish that objective. And I would be happy to answer any questions you may have. [The prepared statement of Mr. Vanderslice can be found on page 73 of the appendix.] Chairman Garrett. And I thank the gentleman for your testimony. Mr. Vanderslice. Thank you. Chairman Garrett. Last, but never least, Mr. Weidner is recognized for 5 minutes. STATEMENT OF NEIL J. WEIDNER, PARTNER, CADWALADER, WICKERSHAM & TAFT, ON BEHALF OF THE STRUCTURED FINANCE INDUSTRY GROUP (SFIG) Mr. Weidner. Thank you. Chairman Garrett. You are welcome. Mr. Weidner. Chairman Garrett, Ranking Member Maloney, and members of the subcommittee, my name is Neil Weidner. I am a partner in the capital markets group of Cadwalader, Wickersham & Taft. I have spent the majority of my 22 years of practice in the field of structured finance, and I have been actively involved in the CLO market since the late 1990s. Today, I would offer testimony on behalf of the Structured Finance Industry Group, or SFIG, a trade industry group with over 240 institutional members that focuses on improving and strengthening the broader structured finance and securitization market. Securitization touches the lives of your constituents on a daily basis, and provides economic benefits that help Main Street to access affordable credit. SFIG believes in a well- regulated and liquid securitization marketplace for all asset classes. I am here today to discuss two specific aspects of the Act which, if enforced in the current form, will have an adverse impact on individuals and businesses in your communities. The clearest example of this is the effect that the final implementation of the Volcker Rule and the proposed risk retention rules are having on the CLO market. The uncertainty due to Volcker is negatively affecting the marketplace today. Analysts have predicted that 2014 estimates of CLO issuance would drop by 18 percent, to $55 billion. This equates to a loss of up to $10 billion in financing to U.S. companies. The proposed credit risk retention rules also present a serious threat to the long-term viability of the CLO marketplace. If implemented as currently proposed, CLO issuance and the amount of credit provided to U.S. businesses could be reduced by 75 percent or more. To put this in context, U.S. companies that employ 7.5 million people use the CLO marketplace to expand their businesses, including opening new factories, paying suppliers' invoices, or simply making payroll. Without significant changes to the proposed regulatory framework, these companies, such as ManorCare, Pinnacle Foods, and Berry Plastics may lose the ability to receive affordable financing provided by the CLO marketplace. We appreciate the recent attention that Federal agencies and lawmakers on both sides of the aisle have given these issues. The market has reacted positively to the bipartisan focus of this committee and, thankfully, largely to your efforts and the prioritization by the regulators. The CLO market experienced a slight upturn this month, that was alluded to. But as such, we urge the committee to maintain the momentum towards developing a near-term solution for the Volcker Rule. And absent a proper solution, there is a strong concern that the market will quickly contract again. We also look forward to continuing our constructive dialogue with the regulators on the proposed risk retention rules. Without a workable solution for retention, the long-term viability of the CLO marketplace has also been called into question. However, SFIG believes there are simple, straightforward solutions for providing regulatory clarity to the participants in the CLO marketplace. With respect to Volcker, SFIG has asked for regulatory clarity regarding the definition of ownership interests as it relates to debt securities in CLOs. This approach does not require the reopening of the Volcker Rule. We simply ask that regulators provide additional interpretive guidance, which can be in the form of a simple FAQ. Such an approach would help provide certainty both on a go-forward basis, and for existing CLOs, commonly referred to as legacy CLOs--that this issue, were this issued prior to the regulation--that were legacy CLOs that were issued prior to regulation. In terms of risk retention, SFIG believes both the structured finance and alignment of interest of participants had contributed to the CLOs strong performance before, during, and after the crisis. In fact, from 1993 to 2012, no CLO debt security rated higher than A has ever experienced a principal loss. Such tranches represent up to 75 percent of the capital structure of a CLO. These are tranches that are bought by banks, including community banks such as the Federal Savings Bank of Elizabethtown, Kentucky. Nevertheless, we continue to work constructively with the regulators to create flexibility to satisfy the retention requirements through an array of options as have been proposed for other asset classes. Specifically, SFIG believes that the agencies should consider adopting both a third-party retention option for CLO