May.14.2020
On Tuesday, May 12, the Federal Reserve (the “Fed”) announced additional information regarding the Term Asset-Backed Securities Loan Facility (“TALF”), including a further revised Term Sheet and an initial set of answers to Frequently Asked Questions (the “FAQ”). The updates supplement and amend the Fed’s initial announcement of TALF 2.0 in March and a previously revised Term Sheet that was released on April 9.[1] This alert summarizes key features of the revised Term Sheet and FAQ that impact the eligibility and treatment of collateralized loan obligations secured by leveraged loans (“CLOs”) under the program. Orrick will shortly release a separate alert related more generally to the program and the treatment of other classes of asset-backed securities (“ABS”).
CLO Issuers and Managers. The Fed eliminated the requirement that the issuer of eligible ABS (pledged to secure the TALF loan) be a “U.S. company.” This would have disqualified the vast majority of CLOs, which are issued by off-shore special-purpose companies. However, the FAQ notes that, for a CLO to be eligible as collateral under TALF, the manager of the CLO must have its principal place of business in the U.S.
The Loan Portfolio. In addition, according to the revised Term Sheet, for CLOs, “all or substantially all of the credit exposures underlying the [CLO]” (i.e., the underlying loans themselves) must (1) have “a lead or a co-lead arranger that is a U.S.-organized entity” (which may be a U.S. branch or agency of a foreign bank) and (2) “be to U.S.-domiciled obligors”. For this purpose, according to the FAQ, “substantially all” means “95% of the dollar amount” (which, presumably, is the aggregate par amount) of the underlying loans.
TALF Borrowers. Borrowers under TALF are still required to be U.S. organized entities with “significant operations in and a majority of its employees based in the United States.” As noted in the FAQ, examples of “significant operations” would include a borrower holding the majority of its assets or generating the majority of its revenue in the U.S. The Fed also clarified that, for borrowers that are investment funds, the U.S. nexus requirement would apply to the funds’ investment managers.
What Is “Newly Issued”? The Fed maintained the original “newly issued” requirement for CLOs. To be eligible as collateral under TALF, a CLO must be, or must have been, issued on or after March 23, 2020. However, a more lenient “newly issued” requirement will now apply to CLOs’ underlying loan portfolios. This will be welcome news to warehouse lenders and CLO managers interested in “terming out” warehoused loan portfolios. As far as the loan portfolios are concerned, all or substantially all (95% or more of the principal balance) of such leveraged loans must have been originated on or after January 1, 2019. Loans refinanced on or after January 1, 2019 will be regarded as “newly issued” for this purpose.
The FAQ identifies certain additional eligibility criteria that will apply to CLOs:
The static pool requirement remains in place for CLOs. However, the FAQ provides that an eligible CLO may include a springing reinvestment period that begins “at least three years after the disbursement date of any TALF loan secured by the pledge of such CLO”, as long as the documents expressly prohibit reinvestment for so long as the New York Fed or the TALF SPV “owns” the senior-most tranche of the CLO. Given that such notes would be in global, book-entry form, it is not entirely clear how a CLO would be able to monitor ownership in order to comply with this requirement.
The FAQ notes that managers may sell underlying loans that have “defaulted in payment of principal and interest” so long as the sale proceeds are used to amortize the CLO. As written, this implies that loans that are defaulted for reasons other than the non-payment of principal and interest may not be sold.
Separately, the FAQ permits the “sponsor” of the eligible CLO to purchase any of the loans for cash at par plus accrued interest so long as the proceeds are applied to amortize the CLO. It is not clear how the term “sponsor” should be interpreted in this context, or why purchases of loans at par that would amortize the CLO should be limited in this way. Unless clarified by the Fed, therefore, this provision seems to be applicable only to middle market CLOs (in which the identity of a sponsor, the originator, is apparent) and not to CLOs of broadly syndicated loans (in which there is no originator). As written, the provision could also be read to prohibit sales above par, which would be illogical in contexts in which a loan might be trading above par.
According to the FAQ, with the exception of customary clean-up calls,[2] any CLO with a redemption option “exercisable prior to three years after the disbursement date of any TALF loan secured by the pledge of such [CLO]” would not be eligible TALF collateral. Additionally, newly issued ABS must prohibit optional redemption at any time when such ABS is owned by the New York Fed or by the TALF SPV. Market participants are already questioning the Fed’s rationale behind these provisions in the context of CLOs, which typically include shorter non-call periods and only permit redemptions at par plus accrued interest to ensure the CLO noteholders can only be redeemed if they get paid their full entitlement to note principal and accrued interest. They see this requirement as a major, perhaps insurmountable, impediment to attracting equity investors to TALF-eligible CLO offerings and, therefore, to getting any TALF-eligible CLOs issued. Moreover, since, according to the terms proposed by the Fed to date, a TALF loan itself can be prepaid at any time, it is not clear why the underlying CLO collateral should not be redeemable at any time as well, so long as the proceeds are applied, as they would be, to prepay the TALF loan.
Another issue of concern is a borrower-attestation requirement that appears in the FAQ. According to the FAQ, “a TALF borrower will be required to certify that it is unable to secure adequate credit accommodations from other banking institutions and that it is not insolvent,” a requirement that appears to impose a duty on every borrower to seek financing from sources other than TALF before requesting financing from the Fed. The FAQ goes on to provide that the Fed “must obtain evidence that the [borrower was] unable to secure adequate credit accommodations from other banking institutions” and that “[the] certification may be based on unusual economic conditions in the market.” However, unless and until the Fed describes more clearly and more objectively the factual basis upon which that certification can be made, borrowers may be reluctant to provide it.
The FAQ clarifies that, for the time being, only Moody’s, S&P and Fitch are eligible NRSROs for purposes of the triple-A (or equivalent) ratings requirement.
The FAQ provides that a company may not securitize its own loan originations, acquire the triple-A-rated tranche of the securitization and then finance its acquisition using a TALF loan. While this would clearly render ineligible a CLO where all or substantially all of the underlying loans are loans originated by the TALF borrower or its affiliates, it is not clear whether a CLO would be rendered ineligible if only a portion of its portfolio consist of such loans.[3]
The FAQ also provides that if a TALF borrower, or its affiliate, is a borrower under a leveraged loan backing a CLO, that CLO will not be eligible collateral unless that loan, together with each other leveraged loan in the CLO made to such TALF borrower or its affiliates, comprises not more than four percent of the aggregate principal balance of the portfolio.
Orrick will continue to monitor and publish information about TALF as it evolves and is implemented. Please contact any one of the authors of this alert if you have any TALF-related questions.
[1] Orrick’s client alert discussing the Fed’s initial announcement of “TALF 2.0” is available here. Orrick’s client alert discussing the Fed’s April revision of the program to include CLOs is available here.
[2] Per the FAQ, a "customary clean-up call" with respect to a sponsor and its securitization refers to a clean-up call which is exercisable by the servicer or the depositor when the remaining balance of the assets or the liabilities of the issuer is not more than 10% (or a higher percentage customarily used by the sponsor in its securitizations that were offered before the TALF program was established) of the original balance of such assets or liabilities.
[3] A borrower, however, is not restricted from using an SBA Pool Certificate or Development Company Participation Certificate as collateral for its TALF loan even if the loans underlying the SBA ABS were originated by such borrower or its affiliates, provided that the borrower has no knowledge that the loans were originated by it or its affiliates.