As the reinstated Term Asset-Backed Securities Loan Facility program (“TALF 2.0”) opened, the Federal Reserve Bank of New York (the “FRBNY”) continues to revise the TALF 2.0 program details, changing the criteria for participants in the Federal Reserve System (the “Fed”) stimulus program. The Fed revised the TALF 2.0 term sheet on April 9, 2020 and May 12, 2020 (collectively, the “Term Sheets”) after the announcement of the program on March 23, 2020. More recently, the FRBNY has updated the Frequently Asked Questions (the “TALF FAQs”) initially released on May 12, 2020, and updated on May 20, 2020 and May 26, 2020. This most recent iterations of the TALF FAQs released on June 8, 2020 and June 15, 2020 include a variety of changes, including by (i) designating sovereign wealth funds as foreign governments, (ii) clarifying that public companies can rely on Section 13 filings to determine their material investors, (iii) changing the credit accommodations certification, including by referencing the ability for the borrower to determine the adequacy of alternative credit accommodations by asset class instead of the ABS market generally and by referencing the repo market for lending against ABS securities, (iv) requiring any trust with a revolving pool to be through a master trust, (v) providing more flexibility to CLOs (as defined below) with market redemption provisions, (vi) expanding the TALF agent due diligence procedures and (vii) defining the average life of the ABS.
The FRBNY clarified that Eligible Collateral with underlying exposures that includes intermediate securities more specifically refers to the special units of beneficial interest, collateral certificates, titling trusts and similar intermediate securities that do not have independent economic features. Previous versions of the TALF FAQs limited use of these structures to credit card, auto lease, floorplan and equipment lease securitizations and the FRBNY removed such limitations.
Master Trusts and Revolving Pools
The TALF FAQs added further changes for master trust issuers of securities backed by auto receivables, premium finance receivables, floorplan receivables or credit card receivables. A requirement that eligible ABS must be issued to refinance existing ABS issued by the master trust was revised so that only eligible ABS that matures on or after January 1, 2020 and prior to the September 30, 2020 (the “TALF Termination Date”) may be included. However, the restriction on refinancing maturities that occur after the TALF Termination Date continues to create challenges for issues of master trust ABS.
The TALF FAQs were also changed to expressly prohibit auto loan ABS with revolving periods that permit replenishment of pool assets by providing for the application of pool proceeds to purchase from the originator (or its affiliates) additional assets, without such trust having other features of a revolving master trust from being ineligible. Essentially, the only revolving structure permitted must be established through a master trust.
ABS with Multiple AAA Tranches
As a result of feedback regarding tranching of the AAA notes into time-tranched classes, including a money market tranche, the FRBNY added language to indicate that such time tranching is permitted in non-CMBS asset classes. The FRBNY, however, only referenced money market tranches but left open the question as to whether additional time-tranched ABS classes other than money market tranches were permitted as Eligible Collateral under TALF 2.0.
The clarification is limited to auto loan and equipment loan transactions even though such concern is common in other eligible asset classes, such as auto leases.
Under the prior TALF FAQs, ABS could not be eligible if it had a redemption option exercisable prior to three years after the disbursement date of the related TALF 2.0 loan (other than customary clean up call provisions), or at any time the ABS was owned by the FRBNY or the TALF SPV. Sponsors of and investors in collateralized-loan obligations (“CLOs”) noted that this ran contrary to CLO market practice, where static CLOs are typically issued with redemption options exercisable after one year. Responding to this concern, the new TALF FAQs now permit CLOs with a redemption option exercisable no earlier than one year after the issuance date, provided that any option is exercised at the full outstanding principal amount plus any accrued interest. Such a CLO redemption option can be exercised even if it is owned by the FRBNY or the TALF 2.0 special purpose vehicle.
Originated Loans by Affiliates
The FRBNY reversed a portion of its earlier guidance with respect to Eligible Collateral originated by a borrower or an affiliate of a borrower. Previously, the FRBNY prohibited any affiliate of a borrower from being the originator of the underlying loan, but has now created an exception that permits a borrower to pledge ABS backed by Small Business Administration (“SBA”) loans that includes loans originated by such borrower or its affiliates, so long as the borrower has no knowledge that such loans were originated by it or its affiliates. Furthermore, a borrower is entitled to use a broadly syndicated CLO as collateral, even if the loans were originated by such borrower or an affiliate.
Average Life Limit of ABS
The new guidance changed the average life requirements to shorten the ABS to under the average lifetime year limit, instead of at the particular average lifetime year limit. This is evidenced with a shift in average life for (i) credit card, auto, equipment, floorplan and premium finance ABS to under five years, (ii) SBA Pool Certificates and private student loan ABS to under seven years and (iii) Development Company Participation Certificates, CMBS and CLO to under ten years, rather than allowing each these classes to include up to the applicable limit.