holders, as has been proposed for CBS, and a qualified CLO option. SFIG believes that these options offer flexibility for the industry in meeting retention requirements. Further, SFIG is committed to continued engagement with the members of this committee and regulators, as we work on developing solutions for the CLO marketplace. Chairman Garrett, Ranking Member Maloney, Congressman Barr, and members of this subcommittee, we appreciate your leadership on these issues. And if we do not find solutions that work for both regulators and the marketplace, then the companies that create jobs, and make capital investments to grow their businesses and provide goods and services will suffer. Thank you. [The prepared statement of Mr. Weidner can be found on page 168 of the appendix.] Chairman Garrett. Thank you. Again, I thank the panel. At this point, I recognize myself for 5 minutes. So let's start with some of the basics, I guess. Mr. Weidner, you were just wrapping up, so I will just throw it right back to you. You heard the assertion in testimony--CLOs and CDOs, are they essentially the same thing that we are talking about here? Mr. Weidner. No. Chairman Garrett. Okay. Gee, I don't normally get just a short answer like that. I want to ask the Administration questions, so-- Mr. Weidner. No, no, I appreciate it. I will elaborate. Chairman Garrett. Great. Mr. Weidner. What we are talking about is two different types of products. I think the only similarity that they really bear is the fact that they have three acronyms in their names. I think if you look at the performance of CLOs and the structural features that have been embed--that are a part of how CLOs are structured, you look at the granularity of the borrowers who are--there would be 100 to 200 borrowers who are typically part of the CLO. Chairman Garrett. Right. Mr. Weidner. Across many different industries. What you have seen is the underlying asset class has been able to--has proven itself. There are a number of other structural features which has demonstrated, including through the downturn in the economy and through the recession that the actual product works. Chairman Garrett. Okay. Mr. Weidner. As compared to ABS deals, which have had the comparison in terms of the performance results are significantly different. Chairman Garrett. Right. So it is a difference in performance. My guess is that you are going to give me the panel answer on this. The difference is that the underlying assets are different, as well. So, where we saw the problem in the crisis was in what type of assets. And what type of assets are we dealing with here? Mr. Weidner. The types of assets that were put into CLOs are not the originate to distribute type assets. They are well- underwritten, they are granular in terms of those--there is a broader array and diversity. But it really goes down to the assets that have been included, and the structural features in the deal. That if the deal starts-- Chairman Garrett. We were talking about mortgage-backed assets and some of the other cases, were we not, during the crisis? Mr. Weidner. Yes, we were. Chairman Garrett. Right. Okay. And someone--Mr. Vanderslice or Mr. Quaadman, do you want to throw--the question here is who are we actually dealing with in this situation? Are we dealing with big businesses being financed, or are we dealing with middle-sized businesses that are being financed? I would assume that big businesses wouldn't necessarily need this, but who are actually--who are the customers, I guess--yes, that is the right word--Mr. Quaadman? Mr. Quaadman. Sure. In fact, the LSTA and the Chamber are working together on a letter with corporate treasurers on the risk retention rule. And I could tell you, in going through the companies that use this, it is thousands of companies. It is primarily mid-sized and small companies. Chairman Garrett. But what--define that in size, somehow. Mr. Quaadman. You are looking at small-cap and mid-size companies. You are not going to look at a Fortune 500 company, you are not going to look at companies of those sizes. Because they have many different ways to access capital. So, this is going to be much smaller businesses. Chairman Garrett. Okay, great. Ms. Coffey, one of the things I was confused about--but I guess everybody is confused about this--is the two rules that are out there. Dodd-Frank has the 5 percent risk retention requirement, right, on the one hand? And then you have the Volcker Rule that prohibits a bank holding more than 3 percent equity in a covered fund, right? So, that is the current law. How does the industry deal with that, first of all? Ms. Coffey. I do believe there is language that suggests that for securitizations, there should not be a conflict between the risk retention rules and the Volcker Rule, other specific language that those--that one is exempt from the other. But I think if you combine the two--the concern with respect to the Volcker Rule and risk retention-- Chairman Garrett. Well, no. Let me step back. You are saying the intent was that