Revisions in the Federal Reserve’s TALF program will allow collateralized loan obligations a broader range of leveraged loans to be used as collateral.
But while welcomed by the loan industry, the changes still leave CLO market observers unsure if the $100 billion Term Asset-Backed Securities Loan Facility program will have the desired impact on investor demand and new-deal issuance, given key restrictions that remain in place.
“It’s not going to open up the floodgates, but it can have some measured effects,” said Gregg Jubin, a partner at Cadwalader Wickersham & Taft LLP. “This looks certainly better than the first iteration.”
The Fed will now accept new AAA CLOs with leveraged loans, including refinanced loans, that priced as far back as January 2019, according to a
Also now eligible for TALF are CLOs with secondary-market loans.
The Fed's moves were designed to boost CLO investment, and in turn create more capital for business lending (including for middle-market borrowers). They could also help unwind $15 billion to $20 billion of warehoused leveraged loans from the books of major banks, according to leveraged-finance research from Wells Fargo.
TALF’s impact "certainly could affect issuance and cost of liabilities in the market overall," said Al Remeza, an associate managing director leading the primary CLO rating team at Moody's Investors Service. "But, it’s speculative at this point."
The Fed’s decision should help increase some demand in the $690 billion CLO market, which so far hasn’t benefited much from the central bank’s effort to boost credit liquidity strained by the economic impact of the coronavirus pandemic.
But TALF will still restrict its financing to so-called “static” CLOs, in which asset managers are disallowed under deal terms with investors from buying and trading loans in the portfolios. For TALF eligibility, CLOs must remain static for the duration of a three-year TALF loan.
Actively managed CLOs traditionally have made up the bulk of annual issuance, as they provide the ability for asset management firms to maximize equity returns and favorable "arbitrage," (i.e., the difference between the interest paid to buyers of the securities and the income collateral managers generate from the underlying loans).
“If the underlying securitization must have a three year non-call, we do not expect CLOs to benefit from TALF,” wrote research analyst David Preston, the head of CLO and commercial ABS research at Wells Fargo on Tuesday.
Larry Berkovich, a partner at Allen & Overy LLP, said it was "a little disappointing in that it doesn't pave the way to arbitrage deals by not allowing any reinvestment whatsoever while the AAA notes are pledged under TALF."
Broadly syndicated CLOs priced since the Fed’s March 23 launch of the new TALF program have largely been issued with static pools of loans, according to analysts.
But other aspects of the Fed’s TALF revision on loan eligibility are still likely to be welcomed by managers, lenders and investors. The new guidelines will permit TALF financing in CLOs that include loans issued since Jan. 1, 2019 — rather than the former restrictions limiting TALF assistance to CLOs pooling only newly issued loans from corporate borrowers.
TALF loans can also be used to purchase securities issued from refinanced CLOs. Managers will often refinance outstanding portfolios reaching the amortization stage, with the consent of investors.
It’s “a positive sign for the market that the look back for eligible collateral extends back to the beginning of 2019 and also includes refinancings since that time, as is the fact that the Fed appears to have taken into consideration certain detailed aspects of how the CLO market operates,” said Nick Robinson, another partner at Allen & Overy.
The TALF changes may particularly benefit existing CLO warehouses that hold qualifying loans, Jubin said. CLOs typically use warehouse credit lines to buy and store loans before going out and marketing the deals to investors. Many remain stuck with the banks that financed them as today’s wider liabilities crimp CLO arbitrage.
"It would certainly be very helpful to monetize and securitize pre-COVID warehouse lines," Berkovich said. "Monetizing those lines would also free up capital for banks to deploy for more lending, which achieves TALF’s concern to allow more funds for corporate America to borrow."
One uncertainty introduced by the Fed’s revision regards the interest rate offering from its program — 150 basis points over the 30-day average Secured Overnight Financing Rate published by the New York Fed. Most CLO notes are typically priced to the higher three-year Libor — setting the stage for a benchmark-rate mismatch affecting investor returns.
“It's clear that there's currently a SOFR requirement for the TALF loan,” said Peter Hallenbeck, a vice president and analyst on the CLO ratings team at Moody’s. “It's not clear yet whether people putting together these deals would actually use Libor or SOFR as the base rate for the CLO liabilities.”
(This story includes reporting from Bloomberg News.)
