April 15, 2020 - On Thursday, April 9th, the Federal Reserve announced an additional $2.3 trillion of lending programs, including rough term sheets for many programs. The good news? Loans and CLOs were explicitly included in Term Asset-Backed Securities Loan Facility (“TALF”). In effect, the TALF program provide funding to entities holding the AAA notes of new CLOs that invest in newly issued loans. The less good news? The fit is not yet perfect. (But we are commenting.) We discuss all below.
As described in the LSTA’s webcast on the “Federal Reserve’s $2.3 Trillion Lending Programs and the Syndicated Loan Market”, it’s important to understand what the Fed is trying to achieve. Specifically, the term sheet states that TALF is intended to help meet the credit needs of consumers and businesses by facilitating the issuance of ABS … and improving the market conditions for ABS more generally. In effect, the Fed is trying to indirectly get liquidity to consumers and businesses through TALF.
The TALF term sheet covers i) characteristics of TALF borrowers, issuers and collateral and ii) the TALF loan terms. TALF Borrowers are the entities that buy the CLO AAA notes and receive TALF financing that is secured by the CLO notes. The Issuer is the entity that issues the CLO notes. The Collateral are the loans in which the CLO invests. A sticking point is that both the Borrower and the Issuer are defined as U.S. Companies in the TALF term sheet. While a U.S. bank (or insurance company investing for the general account) likely would qualify as a “Borrower”, a foreign bank or a Fund would not. Likewise, the Issuer is typically an SPV, not a U.S. company. In addition, the credit exposures (collateral) must be “originated by a U.S. company”, which generally is not accurate in the context of syndicated loans. In these cases, we likely would seek clarifications to make the language work.
Additionally, the TALF programs are generally for static ABS (which many ABS are), and the Fed specifically notes that the CLOs will be static. We believe they feel strongly on that point. A final point is that the CLO is meant to buy “all or substantially all” newly issued loans. Market participants point out that the CLO ramp period is sufficiently slow and diversification requirements are sufficiently broad that some non-new issue loans presumably would be necessary in order to get new CLOs ramped and new loans into the hands of companies.
Next, the TALF loan terms. The TALF CLO loans would be priced at 30-day average SOFR+150 bps; 30-day average SOFR was 5 bps as of Wednesday, so this is an all-in rate of 1.55%. While today’s basis strongly favors the TALF Borrower, they would take on basis risk if the financing were in SOFR and the CLO AAA notes paid on LIBOR.
The TALF loans generally would be haircut by 20% if the ABS average life is less than 5 years (and the haircut increases 1% per additional year). We believe this means that, for example, a Borrower with a $100 million CLO AAA investment could borrow $80 million under TALF at SOFR+150. The loan is secured by the CLO AAA notes – which have never suffered a default – and is non-recourse to the borrower. Finally, TALF loans are scheduled to be extended through September 30, 2020; market participants feel this might be a be short, based on how long it takes to get programs up and running and CLOs ramped. While there are many moving parts, the LSTA also is moving quickly – and will be submitting comments to the Fed by the April 16, 2020 deadline.