there should not be a conflict, but there is a conflict. Ms. Coffey. Correct, although I-- Chairman Garrett. Mr. Weidner, do you want to jump in? Mr. Weidner. Just to the extent that you are required to withhold, retain something greater for risk retention, it overrides the 3 percent. Chairman Garrett. Okay. Ms. Coffey. So to that end, there is not a conflict within the Rule. But, obviously, there are extreme conflicts as far as what the Volcker Rule would do for CLOs, existing CLOs. And risk retention, obviously, would dramatically reduce new CLO formation by 60 to 90 percent. So, they are very problematic. Chairman Garrett. Right. In my last 13 seconds, and with that reduction in the size, then, the cost to the market would be--I think we heard some numbers on that. Ms. Coffey. Yes. We have done research which indicates that if the CLO market was reduced by 60 to 90 percent, borrowers would end up paying $2.5 billion to 3.8 billion in additional interest payments per year simply because CLOs went away. Chairman Garrett. I understand. Thank you. The gentlelady from New York? Mrs. Maloney. Thank you. And I would like to ask Meredith Coffey and others to comment if they so wish. Ms. Coffey, I understand that many in the CLO industry think that the new risk retention proposal won't work for the CLO market because CLO managers don't have the balance sheet to retain the 5 percent of each deal. I think that is a valid concern. But didn't the regulators take that into account when they proposed a separate loan arranger option for CLOs which would allow CLO managers to comply with the risk retention rule without keeping 5 percent of each deal on their own balance sheet? And can you explain why you don't think the loan arranger option will work? Ms. Coffey. Great. Thank you, Congresswoman Maloney. One of the issues around the arranger option on risk retention is that it would say that a bank originator would have to retain--hold and retain 5 percent of what they call a ``CLO-eligible term loan bank.'' When that was reproposed in the rules in August, we went and engaged with our bank members and asked them if this was feasible or if there was some form that was feasible. And ultimately, that became problematic, because the same banking regulators on the supervisory side did not want banks to agree to commit and retain, and never hedge, and never sell a position in a loan because the banking supervisors themselves say that they want banks to maintain the flexibility to work out of bad situations. So on one side you have the regulatory side of the body saying you must hold and retain 5 percent, and on the other side you have the supervisor saying we cannot have you agree to never, ever hedge or never, ever sell. So you had a conflict there. When we were talking to banks and they told us about this conflict, we understood that ultimately that option was not feasible because they would ultimately not be permitted to do that. Again, with never hedging and never selling. Mrs. Maloney. I would like to ask anyone on the panel to comment, and yourself if you so wish. Are there alternative options that would work for CLOs while also complying with the spirit of the risk retention rule? Ms. Coffey. Yes. Actually, one of the things that I would like to hit on is what we call a ``qualified CLO concept.'' And the idea behind a qualified CLO is having a CLO that is a high- quality CLO which meets a number of the agencies' objectives. So it would support strong underwriting, that is a big objective. It would facilitate the continuity of credit. It would ensure the alignment of interests with the managers and investors. And it would limit the disruption in the market and protect investors. How would this qualified CLO do this? For a CLO to become a qualified CLO, its governing documents would have to require six major restriction categories. First of all, restrictions around asset qualities. The CLO must invest in higher-quality non-investment grade loans. Second, restrictions around the portfolio composition. It would have to be a highly diversified portfolio. Third, structural protections in the CLO, including mandating a minimum amount of equity in the CLO to protect the debt holders. Fourth, alignment of interest between the CLO manager and its investor in a number of different forms. Fifth, transparency and disclosure, ensuring investors have just a wealth of information about the CLO itself and every single asset in the CLO. And sixth, regulatory oversight, basically requiring the CLO manager to be a registered investment advisor, being regulated by the SEC, and being subject to fiduciary responsibilities to its investors. If we marry all of those together, I think ultimately what we have is a very high quality CLO that meets all the objectives of the agencies. Mrs. Maloney. Okay, thank you. Professor Levitin, I would like to ask you about Mr. Barr's bill to deal with the CLO issue. While I support a narrow, targeted solution for CLOs as outlined in the letter that I wrote, I am also concerned