As market participants prepare for the launch of the latest version of the Term Asset-Backed Securities Loan Facility (“TALF”) program (“TALF 2.0”), two new developments provide greater clarity as to how the recently established facility will operate in practice.
First, on May 26, 2020, the Federal Reserve Bank of New York (the “FRBNY”) released updated Frequently Asked Questions (the “TALF FAQs”) on TALF 2.0, marking yet another revision of the previously released Frequently Asked Questions from May 20, 2020 and May 12, 2020 (together, the “Predecessor FAQs”).1
Second, on May 27, 2020, the staff of the Securities and Exchange Commission issued a no-action letter permitting registered investment companies (“Registered Funds”) and business development companies (“BDCs”) to participate directly or indirectly through an affiliated pooled investment vehicle in TALF 2.0, reaffirming and, in certain instances expanding upon, prior no-action relief issued in 2009 in response to a predecessor version of the TALF program (“TALF 1.0”).
While there remain a number of questions regarding TALF 2.0, these developments should give both prospective TALF issuers and borrowers a clearer view on their ability to participate in TALF 2.0 and the procedures that will govern the facility’s operation.
FRBNY Further Revises TALF FAQs
Expansion of Eligible Ratings Agencies
The newly revised TALF FAQs expand the eligible rating agency field, allowing one of two required credit ratings to be obtained from DBRS, Inc. (“DBRS”) or Kroll Bond Rating Agency, Inc. (“KBRA”).
The Predecessor FAQs required an asset-backed security (“ABS”) to have a credit rating in the highest applicable investment-grade rating category from two of Fitch Ratings, Inc., Moody’s Investors Service, Inc. and S&P Global Ratings (collectively, the “Initial Agencies”) in order to be eligible collateral under TALF. The May 26 guidance broadened the scope of eligible rating agencies to allow one of the two required credit ratings to come from one of two additional nationally recognized statistical rating organizations (“NRSROs”), DBRS and KBRA. Potential TALF issuers and participants raised concern regarding the exclusion of NRSROs other than the Initial Agencies – after all, many ABS deals, including more than 80% of 2019 US CMBS transactions, are rated by NRSROs outside of the Initial Agencies. In particular, DBRS and KBRA have expanded their presence in the ABS market since TALF 1.0. Critics of the prior eligibility limitation were quick to point out that all NRSROs have been under the ongoing oversight of the Securities and Exchange Commission since the establishment of the Office of Credit Ratings in 2012 and that NRSROs outside of the Initial Agencies had been deemed eligible to rate for other emergency facilities established by the Board of Governors of the Federal Reserve System (the “Fed”). Because of the timeline required to obtain a newly solicited rating, the previous requirement under the Predecessor FAQs effectively shut out from TALF eligibility any ABS issued by issuers lacking established relationships with two of the Initial Agencies. Although the new requirement still excludes issuers without at least one established relationship within the Initial Agencies, this is nevertheless a welcome revision. Notably, the May 26 update also confirmed that unsolicited ratings will not be taken into consideration when evaluating TALF eligibility.
Adequate Credit Accommodations
The Fed’s Predecessor FAQs raised some eyebrows when it introduced the requirement that a potential TALF borrower must provide a certification of its inability to “secure adequate credit accommodations from other banking institutions” outside of TALF in order to qualify for a loan under TALF. This requirement led to apprehension among potential borrowers as to what they needed to do to satisfy this requirement, the extent to which a borrower would need to seek and document their efforts to secure external funding and what cost of capital would be considered inadequate. While the Master Loan and Security Agreement released by the FRBNY on May 20, 2020 included the form of this borrower certification, it remained unclear how a potential TALF borrower should approach the certification. The May 26 revisions provide additional guidance on the required certification regarding the inability to secure adequate alternative credit accommodations, further defining what constitutes “inadequate credit.”
As revised, the TALF FAQs provide that a borrower may rely on unusual market conditions when making its certification to the FRBNY. However, in the revised TALF FAQs, the FRBNY narrows its definition of “unusual economic conditions” from covering the market, generally, to covering the ABS market, specifically. Thus, the overall contraction of the U.S. economy due to the COVID-19 outbreak may not automatically support an inadequate credit conclusion. The revised TALF FAQs remain consistent with the guidance provided to date that the “lack of adequate credit” does not equate to “no credit” being available. However, whereas the Predecessor FAQs stated that credit may be available “at prices or on conditions that are inconsistent with a normal, well-functioning market,” the revised TALF FAQs forego this description, stating instead that credit can be deemed inadequate due to its amount, price or terms, because, for example, ABS spreads are elevated relative to normal market conditions. Thus, the FRBNY has more specifically defined the disruption necessary for the “inadequate credit” certification to be specific to a disruption of the ABS market.
Additionally, the certification relates to adequate credit accommodations from other banking institutions, leading to further ambiguity. As written, it implies that TALF borrowers should only consider what funding would be available from banking institutions, not what funding would be available from the ABS market as a whole. The ABS market traditionally has a large number of non-banking institutions that are active providers of financing, and their participation seems to be ignored in evaluating market functioning for purposes of this certification. While ambiguous, on the positive side, this language does limit the universe of financing providers that the TALF borrower would have to inquire with to determine whether adequate credit accommodations are otherwise available in the ABS market.
The certification also requires the borrower to notify the TALF agent if the certification changes and states that the TALF loan becomes recourse to the borrower if the certification “includes a knowing material misrepresentation.” As a result of these factors TALF borrowers are likely to need a detailed procedure in place to make the statements.
