On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act, or the CARES Act,1 was signed into law. Among other things, Section 4003 of the CARES Act authorizes $500 billion of liquidity to support businesses, states and municipalities "related to losses incurred as a result of coronavirus." Moreover, Treasury Secretary Mnuchin has said that much of this $500 billion will be leveraged in Federal Reserve facilities such that the total liquidity under Section 4003 of the CARES Act could be as high as approximately $4 trillion.2 It can be expected that a portion of this liquidity will take the form of loans to companies that are borrowers under loans held by collateralized loan obligation vehicles ("CLOs"). This, in turn, could ease the impact of the COVID-19 crisis on CLOs, possibly also leading to renewed CLO formation, which plays an important role in the U.S. economy by providing an important source of stable funding to U.S. businesses.
For a full summary of Section 4003 of the CARES Act, please see our March 31 publication, "Legal Update on Section 4003 of the CARES Act – Liquidity for Eligible Businesses, States, and Municipalities."3 In addition, for a summary of certain aspects of the Paycheck Protection Program authorized by the CARES Act related to liquidity for small businesses, please see our March 27 publication, "Government: Small Business Loans Under the CARES Act."4 Because credits in CLOs that are collateralized by broadly syndicated loans typically consist of obligations of larger companies, in this Legal Update we focus on highlighting certain notable features of Section 4003 (as well as related parts of Title IV) of the CARES Act in respect of CLOs.
Aspects of Section 4003 of the CARES Act That Are Relevant to CLOs and Leveraged Borrowers
1. The liquidity authorized by Section 4003 of the CARES Act is likely to be more helpful to CLOs and leveraged companies than other crisis-related programs to date.
Crisis-related programs that were introduced prior to the enactment of the CARES Act appear largely unhelpful to CLOs. The Primary Dealer Credit Facility, established by the Federal Reserve on March 17, 2020, permits CLO notes as collateral, but only those with a AAA rating.5 The new Term Asset-Backed Securities Loan Facility, established by the Federal Reserve on March 23, 2020, does not recognize CLO notes – not even if AAA-rated – as eligible assets.6 And the Primary Market Corporate Credit Facility and the Secondary Market Corporate Credit Facility, also established by the Federal Reserve on March 23, 2020, are restricted to investment grade companies and investment grade debt, and are therefore generally unhelpful to leveraged borrowers whose loans are held by CLOs.7
Unlike the above-mentioned crisis-related programs, liquidity under Section 4003 of the CARES Act has the potential to benefit CLO credits because it is not restricted to businesses with investment grade ratings. Leveraged borrowers, including those that are CLO credits, will not be precluded under the statutory terms from accessing such liquidity based on a specified ratings threshold.
2. Section 4003 of the CARES Act provides for liquidity support for both large and mid-sized businesses that could include CLO credits.
Section 4003 of the CARES Act authorizes up to $46 billion for direct Treasury support for passenger air carriers (and certain specified related businesses), cargo air carriers, and businesses critical to maintaining national security. CLO credits include airline businesses.8 Perhaps more significantly, the bulk of the liquidity authorized by Section 4003 of the CARES Act, in an amount up to $454 billion (plus any amount remaining from the $46 billion allocated to air carriers and related businesses, and businesses critical to maintaining national security), is not restricted to particular industries or business sizes. While it is true that businesses that qualify for the liquidity authorized to be made available to mid-sized businesses under Section 4003(c)(3)(D) of the CARES Act will benefit from an interest rate cap of 2% and a repayment holiday of 6 months after borrowing (or such longer period as the Secretary of the Treasury may determine in his discretion), businesses that are too large to qualify for the special program or facility for mid-sized businesses should not be ineligible, based on size, for liquidity under other Federal Reserve programs or facilities that are expected to be established under Section 4003 of the CARES Act, for which the statute does not impose any size limits.
To be eligible for the mid-sized business funding under Section 4003(c)(3)(D) of the CARES Act, a business must have between 500 and 10,000 employees. Unlike eligibility for small business loans under Title I of the CARES Act, which (with certain important exceptions) is subject to rules requiring that affiliated companies be aggregated for purposes of evaluating employee-based and other size standards, Title IV of the CARES Act does not specify that affiliated businesses must be aggregated for purposes of the mid-sized business threshold. It is possible that further details regarding determining compliance with the mid-sized business thresholds will be included in the terms of such programs that have not yet been released.
3. Section 4003 of the CARES Act authorizes funding to eligible United States businesses, and U.S. CLOs predominantly hold obligations of U.S.-domiciled borrowers.
CLOs frequently include concentration limitations requiring that a specified percentage of the loans in their portfolios (typically a minimum of 80% by par amount) must be obligations of U.S.-domiciled businesses. While the domicile specifications of CLO indentures are not co-extensive with the concept of "United States businesses" under Title IV of the CARES Act, one would expect material overlap in the concepts.
As detailed in our March 31 Legal Update on Section 4003 of the CARES Act,9 a business other than an air carrier must be a United States business in order to be eligible for support under Section 4003 of the CARES Act. In order to be considered a United States business, it appears that an entity must be created or organized in the United States and have significant operations in and a majority of its employees based in the United States.10
The scope of what constitutes a "business" in relation to affiliated entities is not specified in the CARES Act. But reference in certain provisions of Section 4003 of the CARES Act to "the eligible business and any parent company" suggests that a "business" does not necessarily need to encompass an entire corporate family.11 This may be relevant for purposes of determining whether a majority of the employees of a business are based in the United States – e.g., in the case of a U.S.-domiciled and -headquartered business entity, a majority of whose employees are based in the U.S., but which is part of a global corporate family a majority of whose employees are not based in the U.S.