about creating loopholes in the Volcker Rule. So in your opinion, could this draft bill create loopholes for banks to go around the Volcker Rule? And if so, is there a way to fix the language of the bill? Mr. Levitin. Congresswoman Maloney, let me start by saying I have not actually seen the language of Mr. Barr's bill. I have seen some descriptions of it, and I would have concerns about whether it is overly broad and whether it might, in fact, create some loopholes for Volcker Rule evasion. What is not clear to me is the--let's put risk retention aside. For the Volcker Rule, there clearly is some amount of legacy issue that we may need to address. Going forward, though, it is not at all clear why there needs to be any sort of intervention by Congress in order to address the CLO market for Volcker Rule purposes. The market is already starting to find solutions to make sure that CLOs do not--are either not covered funds, or that banks' investments do not qualify as ownership interests. Mrs. Maloney. My time has expired. Chairman Garrett. Thank you. And now, to the vice chairman of the subcommittee, Mr. Hurt, for 5 minutes. Mr. Hurt. Thank you, Mr. Chairman. I just wanted to follow up on the chairman's line of questioning relating to the difference between CLOs and CDOs. And I wanted to direct my question to Mr. Vanderslice and Mr. Weidner. Professor Levitin says in his testimony that for all intents and purposes, CLOs are indistinguishable from CDOs. And he says that there is no clear difference between a CLO and either a CDO or a hedge fund. That seemed to be the opposite of what Mr. Weidner was saying. So I was wondering if you, Mr. Vanderslice, and then Mr. Weidner, could discuss the difference between CLOs and CDOs in the context of the 2008 crisis. And the performance, and then how we as Congress look at this issue going forward to make sure that we are not--that we are taking the most prudent course. Mr. Vanderslice, if you don't mind? Mr. Vanderslice. Yes, I am actually here just for CMBS. So I am going to defer to other witnesses. Mr. Hurt. Okay. Mr. Weidner. Again, I think you need to look at the transaction. There are a couple of things we have outlined in the written testimony that we have submitted, that the types of features that the way CLOs have been structured are ones that have demonstrated its resiliency through the downturn. And I think that the types of features that are in those deals--they include the fact that 90 percent of these deals include senior secured loans. It is diversified across borrowers, diversified across industries. The deals are actively managed by regulated investment advisors who have--or there is a regulatory overview of them. We have features where if the deal starts to underperform, it has the ability to delever itself. And there is an alignment of interest. The managers themselves receive the bulk of their compensation on this coordinated basis. And they are very much incented to manage in the portfolio in the way that one would hope. And when--I think the real striking evidence for us is to say, okay, if we go through all that, that all sounds very nice. But if you actually look at the statistics going from 1993 to 2012, including going down for the recession, the historical performance numbers prove out that they have shown the resilience, see, because of the way they have been structured. And I would also like to think that part of the reason that they have been so resilient is, also, the underlying borrowers themselves, who are part of these pools. Did the deals get stressed? They did get stressed. Deals that were down--every deal that I can tranche that I can thing of that was downgraded became upgraded, was upgraded back to where it was, a particular tranche. So I think there really is a separate analysis of what features make this a good product. And there is proven track history. Then when you look at ABS, the comparison--and certainly I think there have been some that have been submitted--it is a much different product. There was much less diversification and there are other issues. Mr. Hurt. All right, that is great. And then let me just-- because my time is limited, unfortunately, I want to make this question to Mr. Quaadman. And I wanted to thank--first of all, thank the Chamber for its demonstrated push to try to require that the cost--that there be a cost-benefit analysis for the entire impact of Dodd-Frank, and not just looking at these impacts on an individual policy basis, but looking at them from a holistic standpoint. But if you could try to quantify for people back home who will be affected by, or could be affected by the implementation--and we predict will be affected by the improper implementation of Volcker as it relates to these securities. What is the real impact for, as I mentioned in my opening statement, the auto parts manufacturer that relies on this financing to be able to operate. And how do you quantify the increased costs that absolutely get--I believe get--will get passed on to the