The TALF CLO Trilogy Concludes: Too Little, Too Late

The Fed throws a bone to the CLO market by reducing the non-call period from three years to one year, but this small victory will likely have little impact given the numerous obstacles which remain unaddressed.

Introduction

In May 2020, the Federal Reserve Board of Governors (the “Federal Reserve”) and the Federal Reserve Bank of New York (“New York Fed”) released several updated FAQs (“TALF FAQs”) for the Term Asset-Backed Securities Loan Facility (”TALF”) program. During May 2020, we released two Dechert OnPoints, one for each set of changes to the TALF FAQs and their impact on CLOs.¹ On June 8 and on June 15, the Federal Reserve and the New York Fed further updated their FAQs on the TALF program (“Updated FAQs”). One of the most notable changes of the Updated FAQs was a revision which shortened the non-call period applicable to collateralized loan obligation transactions (“CLOs”) from three years to one year. As revised, a CLO can be TALF-eligible if it has a redemption option exercisable no earlier than one year after issuance date, so long as the call option provides for full outstanding principal amount plus any accrued interest. (Customary clean-up calls are still excluded). The New York Fed also further refined the certification regarding adequate credit accommodation. However, on balance, we do not expect any of the most recent changes to result in TALF being widely utilized in the CLO market, barring some unforeseen economic fallout.

Revised Certification

One of the sticking points to the TALF program that market participants have encountered is the requirement that a TALF borrower certify that it is “unable to secure adequate credit accommodations from other banking institutions.” In the most recent Updated FAQs, the New York Fed clarified that, in making such certification, the TALF borrower can rely on the unusual economic conditions present in the specific sector of the ABS market applicable to that TALF borrower, rather than on the ABS market as a whole. As an example, elevated spreads in ABS issuance market for that asset class can support the certification, as well as elevated rates of haircuts in the financing market relevant for the CLO securities. Thus, a TALF borrower could make this certification as to CLOs if they can determine that the borrowing costs for CLO issuers are higher than usual or that the borrowing costs for a holder of CLO securities seeking to finance such CLO securities are higher than usual. 

Outlook

Despite the small victory on the non-call period, the Updated FAQs failed to address the gating items identified in our May 2020 Dechert OnPoints, including uneconomic pricing and haircuts applicable to CLOs and rigid trading restrictions. Meanwhile, the CLO market seems to be tentatively recovering, at least in the broadly-syndicated loan (“BSL”) space. To the extent we see any TALF eligible CLO activity, we expect it to develop primarily in the middle-market CLO space. While we do not anticipate that many CLO managers of BSL CLOs will opt to create TALF-eligible CLOs, the good news is that TALF may not be needed. 

Dechert will continue to monitor all developments relating to the Federal Reserve's announcements closely, and we encourage our readers to follow our regular updates on our COVID-19 Coronavirus Business Impact website.

Footnotes:
1.) See the May 2020 Dechert OnPoint – TALF CLO Update: the Fed Puts More Devil in its Details and the May 2020 Dechert OnPoint CLOs and Term Asset-Backed Securities Loan Facility (TALF)—We’re Not That Desperate (Yet). For a general description of the Fed’s announcement of the TALF Program, see the March 2020 Dechert OnPoint - Federal Reserve Established Term Asset-Backed Securities Loan Facility (TALF). For a general description of the April 2020 term sheet, see the April 2020 Dechert OnPoint – Federal Reserve Releases Updated Term Sheet on the Term Asset-Backed Securities Loan Facilities (TALF). For a general description of the Updated Term Sheet, see the May 2020 Dechert OnPoint - Federal Reserve Further Revises Term Sheet and Releases FAQ for the Term Asset-Backed Securities Loan Facility (TALF 2.0).