Federal Reserve Announces First Subscription Date of June 17, 2020 for the Term Asset-Backed Securities Loan Facility, Further Revises FAQs and Releases Master Loan and Security Agreement
May 22, 2020
Introduction
On May 20, 2020, the Federal Reserve Board of Governors (the “Fed”) and the Federal Reserve Bank of New York (the “FRBNY”) announced the first subscription date of June 17, 2020 for funding under the Term Asset-Backed Securities Loan Facility (“TALF”) program. On the same day, the Fed and the FRBNY also released an updated Frequently Asked Questions (the “New FAQs”) and Master Loan and Security Agreement (the “MLSA”). The New FAQs generally add to the FAQs released by the FRBNY on May 12, 2020 (the “Initial FAQs”). The New FAQs and the MLSA supplement the latest draft of the term sheet released on May 12, 2020 (the “Term Sheet”)1.
The Fed’s most recent announcement together with the New FAQs and the MLSA includes some positive developments and provides both potential borrowers and investors with further guidance as to the operational mechanics of the TALF program. However, there are a number of concerns where further clarification from the Fed would be welcome.
Positive Developments
Loan Subscription and ClosingThe Fed has announced that the TALF’s first loan subscription date will be June 17, 2020, and the first loan closing date will be June 25, 2020. The New FAQs provide that there will be approximately two TALF loan subscription dates per month (seven to eight in total until September 30, 2020, which is the current expected end date for new borrowings), and each will be open to all eligible asset classes. It was also the case under the 2009 TALF program (“TALF 1.0”) that there were approximately two TALF loan subscription dates per month (there were 26 in total over the 15 months that the TALF 1.0 program was open for borrowing), but each window was specific to either CMBS or non-mortgage-backed ABS. As was the case for TALF 1.0, the Fed will set the initial benchmark rates for a TALF loan subscription one business day prior to the loan subscription date.
Minimum TALF Loan Amount
The New FAQs provide that a borrower under the TALF program (a “TALF Borrower”) must request a minimum of US$5 million for each TALF loan. The minimum is a reduction from TALF 1.0, which required a minimum loan amount of US$10 million. As was the case under TALF 1.0, the New FAQs provide that there is no maximum TALF loan amount.
Operational Mechanics and Eligible Collateral Review Process
The New FAQs provide guidance with respect to the operational mechanics of the loan subscription, closing and collateral review processes. As expected, these processes broadly follow the processes that were in place for TALF 1.0. As was the case for TALF 1.0, the New FAQs provide that throughout the risk assessment process, the issuer will be given an opportunity to discuss details and clarify potential areas of concern with the Fed. The New FAQs include additional language providing that, if the Fed becomes aware of any factors that could adversely affect the eligibility of ABS, the Fed will communicate with the issuer as soon as practicable.
Issuer and Sponsor Certification, Sponsor Indemnity Undertaking, and Auditor Assurances for Newly Issued ABS
The issuer and sponsor certifications, sponsor indemnity undertaking and auditor assurance requirements for newly issued ABS broadly follow the processes that were in place for TALF 1.0, subject to updates to account for the applicable eligible collateral and the introduction of Rule 15Ga-2 since TALF 1.0 was in place.
The New FAQs provide that the “sponsor” must sign (i) the issuer and sponsor certification as to TALF eligibility and (ii) the sponsor indemnity undertaking (in respect of damages incurred or suffered in connection with any misrepresentation, breach of warranty or breach of undertaking in respect to the issuer and sponsor certification). For CLOs, the collateral manager is the “sponsor” for these purposes even if the collateral manager is not the “sponsor” for purposes of the risk retention rules. If the sponsor is a special purpose vehicle, the sponsor’s direct or indirect ultimate parent must also execute the certification and indemnity undertaking. As a result, the identity of the party that serves as a sponsor is an important designation, particularly for CLO collateral managers of broadly syndicated loans. In addition to other hurdles posed by TALF requirements, the sponsor definition may raise further concerns about the use of TALF by the CLO and ABS markets.
As was the case for TALF 1.0, as a condition for the disbursement of a TALF loan to be secured by newly issued ABS, an auditor attestation providing an opinion on the assertion of management of the issuer and sponsor that the ABS is TALF eligible (an “Auditor Attestation”) must be provided. The New FAQs provide that, for CLOs, the requirement is that agreed upon procedures with respect to factual matters related to the various TALF eligibility criteria for leveraged loans (an “AUP Report”) must be provided. The Auditor Attestation or the AUP Report, as applicable, must be submitted to the Fed no later than 5pm (New York time) on the same day the issuer furnishes the report on Form ABS-15G to the SEC.
