For several months now market participants have speculated whether the government would intervene in the CLO market.
Now, it seems that is becoming more likely, with bankers, market associations and investors calling for Uncle Sam to include CLOs within the Term Asset-Backed Securities Loan Facility (TALF). But while some say this could help the overall economy, others are not convinced.
TALF was created last fall to help jumpstart lending to small businesses and consumers. Initially, the plan was to loan $200 billion to the holders of triple-A-rated asset-backed securities the securitized products for credit cards, auto, student and small business loans.
But that number, and the scope of where TALF would invest, grew, and now the piggy bank is around $1 trillion. Moreover, the economy has weakened further, along with the financial strength of many noninvestment-grade companies, which make up the majority of U.S. businesses. And this has caused the government to propose extending TALF funding to CLOs, a significant buyer of corporate debt.
By the end of 2008, CLO issuance in the U.S. had fallen to less than $20 billion for the year, according to Citigroup Global Markets. However, even to the Citi analysts who analyze CLO data, that was an exaggeration of just how much demand there was out there. And, without any external intervention, they said the outlook for 2009 will be even bleaker. To stimulate lending to this segment of the market, we believe government action is key, the analysts said in a recent report.
The train of thought here is that if the government helps revive the market for leveraged loans, a market that was primarily supported by CLOs, then it will refuel corporations across the country. The Feds TALF program would be a logical mechanism for doing this, Steven Bavaria, the director of leveraged finance at DBRS, said in a March 17 letter. It would have a powerful impact on, first, the credit markets, but with a secondary spillover onto the equity markets.
Better Fed Than Dead
If TALF were extended to include CLOs, it would be good news for banks and investors because of the added liquidity it would provide. Banks would be able to put investors on one side, companies on the other and TALF in the middle, said a Boston-based investor.
Moreover, if TALF were made available to buy collateralized pools of loans made to companies with loans trading at distressed levels, it would unlock the leveraged loan market and prices of debt for healthy borrowers would return to par or close-to-par, Bavaria said. This would remove the fear factor for thousands of investors and allow money to flow back into high yield bonds, leveraged loans and similar funds.
The idea of extending TALF to include CLOs is just that, an idea. But some investment managers are already looking to capitalize on the additional funds. If there is a business and there is money to be made, we would definitely be involved in that, the Boston investor said. We have people here that are looking at the opportunities of TALF. This is money that is coming into the market, money to be made. And we should be on top of it.
Churchill Capital, in a recent letter to its clients, said, Just as ABS is a good proxy for consumer debt, CLOs (half of leveraged loans) speak for corporates. CLO technology is also well-suited for TALF: The buyer network is in place, risks are somewhat diversified, and the Fed avoids direct lending.
However, other market participants feel that there would be a conflict with loan investors regarding an extended TALF program. Considerable hurdles exist, such as tenor mismatches, diversity requirements, ramping requirements, triple-A-rated subordinated issues and equity returns, according to the Loan Syndications and Trading Association (LSTA). These issues, the LSTA said, must be addressed before TALF would be able to work for CLOs.
The prospect of the government buying corporate debt is not just an American initiative, its also happening across the pond. The Bank of England, the U.K.s central bank, is planning to purchase approximately £75 billion ($106.9 billion) in corporate bonds. These would be investment-grade bonds because tax payers would be reluctant to take the idiosyncratic risk of owning lower-rated companies, the Citi analysts said.
The U.K. model differs with what some sources say is the point of extending TALF to include corporate debt: to make it easier for lower-rated companies to access the funding they need. Investment-grade companies, they say, already have easy access to funding.
Others disagree with the idea of extending TALF to include CLOs because they dont see it impacting the economy much, and thus see it as a waste of taxpayer dollars.
[TALF extended to CLOs] wouldnt do much. The government needs to help consumers more, a Connecticut-based investor said. From my position, its great because I would obviously do a TALF CLO with the added liquidity. But the CLO market will not help the economy. Depressed loan prices arent hurting the economy. Im cured by economic gains, meaning its better for me if more people buy crafts and school supplies and I own debt for Michaels Stores. People spending money is the cure.
Waiting To Hear
On March 24, the market will learn whether the government will try to cure the CLO market. That is when the Federal Reserve and Treasury Department will announce the second phase of TALFs funding policy, which could include CLOs.
While some have their doubts, most agree that, in a market like this, getting new funds to companies and adding liquidity is a crucial step towards recovery.
The concept of CLOs being a part of that could be very helpful, a source said. It certainly can be helpful because there is a lack of liquidity. Most people find CLOs to be fundamentally a good investment, but the problem with CLOs is the money it takes to run them. People are lacking size and scale, and that really prevents new issuance. Under TALF, $1 of investment creates $8 or $9 through government financing. So with that, youd have a better chance of getting what is the majority of a companys capital structure together.