customer, consumer? Mr. Quaadman. Let me take that question in two separate ways. One is, in that letter from December 2011 with the server that we have put in with the regulators we found that with large borrowers, or large companies that were in the debt markets, their costs would increase by 25 to 50 basis points. Or with smaller borrowers, it would actually go up by 50 to 100 basis points. So when you take a look at the size of debt markets, you are talking in the tens of billions of dollars, potentially, when you put it all together. When you are looking at CLOs here, particularly as this dries up--because remember what happened in January, the markets were reacting that these products were going to go away. The reason why they have come back a little bit in February is because you are here talking about solutions, the regulators are saying something. So the markets are sort of looking--while they may not be going away. If they do go away, those small businesses and the businesses you are talking about, you are going to have to go to a more risky form of financing if you can even find it. Mr. Hurt. Okay. Mr. Quaadman. So that is going to make our system that much less stable. Mr. Hurt. And jack up the costs. Mr. Quaadman. And jack up the costs. Chairman Garrett. Thank you. The gentleman yields back. The gentleman's time has expired. The gentleman from Massachusetts for 5 minutes. Mr. Lynch. Thank you, Mr. Chairman. I think that the arguments that you are making for changes in the risk retention rule are much more valid than an exemption from the Volcker Rule. So let me talk about risk retention and what we are requiring. I understand the structure is much different, and that Ms. Coffey, you have talked about this QCLO. Do you anticipate--I haven't drilled down on the documents, but do you anticipate that these are corporate loan only? Because I think, generically, CLOs could also include bonds or derivatives. And to that extent, Mr. Levitin is right. They present some of the same risks that we are trying to get at for CDOs. So they are similar in that respect. So are you anticipating that this QCLO would be limited just to corporate loans? Ms. Coffey. Certainly. Thank you for the question. In our proposal, we recommended that in the asset quality bucket that in the QCLO that 90 percent of the assets would be senior secured loans to U.S. companies that are subject to annual audits and that whole thing. We were saying that perhaps up to 10 percent could be things like corporate bonds to those same companies. But I think that is a point of discussion. But we ultimately see this as being a vehicle that is specifically focused on providing financing to U.S. companies. Mr. Lynch. What about the equity tranche where the risk is? How do you adjust that in the QCLO? Ms. Coffey. Certainly. One of the things that we said in the QCLO is that we should have structural protections that are mandated in a qualified CLO. And that the equity component of the qualified CLO should be at least 8 percent of the assets. Mr. Lynch. Okay. And what would you--so what would be the protection for the equity tranche? Are you saying 5 percent of the 8 percent? Is that-- Ms. Coffey. What we are saying is the risk retention component of the CLO manager. Now, remember, a CLO manager is a thinly-capitalized asset manager. Mr. Lynch. Yes. Ms. Coffey. And so what we are saying is in order to do a QCLO, in order to manage CLOs going forward like they have done for the last 20 years and have seen no losses whatsoever, a CLO manager would have to purchase and retain 5 percent of the equity of that CLO. Mr. Lynch. Okay. Ms. Coffey. So a CLO manager would have to bring--find, and bring $2.5 million simply to run its business going forward. Mr. Lynch. All right. Mr. Levitin, what do you think? Mr. Levitin. I actually am somewhat sympathetic to the QCLO concept. Mr. Lynch. Me, too. Mr. Levitin. The devil is in the details. But the concern with risk retention is that you are going to have a conflict of interest--without it, there is going to be a conflict of interest between whoever is putting together the securitization, whether it is CLOs or mortgages or what have you, and the investors. And as Ms. Coffey has outlined the QCLO concept, it seems to be--if all the things she laid out are actually done right, that probably addresses a lot of those concerns. Mr. Lynch. Yes. Okay. I guess I am going to reserve my right to object at some point. It sounds like you are on the right path. And I agree that structurally it presents a different set of problems than what we originally focused on. And it is sort of like the trust preferred security solution that we came up with recently. But I think it is, in Mr. Levitin's words, the devil is in the details here on how we get this done. But I think there could be a way forward. I just hope that the Democrats and Republicans can work together here. I think, just a flat-out exemption, as in the language of the draft bill, is a non-starter. I don't think it is necessary, and I think that