Special Requirements for Documentation for ABS Issued on or after March 23, 2020 and before May 22, 2020
The New FAQs provide that some of the TALF disclosure and documentation requirements are relaxed for ABS issued on or after March 23, 2020 but before May 22, 2020. As such, issuers that issue ABS constituting TALF-eligible collateral during this period will not be required to comply with additional requirements set out in the New FAQs which may not have been announced in advance of the applicable issuance. As of May 22, 2020, approximately 30 US ABS issuers have issued AAA rated securities since March 23, 20202.
TALF Agents, Collateral Monitors and Other Agents
The New FAQs provide that the Fed will consider expanding the pool of TALF agents beyond the initial list of 24 TALF agents to include a wider range of entities and will seek opportunities to consider a broader set of firms for various short-term vendor roles supporting the TALF. The New FAQs provide that initially, Pacific Investment Management Company LLC (PIMCO) will be the collateral monitor and The Bank of New York Mellon will be the TALF custodian, but that additional collateral monitors or agents may be engaged in the future.
Grace Period for TALF Borrower’s Obligation to Pay Interest on a TALF Loan
Similar to TALF 1.0, a TALF Borrower has a grace period of 30 days to pay interest on a TALF loan if the net interest on the pledged ABS is not sufficient to cover the interest payment associated with the TALF loan. Upon expiry of this grace period, the Fed can enforce its rights to the TALF loan collateral. The New FAQs further provide that where the “insufficiency” referred to above relates solely to a timing difference between the interest payments on the pledged ABS and the interest on the TALF loan (and the pledged ABS continue to pay in accordance with their terms), that timing differential is not considered a delinquency.
Compensation, Stock Repurchase, and Capital Distribution Restrictions
The New FAQs provide welcome confirmation that the compensation, stock repurchase, and capital distribution restrictions that apply to direct loan programs under section 4003(c)(3)(A)(ii) of the CARES Act do not apply to the TALF.
SBA Loan Haircuts
The Term Sheet and Initial FAQs did not provide complete guidance on haircuts for SBA loans with an average life beyond seven years. The New FAQs clarify that for ABS backed by SBA loans, haircuts will increase one percentage point for every two additional years (or portion thereof) of average life at or beyond five years.
Additional Documents and Forms
In addition to the MLSA and related appendices (Appendix 2B: Form of Borrower Solvency and Inadequate Credit Accommodations Certification; Appendix 2C: Form of Borrower Conflicts of Interest Certification; Appendix 3B: Form of Assignment and Assumption (Assignment by Borrower); and Appendix 5: Form of Prepayment Notice), the Fed has also published the following forms and documents:
- Loan Request Form and Instructions
- Borrower Type InstructionsList of TALF Agents
- Borrower Due Diligence Policy for TALF Agents
- Conflicts of Interest Policy for TALF Agents
- Form of Issuer and Sponsor Certification as to TALF Eligibility for ABS; Form of Sponsor Indemnity Undertaking
- Form of Auditor Attestation; Form of Management Report on Compliance
- Form of TALF-Specific Agreed-Upon Procedures Report for CLOs
- Form of Undertaking in Connection with SBA 7(a) Pool Certificates
- Guidance for Accounting Firms in Determining TALF Collateral Eligibility for ABS
In particular, the due diligence procedures the TALF agent is required to perform in respect of a TALF Borrower pursuant to the Borrower Due Diligence Policy for TALF Agents was released. To the extent that a prospective TALF Borrower has an affiliate relationship with a TALF agent, limits were also included with respect to conflicts of interest.
Additional Concerns
Fed has Sole Discretion to Reject Collateral
The New FAQs provide that, the Fed, in its sole discretion, may reject collateral for any reason, even if the collateral meets the eligibility requirements. In making such determination, the Fed may consider, among other factors, the credit quality, transparency, and simplicity of the structure. In addition, the Fed has further discretion (as it had under TALF 1.0) to refuse to fund a loan if, in its judgment, a potential TALF Borrower is motivated to request a TALF loan due to the direct or indirect economic interest of such TALF Borrower, or any of its affiliates, in the underlying collateral, and such economic interest would impact the incentive of such TALF Borrower to independently assess the risk of investment in such ABS. Although it is true that under TALF 1.0 the Fed reserved the right to reject collateral in circumstances other than the limited scenarios set out in the TALF 1.0 FAQs, the language in the New FAQs is more explicit than in 2009. It is unclear at this time how the Fed’s unfettered discretion to reject collateral will be interpreted by market participants and in what circumstances the Fed may in fact reject collateral that meets the eligibility requirements. In this circumstance, a TALF Borrower may require bridge funding in order to purchase the collateral, because it would not receive funding under the TALF.
