TALF 2.0 Expanded to Include Static CLOs as Eligible Collateral

Today, the Federal Reserve announced that it will expand the Term Asset-Backed Securities Loan Facility program (“TALF”) to include certain collateralized loan obligations (“CLOs”). The Fed’s initial term sheet released in March did not include CLOs on its list of eligible collateral that prospective borrowers could pledge to secure TALF loans. Orrick’s post discussing the Fed’s initial announcement of “TALF 2.0” is available here.

The announcement is a welcome development, but, for the reasons described below, will have a very limited effect on the traditional CLO market.

CLOs under TALF 2.0

A revised term sheet attached to the Fed’s announcement adds asset-backed securities (“ABS”) backed by “leveraged loans” to the definition of Eligible Collateral, subject to the following restrictions:

• only AAA-rated CLO paper (rated by at least two NRSROs) will be considered eligible collateral;
• only static CLOs will be considered eligible collateral, meaning that traditional, managed CLOs with reinvestment features will not be eligible collateral under TALF;
• to be eligible under TALF, a CLO must be issued on or after March 23, 2020;
• the underlying leveraged loans in the CLO’s portfolio must be “newly issued” — a term that, as it applies to the underlying collateral for eligible ABS, is yet to be clarified by the Fed (as discussed in more detail below);
• the CLO issuer must be a “U.S. company”, which presumably means a U.S. organized entity (this is a departure from market practice in the U.S. CLO market, in which CLO issuers are most commonly organized in off-shore jurisdictions, such as the Cayman Islands);^[1]
• eligible CLOs must have a weighted average life of less than ten years; and
• commercial real estate CLOs will not be eligible collateral under TALF.

Haircut: CLOs pledged as collateral will be assigned a haircut of 20% where the weighted average life of the collateral is less than five years. The haircut will increase one percentage point for each additional year (or portion thereof) beyond five years.

Pricing: For CLOs, the interest rate will be 150 basis points over the 30-day average secured overnight financing rate (“SOFR”).

Maturity: Each loan provided under TALF will have a maturity of three years.

Looking Ahead

The Fed’s revised term sheet leaves open a number of issues relevant to CLOs that are likely to be addressed in the more detailed TALF terms and conditions that have not yet been published.

For example, the Fed’s forthcoming detailed terms and conditions is expected to provide clarity on when a “newly issued” leveraged loan must have been originated. The 2008 TALF terms and conditions specified different origination cut-off dates for each of the various types of underlying credit exposures, which ranged from 0-2 years prior to the related ABS issuance cut-off date.^[2] The timing of the cut-off date for leveraged loans under TALF 2.0 will determine how useful TALF will be to the CLO market, and, in particular, how it might apply to outstanding leveraged loans that are currently being warehoused.

In addition, the revised term sheet does not indicate whether eligible collateral may have the type of redemption features that are common to CLOs. If, in fact, the new terms and conditions will be closely modelled on the 2008 TALF terms, it is important for CLO market participants to note that the 2008 TALF terms and conditions provide that ABS “with a redemption option (other than pursuant to a customary clean-up call) [are] not eligible as collateral unless the ABS issuer has received acceptance of such redemption option from the New York Fed.”^[3] At this point, it is not clear whether TALF 2.0 will have a similar prohibition. However, if it does, the prohibition would impact the structuring of a CLO intended to be TALF-eligible.

Although only static CLOs are considered eligible collateral under the term sheet, the Fed stated that it will consider “expanding the scope” of eligible asset classes in the future. Currently, the exclusion of managed CLOs from the definition of eligible collateral and the requirement that the CLO issuer be a U.S. entity severely limits TALF-access for the majority of the CLO market.

^[1] The revised term sheet includes, in its description of the ABS that will be eligible collateral, new language (italicized in the following quote) that provides: “All or substantially all of the credit exposures underlying eligible ABS must have been originated by a U.S. company, and the issuer of eligible collateral must be a U.S. company.” If that remains a requirement under TALF, then all TALF-eligible CLOs will be required to be brought on-shore, requiring some adjustments for U.S. tax purposes.
^[2] For example, under the 2008 TALF terms, eligible ABS collateral had to be issued on or after January 1, 2009, but, for certain asset classes, the underlying assets themselves had to have been issued on or after an earlier cut-off date. Student loans, for example, had to have a disbursement date on or after May 1, 2007; and equipment loans, October 1, 2007.
^[3] See Term Asset-Backed Securities Loan Facility: Terms and Conditions (November 13, 2009), https://www.newyorkfed.org/markets/TALF_Terms_print.html.