would get in the way of us coming to a general agreement here that I think would serve the industry and investors and taxpayers, as well. I will yield back, thank you. Chairman Garrett. The gentleman yields back. Mr. Stivers is recognized for 5 minutes. Mr. Stivers. Thank you, Mr. Chairman. I appreciate the witnesses being here today, and I appreciate their testimony. So under the Volcker Rule, when you combine, I guess, the Volcker Rule, the qualified mortgage rule, the QRM rules, the risk retention rules, the proposed rules of Basel III and other capital requirements, what--I guess I will direct this question to Mr. Quaadman. What cumulative impact do you think all that will have on the ABS market? Mr. Quaadman. I think overall it is going to have a negative impact. If you take a look at the way that business is financed, when you take a look at Basel III it is going to impact their commercial lines of credit. It even impacts their ability just to park cash in banks. When you take a look at risk retention, and with the Volcker Rule, in particular with CLOs, as we have talked about, that is going to be impacted, as well. What we don't know yet with the Volcker Rule is how the Volcker Rule is going to start to impact other debt and equity instruments that corporate treasurers use and how they are underwritten. Mr. Stivers. I think Mr. Hurt asked some questions that you answered about what that will do to the cost of borrowing. And you brought up the ABS, or the CLO problem. And given that the last questioner talked about bipartisanship, I think on the CLO issue, there has been some bipartisanship. And I want to remind the committee of the remarks of the ranking member, Ms. Waters, on January 15th, when she said that, ``I think that we are able to work with the regulators on some of the issues being identified, such as the CLO issue.'' And I think there is a real acknowledgment that in the Volcker Rule, there is a problem with the CLO. I guess this question is for Ms. Coffey. What do you think the easiest way to fix the CLO rule would be? Ms. Coffey. With respect to the Volcker Rule? Mr. Stivers. Yes. Ms. Coffey. We are very heartened by the work that Mr. Barr has done on this with the prospective legislation. We think it goes a long way to addressing the issues both in dealing with the legacy issues of CLOs that were purchased over many years. We think that will be very helpful. And we also think the language that he proposed for clarifying what an ownership interest would be will be very helpful going forward. One of the things, however, that has emerged since Mr. Barr has been working on his legislation is that we have heard from the regulatory agencies that they might expand their definition of what an ownership interest is, to like subsection D, subsection E, which talks about conflating, perhaps, interest payments with excess spread. And to the extent that continues to be a problem, we might want to provide additional support on that bill. Mr. Stivers. So what Ms. Coffey said, and I think it makes sense, is that Mr. Barr's approach is a good starting point for fixing the CLO problem. And I think while there have been some potential new issues brought up or are being discussed by the regulators that could require some additional changes, I think his approach is certainly a good start. And I want to applaud him for all the work that he has done on this issue, and thank him on behalf of manufacturers in my district that use asset- backed securities and on behalf of folks who have been purchasers of CLOs in the past. I think all the work he is doing will make a big difference for the future of the whole ABS market. I guess my other question is on coordination. And we will just kind of ask the panel, since I have a minute and 15 seconds left. Do you agree with the statement that the regulators have coordinated all the regulations that I talked about well so that they interact well? If the answer is yes, raise your hand. I would like to note that no one raised their hand, and that I do believe there are real problems with the interactions of many of these rules and they haven't looked at the cumulative impact in how they interact with each other. And while it was stated earlier that the risk retention rules may supersede some of the requirements on what the limits under the Volcker Rule are, it is still unclear what the interactions of many of these rules are doing together. And I think it is really important that the regulators sit down and try to coordinate these rules. Because as they come out drip, drip, drip one by one there is no real coordination on this and not enough coordination that makes them work well together. Does anybody disagree with that statement? I would like to note for the record that everyone agreed with that statement. Mr. Weidner. We agree. And I think what we see--what we are heartened to see is that there is now an effort to try to coordinate. And I think that is going to be very helpful, as we try to address these issues across multiple agencies