On April 1, 2013, final FDIC rules take effect that could require banks to incur higher deposit insurance premiums for their holdings of collateralized loan obligation (CLO) tranches. FDIC assessment rates are now based on a bank's assets less liabilities, instead of being deposit-based. The FDIC's final rules amend and clarify certain regulatory definitions used to determine deposit insurance premium assessment rates on the holdings by large depository institutions of assets deemed "higher-risk." Under the new rules, the FDIC will charge higher assessments for certain higher-risk assets, which will now include many CLOs, regardless of rating or subordination. Even AAA-rated CLO notes may now be considered higher risk and could trigger higher assessment rates.

The new rules apply only to loans and asset-backed securities (ABS) issued after April 1, 2013, and any loans or ABS purchased before April 1, 2013 are grandfathered in as non-higher-risk assets. As the LSTA points out, the rule states that "[b]anks will not need to review securitizations issued before April 1, 2013 to determine whether they are higher risk under the final rule. The new higher-risk definitions in the final rule will apply only to securitizations on or after that date, regardless of the date of origin of the underlying loans."

The LSTA notes that the higher-risk category includes ABS backed by at least 50% higher-risk assets, defined in the rules as the sum of construction and land development (C&D) loans, leveraged loans, subprime loans and nontraditional mortgage loans, regardless of rating or subordination of the securities backed by these assets. The new definition of higher-risk assets encompasses the leveraged loans that underlie and collateralize most CLOs. These loans are referred to in the rules as "higher risk C&I loans," which the LSTA describes as M&A-related loans with a debt-to-EBITDA multiple greater than 4X or a senior-debt-to-EBITDA multiple greater than 3X. The assessment will therefore now capture many AAA-rated CLO tranches. The revised assessment definitions also include subprime consumer loans, which are renamed "higher-risk consumer loans."

While these new definitions apply to all ABS, CLOs are affected the most because they are backed by the leveraged loans that are captured by the new FDIC definitions. Subprime and nontraditional transactions have been rare since the onset of the financial crisis.

This development stems primarily from two rule changes:

For more detailed information on these rules, see Legal Updates, FDIC Approves Final Rule on Deposit Insurance Assessments and FDIC Issues Final Rules on Deposit Insurance Pricing for Large Banks.

As a result of the pending expiration of the grandfather date for these rules, there has been a rise in bank purchases of CLO tranches, as banks look to avoid the higher assessment rates. However, it should be noted that there is uncertainty around what effect the new rules will actually have on the assessment rate because the formula for determining the assessment rate is complex and bank-specific. The recent rise in CLO purchases may therefore reflect banks' choice of certainty over uncertainty.

For more on current issues facing CLO managers, see Practice Note, Current Issues Facing CLO Managers.