April 22, 2020 - On April 9th, the Federal Reserve announced an additional $2.3 trillion of lending programs, which included the Term Asset-Backed Securities Loan Facility (“TALF”). In effect, the TALF program, as released, could provide funding to entities holding the AAA notes of new CLOs that invest in newly issued loans. This could indirectly provide financing support to U.S. companies that needed it.
Unfortunately, there were aspects of the TALF program that made it an imperfect fit. And so, the LSTA submitted a comment letter describing how the TALF can be refined to most quickly provide financing to companies in need. We believe that the CLO market could provide new credit to U.S. corporate borrowers if TALF CLOs are also attractive to investors and workable in rating agency models. Our comments attempt to satisfy both the Federal Reserve’s efforts to provide liquidity through CLOs and investor and rating agency criteria for new CLOs.
Our letter provides (i) specific recommendations to the definitions of borrower, issuer and credit exposures, (ii) recommended refinements of the definition of “newly issued” assets to facilitate a rapid ramp-up of CLOs (and hence a more rapid deployment of capital to U.S. companies), (iii) historical context on CLO AAA performance and its relevance to haircut schedules, (iv) recommendations on the timeline for TALF loans and (v) other changes that could make the TALF program most effective.
First, the TALF defined Borrowers (those entities that would borrow from the TALF, using CLO AAAs as collateral) and Issuers (the SPVs that issue CLO notes) as U.S. companies. We explained that this definition was too narrow and provided a better fitting definition. Likewise, the credit exposures had to be originated by U.S. companies; again we provided a definition that was workable within the context of the loan market.
Next was the definition of “newly issued”. The TALF requires “all or substantially all” credit exposures to be newly issued. CLOs are unlike most other securitizations in that they buy pieces of loans, which take time to aggregate into a portfolio. By the time a CLO could buy enough loans that were originated after April 2020 to fully ramp, the TALF window would be closed (and so, a rational CLO investor would never start providing credit under the TALF program in the first place). To solve this problem, we suggested that newly issued be defined as 2020 syndications and existing warehouses (which need to be cleared to start the ramping for new CLOs). In addition, we suggested that “substantially all” was 75%. We believe some modest amount of existing credits could start the CLO ramping process and allow them to provide new liquidity to companies.
We moved on to the haircut for CLOs. All TALF loans are subject to a haircut ranging from 5% for equipment leases to 20% for CLOs; this means that the Fed would lend $80 million against collateral of $100 million CLO AAAs. CLOs have the highest haircut of all the asset classes. We noted – and charted in the COW last week – that CLO AAAs have one of the lowest loss rates (0%) of all securitization asset classes and asked that the CLO haircut be more in line with their loss experience.
We also addressed timing; the TALF loans are scheduled to be available through September 30, 2020. However, between the time it takes to get TALF running and the time it takes to ramp a CLO, it would be more productive if the TALF loans were available through the end of 2020. Finally, we addressed several miscellaneous items that still could be problematic if not resolved.
The LSTA will continue engaging with the Fed to try to make credit available – directly or indirectly – to companies that need it.