and try to come to consensus. And-- Mr. Stivers. It is a starting point. Thank you. Mr. Weidner. It is a starting point. And I think that we are appreciative of that, but to this point I think it was something that was needed. Mr. Stivers. Thank you. I am out of time, so I will yield back. Thank you, Mr. Chairman. Chairman Garrett. The gentleman yields back. Mr. Foster is now recognized. Mr. Foster. First off, I would like to compliment the chairman and the bipartisan members of the committee who have engaged on this issue. I think it has been very productive and a breath of fresh air. And seeing the committee and the regulators coming in and trying to deal with, in particular, the legacy issues, which I think are really more an unintended consequence of this. But I was more interested--my one question has to do with going forward. Ms. Coffey, you had mentioned the interest cost savings from borrowers, basically having to do with the existence of the CLO market. And the CLO market, by most accounts, has significantly healed itself by finding Volcker compliance ways of doing business. And so, it is at least partially recovered. I was wondering what fraction of the lowered cost of interest rates really have been recaptured by that healing and the workarounds for the Volcker Rule versus what fraction-- because of compromises in the structure that the market might have found all by itself without the Volcker Rule presumably has some increased interest rate cost. What fraction of the potential savings from CLO have been recaptured by the market healing itself? Ms. Coffey. I think that is an excellent question. The Volcker Rule is an immediate dislocation in the market that we are dealing with today. So, we are observing that right now. And any healing that we have seen with respect to Volcker has come from the comfort market participants are taking in the fact that lawmakers are taking this issue very seriously and working together to resolve it. So, we are hoping we can heal that. The numbers I quoted before, the fact that you could see if CLOs go away, that it would cost U.S. companies $2.5 to $3.8 billion of annual interest. That excludes concerns around Volcker and was focused significantly on risk retention. If risk retention went forward the way it is currently written, it is estimated it would reduce CLO market by 60 to 90 percent. And that in and of itself, excluding Volcker, would cost U.S. companies $2.5 to $3.8 billion. Mr. Foster. Okay. Is there now, or will there be--would it be possible in the future to quantify the impact of the restructures to work around Volcker that have taken place in the marketplace? To eyeball roughly what the economic damage was or was not? Ms. Coffey. I think once we come through and resolve this, which I do hope that we can do with your help, then I think we can look back and say, here is the damage that we avoided because we did resolve it. It may be a little too early to assess that now. Mr. Foster. Okay. Well, thank you. That was my one question. I yield back. Chairman Garrett. Mr. Barr? Mr. Barr. Thank you, Mr. Chairman. I appreciate the testimony of the panel. And Ms. Coffey, a question to you. You testified that it has been estimated that if Volcker is not changed, demand among banks for CLO notes could drop by 80 percent, significantly reducing CLO formation and reducing credit availability. If these borrowing--if borrowing costs do increase because of lack of credit availability, what will that mean to these businesses that rely on CLO financing? Ms. Coffey. Right. I think that is a very good question and very important going forward. I think one of the things that is important to understand is just how broad the Volcker problem is. Some people say it is hard to quantify exactly how much of a problem Volcker is. But in fact, that information is available and it is available publicly. Reuters published a publication and a chart that observed that 62 percent of U.S. CLOs have bonds in them, usually less than 3 percent, but do have bonds in them. And all CLOs have bond buckets so they are able to invest in bonds. And hence, they would end up being covered funds. Moreover, these CLOs will not go away any time soon. There are about $300 billion of CLOs outstanding today. In July 2015, it is estimated there will still be $240 billion of CLOs outstanding. So, this is a big problem. This goes to the issue that you asked of what will this do to borrowers. If you have a situation where the Volcker Rule basically impedes U.S. banks and some foreign banks from investing in CLOs, you could see their appetite reduced by about 80 percent. They just will not participate in the CLO market. And ultimately, that leads to our other point, in that we could see a significant cost of financing for U.S. companies. What happens when you have a significant cost of financing, or a decreased credit availability for companies? That means these companies which have over 5 million employees can't build new factories, and can't build new cellular networks; they