Collateral Issued by U.S. Entities That Have Received Specific Support Pursuant to section 4003(b)(1)-(3) of the CARES Act not Eligible Collateral
The New FAQs provide that collateral issued by or sponsored by (or, in the case of CLOs, with collateral managers which are) U.S. entities that have received specific support pursuant to section 4003(b)(1)-(3) of the Coronavirus Aid, Relief, and Economic Security Act of 2020 (Subtitle A of Title IV of the CARES Act) will not be eligible collateral. Section 4003(b)(1)-(3) authorizes the Treasury to make loans, loan guarantees, and other investments in support of certain eligible businesses, including passenger air carriers, cargo air carriers and businesses critical to maintaining national security.
TALF Borrower Hedging Restrictions
The New FAQs and the MLSA introduce new restrictions on the hedging activities of TALF Borrowers. The New FAQs provide that to participate in TALF, pursuant to the MLSA a TALF Borrower must agree that prior to and after the applicable TALF loan settlement date (for as long as it has a TALF loan outstanding), the TALF Borrower has not entered and will not enter into a transaction intended to serve as a credit hedge for the collateral posted as security for that loan. Under the MLSA, a credit hedge means a transaction or series of transactions that are intended to offset in whole or in part the credit risk associated with the collateral, including direct hedges, such as credit default swaps, and correlative hedges, such as short-selling the ABX index. A credit hedge does not include hedges on a TALF Borrower’s broader portfolio (which may include securities purchased with TALF Loans), or interest-rate hedges.
The new restrictions on the hedging activities of TALF Borrowers appear to replace the TALF 1.0 restrictions on certain hedging activities of TALF agents.
TALF Borrower Certification
The Initial FAQs introduced a requirement that the TALF Borrower will be required to certify that it is (i) unable to secure adequate credit accommodations from other banking institutions and (ii) not insolvent. It remains unclear how TALF Borrowers are to interpret this provision or be comfortable signing the certificate. The MLSA includes the form of TALF Borrower certification but does not provide further guidance beyond what was provided in the Initial FAQs as to how the TALF Borrower should approach such certification. The MLSA confirms that a “knowing material misrepresentation” of this certification will (i) constitute a Collateral Enforcement Event (as defined in the MLSA), (ii) cause the TALF loan to become immediately due and payable and to become full recourse to the TALF Borrower, and (iii) cause the Fed to promptly refer the matter to appropriate law enforcement authorities for investigations and action in accordance with applicable criminal and civil law. The lack of a clear definition of what it means to be “unable to secure adequate credit accommodations from other banking institutions” has many potential TALF Borrowers concerned given the potential for criminal and civil penalties, and could lead to depressed participation in the TALF if more specific guidance is not provided.
Further Updates and Commentary
The Fed’s newest revisions and clarifications give both potential TALF Borrowers and investors a clearer view of the mechanics of the TALF program as we move closer to its first subscription date of June 17, 2020. Dechert will continue to monitor all developments relating to TALF, and will continue to provide in depth analysis on the specific changes to particular asset classes and other issues relating to both issuers and investors. We continue to encourage our readers to follow our regular updates on our Term Asset-backed Securities Loan Facility (“TALF”) Funds Resources website.
Additional Concerns
Fed has Sole Discretion to Reject Collateral
The New FAQs provide that, the Fed, in its sole discretion, may reject collateral for any reason, even if the collateral meets the eligibility requirements. In making such determination, the Fed may consider, among other factors, the credit quality, transparency, and simplicity of the structure. In addition, the Fed has further discretion (as it had under TALF 1.0) to refuse to fund a loan if, in its judgment, a potential TALF Borrower is motivated to request a TALF loan due to the direct or indirect economic interest of such TALF Borrower, or any of its affiliates, in the underlying collateral, and such economic interest would impact the incentive of such TALF Borrower to independently assess the risk of investment in such ABS. Although it is true that under TALF 1.0 the Fed reserved the right to reject collateral in circumstances other than the limited scenarios set out in the TALF 1.0 FAQs, the language in the New FAQs is more explicit than in 2009. It is unclear at this time how the Fed’s unfettered discretion to reject collateral will be interpreted by market participants and in what circumstances the Fed may in fact reject collateral that meets the eligibility requirements. In this circumstance, a TALF Borrower may require bridge funding in order to purchase the collateral, because it would not receive funding under the TALF.
