The federal reserve resurrected the Term Asset-Backed Loan Facility (TALF) program in May following the COVID-19 liquidity crisis. The structure of this loan facility is nearly identical to the one that was stood up following the 2008 recession, whereby a borrower may pledge eligible asset-backed securities (ABS) (and now collateralized loan obligations or CLO) products in exchange for highly-favorable financing arrangements. Firms may choose to engage with the TALF program as either borrowers or investors, and each method comes with unique operational processes and accounting treatment. At Clearwater we are seeing clients (and their clients) approach the program from both sides and are advising on what to be mindful of as you look to take advantage of this loan facility.
TALF borrowers should remain cognizant of the operational requirements to support the exchange of collateral. Assets pledged to collateralize the loan facility are often marked as encumbered in the lot inventory and reclassified to "out-for-collateral" on the investment ledger. Further complicating the matter, any prepayments on ABS/CLO securities may reduce the accepted value of the collateral beyond the value of the loan and require intervention. This needs to be tracked daily, and requires alignment of interested parties across treasury, investment, and accounting stakeholders.
TALF investors will not have the same operational concerns that borrowers, as they do not have the same collateral obligations as borrowers. Instead, investors will commit capital to a special purpose vehicle representing the TALF fund. The fund will purchase eligible ABS/CLO products to collateralize TALF loans, using the loan facility to repeat and unwind the process and lever and de-lever the fund over time. Investors in this fund are limited partners and should view these capital contributions similar to other private equity and hedge fund relationships.
Mechanically, the loan facility is relatively straight-forward and comparable to other short-term financing operations. However, it does come with accounting and reporting nuances, especially for insurers. For US insurers and managing partners, the NAIC released new guidance on the refurbished TALF program at the last working group.
From the Clearwater’s NAIC Spring 2020: Temporary Interpretations for Statutory Accounting, regarding INT 20-06T:
Under this item, reporting entity borrowers shall report ABS pledged as restricted assets, and the assets pledged are subject to the underlying asset risk-based capital “RBC” charge but are excluded from an additional “restricted asset” RBC charge. The borrowers can continue reporting pledged ABS as admitted assets if the asset was qualified as an admitted asset before it was pledged to the TALF program and the borrower has not committed an uncured contract default. This interpretation provides an exception to INT 01-31, which requires a pledged asset be readily substitutable to be admitted. ABS that are pledged to this program can be admitted even though they are not substitutable.
Reporting entity investors do not directly receive the TALF loan, but are investors to borrowers that receive the TALF loan. They are not allowed to admit assets pledged to the TALF program if they are not the direct borrower because the return of the assets would be contingent on the action of the borrower to the TALF program and not the reporting entity. This provision is consistent with SSAP No. 4, footnote 2.
For global insurers, specifically life insurers required to file Solvency II, taking advantage of the TALF program as an investor may necessitate full look-through reporting for the underlying fund investments to reduce solvency capital requirements (SCR). This also applies to asset managers with life insurance mandates who supply their clients with look-through data. Those managers who can provide full portfolio look-through functionality will continue to stand out in the market and win new business.
In any case, we at Clearwater encourage you to consult with your managers and current investment accounting and reporting providers if they are ready for the next wave of TALF financing.