What remains unclear is whether the FRBNY will provide guidance as to what evidence a borrower needs to use regarding inadequate credit accommodations, the form and type of such evidence and the way that such evidence will be received operationally (although it does seem, based on the guidance to date, that any “evidence” will be limited to the borrower certification). It also remains unclear how a normal, well-functioning market is defined for the purpose of a borrower’s analysis, or how a borrower should account for variances between financial institutions in the availability of financing even in normal market conditions when making this certification. As the repercussions for misrepresentations in this certification include not only default under the TALF loan but also potential criminal and civil penalties, it understandably remains an area of concern for potential TALF borrowers.
SEC Staff No-Action Letter Addressing Participation in TALF 2.0
In a letter to the Investment Company Institute and the Securities Industry and Financial Markets Association’s Asset Management Group,2 the Securities and Exchange Commission’s Division of Investment Management (“Division”) reaffirmed, and in certain instances expanded upon, prior no-action relief that the Division had issued in 2009 in response to TALF 1.0, thereby providing a coherent framework of relief on which Registered Funds and BDCs can rely as they assess whether to participate in TALF 2.0.
The Division had issued two no-action letters in connection with TALF 1.0, to Franklin Templeton Investments3 and to T. Rowe Price Associates, Inc.,4 regarding the investment by a Registered Fund in TALF 1.0 and the application of relevant provisions of the Investment Company Act of 1940, as amended (“1940 Act”), and rules promulgated thereunder.
In the Franklin Letter, the Division generally took the view that a Registered Fund could participate directly in TALF 1.0 without (i) treating its TALF borrowing as a senior security representing indebtedness for purposes of compliance with sections 18(a)(1), 18(c) and 18(f)(1) of the 1940 Act, and (ii) violating section 17(f) of the 1940 Act, or the rules thereunder, on account of the unique custody arrangements TALF 1.0 required. Importantly, the Franklin Letter required a Registered Fund to segregate liquid assets to cover the outstanding amount of the TALF borrowing, noting that the TALF eligible assets acquired by the Registered Fund could not be used to cover the TALF borrowing.
In the T. Rowe Price Letter, the Division permitted certain affiliated Registered Funds and institutional separately managed accounts and common trust funds to participate indirectly in TALF 1.0 by purchasing interests in an affiliated pooled investment vehicle that would rely on the exclusion from investment company status under section 3(c)(1) or 3(c)(7), where such vehicle was organized for the specific purpose of acquiring eligible collateral and borrowing under TALF 1.0. The T. Rowe Price Letter contained 12 conditions with which T. Rowe Price needed to comply designed to address the potential affiliation issues associated with the pooled investment vehicle structure, including that a T. Rowe Price-advised Registered Fund could not invest more than 5% of its assets in the pooled investment vehicle and no single investor could own 25% or more of the pooled investment vehicle’s interests. Notably, however, the T. Rowe Price Letter could not be relied on by third parties, given its unique facts and circumstances.
Although TALF 2.0 differs from TALF 1.0 in certain key respects, such as the type of assets qualifying as eligible collateral for the facility and the conditions to borrower eligibility, TALF 2.0 shares broad similarities with its predecessor. This has prompted questions from the industry about whether and how the Division’s previously issued relief would apply to the TALF 2.0 context.
In the ICI/SIFMA Letter, the Division expressed the view that “for purposes of the staff no-action positions taken in the [Franklin and T. Rowe Price] Letters,” TALF 2.0 was “substantially similar” to TALF 1.0 with respect to its terms and conditions. Accordingly, the Division reaffirmed the Division’s positions in the Franklin and T. Rowe Price Letters as applicable to Registered Funds’ participation in TALF 2.0.
In addition, the ICI/SIFMA Letter expands the relief offered in the T. Rowe Price Letter by 1) permitting any third party Registered Fund seeking to participate in TALF 2.0 to rely on the T. Rowe Price relief and 2) providing no-action relief under section 57(a) of the 1940 Act for BDCs seeking to participate in TALF 2.0 indirectly through an affiliated pooled investment vehicle, in each case so long as the facts and circumstances of a transaction are substantially similar to those described in the T. Rowe Price Letter.
As noted above, these developments provided additional details on the TALF program to market participants. The FRBNY’s newest revisions to its TALF FAQs give potential issuers, borrowers and investors a clearer view of the requirements of TALF 2.0, and in particular the details surrounding collateral eligibility and borrower certifications. Likewise, the ICI/SIFMA Letter clarifies the ability of Registered Funds and BDCs to participate directly or indirectly through an affiliated pooled investment vehicle in TALF 2.0. Dechert will continue to monitor all developments relating to TALF 2.0, 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.
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 Term Sheet, in the April 2020 Dechert OnPoint - Federal Reserve Releases May Term Sheet on the Term Asset-Backed Securities Loan Facility (TALF); see also, Dechert’s commentary on the May Term Sheet and the Frequently Asked Questions, 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) Investment Company Institute and SIFMA AMG, SEC Staff No-Action Letter (May 27, 2020), https://www.sec.gov/investment/ici-sifma-052720 (the “ICI/SIFMA Letter”).
3) Franklin Templeton Investments, SEC Staff No-Action Letter (Jun. 19, 2009), available at https://www.sec.gov/divisions/investment/noaction/2009/franklintempleton061909.htm (the “Franklin Letter”).
4) T. Rowe Price Associates, Inc., SEC Staff No-Action Letter (Oct. 8, 2009), available at https://www.sec.gov/divisions/investment/noaction/2009/troweprice100809.htm (the “T. Rowe Price Letter”).