After excluding the collateralized loan obligation asset class from its first incarnation of the Term Asset-Backed Securities Loan Facility in March, the Federal Reserve on April 9 announced it would include AAA-rated CLO paper as part of the facility, among a bevy of other revisions designed to bolster the economy.
Per the Fed's announcement today, holders of AAA-rated CLO debt can take out loans from the Fed, but only static CLOs will be eligible collateral, and the CLOs must be issued after March 23, 2020. The paper will also require two ratings from rating agencies and must be backed by newly issued credit exposures.
The interest rate on the facility for CLOs will be the Secured overnight financing rate plus 150 basis points, and some market sources comment that at the given rate, banks will have limited incentives to load up on new CLO AAA debt. Likewise, it is not expected that any more than 10 to 15 eligible static deals would successfully come to market in the near-term.
It also does not appear to address the numerous underwater warehouses currently in the market.
"If the collateral for the newly issued static CLOs must be newly issued loans, the program will likely have little effect on the estimated $15 [billion to] $20 billion in existing warehouses," wrote Wells Fargo researchers in an April 9 note. "Also, the print and sprint static CLOs currently in the market typically take advantage of the manager's ability to purchase loans at a significant discount in the secondary market, which this program would exclude based on first reading. Ultimately, we believe that the success of TALF's effect on the CLO market will depend on the restriction on the underlying collateral."
Other sources note that while the inclusion of AAA debt into TALF may only have a modest impact on facilitating new issuance, the newly announced support by the Fed for secondary commercial mortgage-backed security paper under TALF and purchases of high-yield exchange-traded funds may end up doing more. Supporting CMBS spreads may ultimately benefit CLO markets, while the Fed stepping in to buy bond ETFs should improve the tone for loan and bond issuance and retail fund flows. BlackRock's iShares iBoxx High Yield Corporate Bond ETF jumped nearly 8% this morning on the back of the news.
Banks mostly are the largest holders of AAA-rated CLO paper. Per an LCD report on year-end bank data, CLO holdings at U.S. banks increased by about 12% in 2019, to $99.5 billion, with JPMorgan Chase & Co., Wells Fargo & Co. and Citigroup Inc. collectively holding $80.2 billion of the CLO debt in securities form. Japanese banks are also large holders of the paper, but TALF is designed for U.S. companies created or organized in the U.S. and with a majority of its employees based in the U.S.
TALF is designed to help meet the credit needs of consumers and businesses by facilitating the issuance of asset-backed securities. As part of COVID-19-related volatility, CLO markets have been effectively shuttered since mid-March, although one static deal from Blackstone/GSO did price last week.