can't expand. They can't combine and merge to build bigger companies that can compete effectively globally. It ultimately would have a very destructive effect on U.S. companies. Mr. Barr. With all respect to Professor Levitin, when he talks about systemic stability and the need to fulfill the Dodd-Frank's mandate for systemic stability, what does this actually do in practice in terms of the stability of the financial markets? Ms. Coffey. I think it certainly reduces financing for U.S. companies. And I think financing for U.S. companies is very important for the economic situation in the United States. Mr. Barr. Professor, in all fairness, I will give you an opportunity to respond. Mr. Levitin. I greatly appreciate that. I think there is a really important assumption underlying Ms. Coffey's analysis. And that is that to the extent that banks are not able to invest in CLOs, the pool of money that would be invested there just disappears from the economy. It doesn't. Banks may reduce their lending, but they can also put that money into other forms of asset classes. And it is actually a very complicated analysis that I don't think anyone has done to figure out really what the ultimate cost effect is going to be on cost to financing. It may go up. Mr. Barr. But we do--in January, we had a cratering of the CLO market. So we do know that without any kind of congressional intervention, we saw what it was going to do. Let me--because my time is running out. Mr. Levitin. We saw that for 1 month, but we have this month also. I would just add to this that CLOs are one way that companies can finance themselves. There are other ways. It is not as if companies are not going to have financing routes. This isn't as if no one could get a mortgage. This is just one particular financing channel. Mr. Barr. Professor, thanks for your testimony. Since my time is running out, I do want to get at kind of the crux of the matter here. In your testimony, you argued that structured financial products fueled the housing bubble and produced the financial crisis. I would be interested to hear from the other members on whether or not there was any reason why either the Volcker Rule or the risk retention rules should not apply to CLOs in a way that they would apply to mortgage-backed securities. In other words, is there a reason why CLOs are different? Mr. Weidner. If I could take the--I think we have consistently said, our membership, is that CLOs are not the type of originate-to-distribute type of securitization that is cause for concern, and has been really the impetus behind risk retention in terms of aligning interests in a way that ensures that the underlying assets are well-underwritten. What we have seen, and it is just very--we have seen the structural feature of these deals, the quality of the assets and how they have been actively managed, the rigorous reviews that they have. There are a number--those types of things have led to the performance of those assets through very difficult times. So from our point of view, there is an alignment of interest. There hasn't been--who is to say who the sponsor of these are? The assets are acquired in from the market. So from our point of view, there isn't a driver here to say that risk retention is needed because we need someone to hold for the duration of the deal to make sure that the pool is being properly--is put together. But one thing to appreciate about all this--and when you think about different type of ABS--CLOs are the only asset type that are actively managed. Pool assets are coming and going out, you could turn a portfolio over to 35 to 40 percent. So I think that what we are seeing is the structural feature and the criteria of what goes into underwriting an asset going in are the types of things that risk retention is getting at, which is to make sure that there are good underwriting standards of the assets that come in. And so we see a difference as opposed to these other ABS assets, which are static, and you are wanting to make sure-- most of these are static, and making sure that somebody retains an interest who is actually securitizing these assets. This is not that product. Mr. Barr. Thank you. I yield back. Chairman Garrett. Thank you. The gentleman yields back. And that completes our hearing for today. We have been called to votes. I once again want to thank each and every one of the witnesses, those who have been here before and new witnesses, as well. The Chair notes that some Members may have additional questions for this panel, which they may wish to submit in writing. Without objection, the hearing record will remain open for 5 legislative days for Members to submit written questions to these witnesses and to place their responses in the record. Also, without objection, Members will have 5 legislative days to submit extraneous materials to the Chair for inclusion in the record. And without objection, we are hereby adjourned. [Whereupon, at 4:03 p.m., the hearing was adjourned.] A P P E N D I X February 26, 2014 [GRAPHIC] [TIFF OMITTED]