The FRBNY clarified the prohibition on foreign governments acting as “Material Investors” (defined as an entity that owns, directly or indirectly, 10% or more of any outstanding class of securities of an entity), to include sovereign wealth funds as foreign governments for the purpose of the TALF FAQs. In addition, a pension plan established by a foreign government for the benefit of its employees would not be considered to be a foreign government so long as such foreign government does not own, directly or indirectly, 10% of more of any outstanding class of securities of the plan or any investment manager of the plan.
The new TALF FAQs clarified that public companies may calculate their direct and indirect ownership interests to determine whether they have a Material Investor by referencing information included in Schedule 13D and 13G filings pursuant to the reporting requirements for public filings under Section 13 of the Securities Exchange Act of 1934, or the customer due diligence requirements set forth in 31 CFR 1010.230, as applicable, to identify beneficial owners that have acquired more than five percent of any class of a company’s shares. The TALF agents may use existing processes for identifying beneficial owners under the ownership prong of the aforementioned due diligence requirements (such as risk-based reliance on information, forms and certification provided by customers). This clarification reduced concerns among public companies that are unable to make certifications about ownership interests because of the public ownership of their securities.
Adequate Credit Accommodations
The FRBNY continued to adjust the certification regarding the existence of adequate credit accommodations from other banking institutions. Previously the certification could be made based on the existence of unusual economic conditions in the ABS market as a whole, whereas under the new TALF FAQs, the focus may be limited to the sector of the ABS market applicable to the specific ABS to be pledged. The certification continues to conflate the ABS market with the market for financing ABS securities, which continues to create concern for borrowers. The FRBNY added an additional reliance factor, stating that a borrower may rely on elevated rates or haircuts in the financing market (e.g. repo market) relevant for the collateral that the borrower is seeking to use for such TALF 2.0 loan. These alternative factors may increase the diligence burden on borrowers for purposes of making this certification. Unlike the due diligence certification (discussed below), TALF agents are entitled to rely on the borrower’s certification regarding adequate credit accommodations and are not being asked to conduct their own review or analysis.
TALF Agent Risk Management
The revised TALF FAQs provide additional insight as to the requirements the TALF agents need to satisfy in order for a potential market participant to qualify for the TALF 2.0 program.
The standards for a TALF agent’s due diligence procedures with respect to potential borrowers was addressed in the updated TALF FAQs. The revisions provide that the TALF agents should use the “judgment and the standards of their own Customer Review Program to determine what level of verification and scrutiny of TALF borrower-provided information is appropriate.” The guidance therefore adopts the TALF agent’s general internal review policies and incorporates a reasonable care standard. The TALF agents, however, will not only need to collect the information from the borrower but also consider the entirety and consistency of the information received from borrowers, without solely relying on the certification if the TALF agent is aware of information that raises material doubts about such certification’s accuracy. This added level of scrutiny is not overly burdensome, but does require the TALF agent to review the certifications with a more watchful eye. The FRBNY also clarified that TALF agents are not expected to conduct a de novo review of the factual evidence submitted in such certifications.
Due Diligence Policy
The additional language describing the TALF agent’s role in examining its customer due diligence procedure adds additional TALF agent responsibilities, but does not impose prescriptive requirements for TALF agents to verify and identify “Covered Persons” with respect to TALF 2.0 borrowers. Rather, this policy allows TALF agents to utilize a risk-based approach consistent with the TALF agents’ customer review program. The TALF Due Diligence Policy does, however, include a requirement on TALF agents to screen all Covered Persons associated with a borrower for negative or adverse information.
The TALF agent is able to satisfy the TALF Due Diligence Policy relating to Material Investors by identifying and screening the Material Investors of any investment manager of a potential borrower, but is not required to verify the identity of such Material Investors.
Rather than prescribing a particular signatory for borrower certifications as the previous TALF FAQs seem to do, the updated TALF FAQs clarify that such certifications may be signed by anyone who has requisite signing authority under the TALF agent’s current practices and procedures, and is knowledgeable about the certifications.
Conflicts of Interest Plan
The revised TALF FAQ adds a further explanation around expectations for the TALF agent’s conflict of interest plan, setting out the following criteria that should be incorporated, including:
(i) Be Specific to TALF – Conflicts of interest should be specifically tailored to the TALF 2.0 program, and while market participants may use existing policies and procedures, the TALF agent should not rely on these alone. Further, the firms should describe the possible roles they may play within the TALF 2.0 program, and criteria for escalating conflicts;
(iii) TALF-Specific Training – The TALF agent should identify individuals with responsibilities for TALF 2.0 and provide TALF specific training to such employees who may be in a higher risk position for conflicts of interest;
(v) Governance and Decision Making – The TALF agent should document which individuals within the various TALF agents that are responsible for determining conflicts-related issues, and implement appropriate governance and recordkeeping around such decision-making; and
Accordingly, the additional guidance provides that all TALF agents should escalate any potential conflict of interest and the related plans to mitigate such risks immediately to the FRBNY. The FRBNY does assure the TALF agents, though, that any escalation by a TALF agent that has an appropriate mitigation plan would not result in an outright denial of a TALF loan request exclusively because of such escalation.
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