TALF just lip service for CLOs
The CLO market is still struggling to find equilibrium as the coronavirus pandemic spreads. The Federal Reserve’s expansion of its Term Asset-Backed Securities Lending Facility (TALF) to include CLO paper as eligible collateral was cheered upon announcement last week. But some puzzling limitations to the Fed’s terms will do little to help the market reboot.
Market participants secured two long sought after expansions to TALF 2.0 last week, with an updated term sheet extending support to triple-A rated CMBS and CLOs. But compared to CMBS, the terms for CLOs amount to lip service for a market that has been all but frozen since the pandemic began. The Fed may have a financial tool box but it has done little to dislodge the wrench that has jammed up new CLO formation.
The Fed’s buying is limited to static CLO vehicles, historically a tiny segment of the market compared to actively managed, broadly syndicated deals. On top of that restriction, the Fed will only consider CLOs that package newly issued loan collateral. This means that any loans sitting in a manager’s warehouse will not be eligible to be turned into CLO paper for the purposes of accessing Fed liquidity and freeing up money to fund new loans.
It is a curious restriction on the part of the US central bank, which is scrambling to mitigate what could be an economic disaster looming over corporate credit.
Some managers have come to market with static deals, but the overall issuance is stuck in low gear. The Fed must do more to get the market going.
Extending support to legacy triple-A rated conduit CMBS may prop up commercial real estate owners, but with its timid approach to CLOs the Fed will find that many of their tenants — the companies that raise raise the leveraged loans that feed CLO collateral pools — have less access to funding than they might need and could not only struggle to pay the rent but could go out of business altogether.
At that point TALF will have been nothing but an expensive token gesture that will exacerbate one part of the economy’s crisis and prolong another’s.