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April 17, 2020  

Banks See CLO-Issuing Window in TALF

Even as most collateralized loan obligation professionals dismiss the Federal Reserve’s Term Asset-Backed Securities Loan Facility as being too restrictive to lure them into the market, banks are thinking about taking advantage of the program.

The efforts primarily would see the banks create so-called balance-sheet CLOs backed by their own newly originated loans, and retain at least the top classes of the issues. The institutions then would turn those securities over to the Fed as collateral for the low-cost financing TALF promises to provide.

Banks also are looking at the possibility of stepping in to arrange CLOs underpinned by loans they have been warehousing for issuers, again with the intent of retaining the senior bonds for use in TALF. But such offerings could prove more difficult to carry out, due to a yet-to-be-defined provision that limits TALF financing to CLOs backed by newly originated accounts.

To that end, banks might combine aspects of the two approaches by allowing CLO issuers on their client rosters to buy new “A” loans that normally are syndicated among banks, as opposed to “B” accounts that more often are sold to institutional investors. The CLO issuers also could buy interests in revolving lines of credit.

“People are definitely working on that,” one source said. “It will let them get warehouse lines off their books and [in doing so] maintain their relationships with managers. It gets other loans they had to make for relationship purposes with loan issuers off their balance sheet at a reasonable price.”

The thought is that the maneuvers would help achieve the Fed’s goal of boosting corporate lending by freeing up capacity for banks to both write new loans and extend fresh warehouse lines to CLO issuers. An April 9 term sheet that added CLOs to the list of TALF-eligible deals, meanwhile, contains a number of qualifications that limit its usefulness for mainstream managers and investors.

In addition to being backed by new loans, for example, a CLO must be underpinned by a static asset pool, as opposed to an actively managed portfolio. Financing also is limited to deals completed after March 23. “A CLO manager can’t stay in business by printing static deals,” one source said, pointing to low management fees attached to such offerings. “It’s not a viable business model. You need the same amount of credit analysis as an actively managed deal.”

There also is concern about a move in which the Fed removed U.S. branches of foreign banks from its list of companies eligible for TALF loans, a move that would seem to deny participation to Japanese banks. But those institutions are such big buyers of senior CLO paper that the Fed is expected to clarify its position to include them.

Another issue: The Fed’s decision to use its Secured Overnight Funding Rate as the benchmark for TALF loans written against CLOs raises concerns about potential interest-rate mismatches, since the underlying securities typically are pegged to three-month Libor. And even if the CLO notes themselves were benchmarked to SOFR, there would still be potential mismatches between the bonds and their underlying loans.

“The only good news is the [latest] Fed term sheet has a provision that says ‘subject to further review,’ ” another industry professional said. To that end, it could make more sense to push for the inclusion of older CLOs than to get the Fed to agree on a favorable definition of a new deal, the source said.

When it comes to the banks’ possible efforts, Greg Cioffi, a partner at law firm Seward & Kissel, noted that current TALF terms don’t explicitly address balance-sheet CLOs. “This would not have been possible in the original TALF, which typically restricted a borrower from obtaining a TALF loan for ABS backed by loans originated or securitized by the borrower or affiliate of the borrower,” he said.

However, CLOs weren’t an approved asset class in the first iteration of TALF in 2009-2010.