Collateral Issued by U.S. Entities That Have Received Specific Support Pursuant to section 4003(b)(1)-(3) of the CARES Act not Eligible Collateral
The New FAQs provide that collateral issued by or sponsored by (or, in the case of CLOs, with collateral managers which are) U.S. entities that have received specific support pursuant to section 4003(b)(1)-(3) of the Coronavirus Aid, Relief, and Economic Security Act of 2020 (Subtitle A of Title IV of the CARES Act) will not be eligible collateral. Section 4003(b)(1)-(3) authorizes the Treasury to make loans, loan guarantees, and other investments in support of certain eligible businesses, including passenger air carriers, cargo air carriers and businesses critical to maintaining national security.
TALF Borrower Hedging Restrictions
The New FAQs and the MLSA introduce new restrictions on the hedging activities of TALF Borrowers. The New FAQs provide that to participate in TALF, pursuant to the MLSA a TALF Borrower must agree that prior to and after the applicable TALF loan settlement date (for as long as it has a TALF loan outstanding), the TALF Borrower has not entered and will not enter into a transaction intended to serve as a credit hedge for the collateral posted as security for that loan. Under the MLSA, a credit hedge means a transaction or series of transactions that are intended to offset in whole or in part the credit risk associated with the collateral, including direct hedges, such as credit default swaps, and correlative hedges, such as short-selling the ABX index. A credit hedge does not include hedges on a TALF Borrower’s broader portfolio (which may include securities purchased with TALF Loans), or interest-rate hedges.
The new restrictions on the hedging activities of TALF Borrowers appear to replace the TALF 1.0 restrictions on certain hedging activities of TALF agents.
TALF Borrower Certification
The Initial FAQs introduced a requirement that the TALF Borrower will be required to certify that it is (i) unable to secure adequate credit accommodations from other banking institutions and (ii) not insolvent. It remains unclear how TALF Borrowers are to interpret this provision or be comfortable signing the certificate. The MLSA includes the form of TALF Borrower certification but does not provide further guidance beyond what was provided in the Initial FAQs as to how the TALF Borrower should approach such certification. The MLSA confirms that a “knowing material misrepresentation” of this certification will (i) constitute a Collateral Enforcement Event (as defined in the MLSA), (ii) cause the TALF loan to become immediately due and payable and to become full recourse to the TALF Borrower, and (iii) cause the Fed to promptly refer the matter to appropriate law enforcement authorities for investigations and action in accordance with applicable criminal and civil law. The lack of a clear definition of what it means to be “unable to secure adequate credit accommodations from other banking institutions” has many potential TALF Borrowers concerned given the potential for criminal and civil penalties, and could lead to depressed participation in the TALF if more specific guidance is not provided.
Further Updates and Commentary
The Fed’s newest revisions and clarifications give both potential TALF Borrowers and investors a clearer view of the mechanics of the TALF program as we move closer to its first subscription date of June 17, 2020. Dechert will continue to monitor all developments relating to TALF, and will continue to provide in depth analysis on the specific changes to particular asset classes and other issues relating to both issuers and investors. We continue to encourage our readers to follow our regular updates on our Term Asset-backed Securities Loan Facility (“TALF”) Funds Resources website.
Footnotes:
1) See full description of the Fed’s announcement of the TALF program, in the March 2020 Dechert OnPoint - Federal Reserve Establishes Term Asset-Backed Securities Loan Facility (TALF); see also, Dechert’s commentary on the April 9, 2020 Term Sheet, in the April 2020 Dechert OnPoint - Federal Reserve Releases Updated Term Sheet on the Primary Market Corporate Credit Facility (PMCCF) and Dechert’s commentary on the May 12, 2020 term sheet and the May 12, 2020 FAQs, in 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).
2) Bloomberg, Fixed Income Search, May 22, 2020.
1) See full description of the Fed’s announcement of the TALF program, in the March 2020 Dechert OnPoint - Federal Reserve Establishes Term Asset-Backed Securities Loan Facility (TALF); see also, Dechert’s commentary on the April 9, 2020 Term Sheet, in the April 2020 Dechert OnPoint - Federal Reserve Releases Updated Term Sheet on the Primary Market Corporate Credit Facility (PMCCF) and Dechert’s commentary on the May 12, 2020 term sheet and the May 12, 2020 FAQs, in 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).
2) Bloomberg, Fixed Income Search, May 22, 2020.
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