4. Section 4003 of the CARES Act does not specify particular loss criteria for funding under the Section 4003(b)(4) programs.
While liquidity available to air carriers (and certain related businesses) and businesses critical to national security under Sections 4003(b)(1), (2) and (3) of the CARES Act is conditioned upon the Secretary of the Treasury's determining that the eligible business has incurred or is expected to incur covered losses12 such that the continued operations of the business are jeopardized, the statute does not specify any equivalent condition to liquidity for eligible businesses under Section 4003(b)(4) of the CARES Act.13 While it can be expected that borrowers will be required by program terms to demonstrate financial need, the difference in statutory terms in the text of Section 4003 of the CARES Act could potentially result in access to liquidity for a broader range of leveraged borrowers experiencing various coronavirus-related business disruptions than would otherwise be the case.
5. Section 4003(b)(4) of the CARES Act has more limited restrictions on business operations than Sections 4003(b)(1), (2) and (3).
It is also notable that Section 4003(b)(4) generally does not include all of the same restrictions on business operations that apply under Sections 4003(b)(1), (2) and (3) of the CARES Act. For example, the condition that, until September 30, 2020, a funding recipient shall not reduce its employment levels by more than 10 percent applies under Section 4003(b)(4) of the CARES Act to businesses accessing funding under the mid-sized business provisions, but otherwise is not applied by Section 4003 of the CARES Act to funding recipients other than air carriers (and certain related businesses) and national security-related companies accessing funds under Sections 4003(b)(1), (2) or (3).
Additional Information
As more fully described in our March 31 Legal Update, several requirements applicable to loans or loan guarantees made under Section 4003 of the CARES Act may, for many potential recipients, raise issues under those businesses' existing contractual arrangements, including shareholder agreements and debt documentation. It will be important for the programs and facilities established under Section 4003 of the CARES Act to be structured in a way that is workable in light of the existing contractual arrangements to which eligible businesses are subject.
The application procedures and terms and conditions of programs and facilities under Section 4003 of the CARES Act must first be published by Treasury and or/the Federal Reserve before eligible businesses may apply for funding. On March 30, 2020, Treasury published preliminary application procedures and minimum requirements, to be "supplemented promptly with additional terms," for Treasury's direct lending under Sections 4003(b)(1), (2) and (3) of the CARES Act to air carriers and businesses related to national security. This was almost a week before the April 6 deadline for publication of application procedures and minimum requirements under the statute. The CARES Act does not provide a timetable for publishing application procedures and minimum requirements for the Federal Reserve programs and facilities contemplated by Section 4003(b)(4) of the CARES Act. That said, Section 13(3) of the Federal Reserve Act requires that within seven days of a vote by the Federal Reserve Board of Governors to authorize a program or facility under "unusual and exigent circumstances," the Federal Reserve must publish information about such program or facility, including the terms and conditions for participation.
While this Legal Update provides a summary of certain aspects of the recently enacted CARES Act, the ultimate terms and conditions for any programs established thereunder could change dramatically as Treasury and the Federal Reserve determine the most efficient and expeditious way to distribute the funds authorized under the Act. For example, the Troubled Asset Relief Program (TARP) legislation enacted in October 2008 provided that the Federal government would purchase troubled assets from various financial services firms. Ultimately, no assets were ever purchased by the Federal government, as Treasury decided to directly inject capital funds into the financial system through the Capital Purchase Program by purchasing preferred shares from depository institutions and their holding companies.
Footnotes
2 "Fed will make up to $4 trillion in loans to businesses to rescue the U.S. economy," MarketWatch, March 28, 2020. Secretary Mnuchin's comments regarding leveraging of Treasury Department investments in Federal Reserve CARES Act facilities is consistent with announcements concerning Treasury Department equity investments for other Federal Reserve programs established to address the COVID-19 crisis: the Primary Market Corporate Credit Facility, the Secondary Market Credit Facility, the Commercial Paper Funding Facility, and the Term Asset-Backed Securities Loan Facility. For initial summaries of these programs see "US Treasury and Federal Reserve Announce Two Corporate Credit Facilities for Large Employers," March 25, 2020 (https://www.mayerbrown.com/-/media/files/perspectives-events/publications/2020/03/us-treasury-and-federal-reserve-announce-two-new-corporate-credit-facilities-for-large-employers.pdf); "Government: Federal Reserve launches commercial paper funding facility," March 24, 2020 (https://covid19.mayerbrown.com/government-federal-reserve-launches-commercial-paper-funding-facility/); and "Financing: New Term Asset-Backed Securities Loan Facility," March 25, 2020 (https://covid19.mayerbrown.com/financing-new-term-asset-backed-securities-loan-facility/)." See also "How the Fed's Magic Money Machine Will Turn $454 Billion into $4 Trillion," New York Times, March 27, 2020.
3 At https://www.mayerbrown.com/en/perspectives-events/publications/2020/03/legal-update-on-section-4003-of-the-cares-act-liquidity-for-eligible-businesses-states-and-municipalities.
4 At https://covid19.mayerbrown.com/small-business-loans-under-the-cares-act/. See also "Paycheck Protection Program FAQs for Small Businesses" at https://www.covid19.law/2020/03/paycheck-protection-program-faqs-for-small-businesses/.
5 See Term Sheet for Primary Dealer Credit Facility (PDCF), https://www.federalreserve.gov/newsevents/pressreleases/files/monetary20200317b1.pdf .
6 See Term Sheet, "Term Asset- Backed Securities Loan Facility," https://www.federalreserve.gov/newsevents/pressreleases/files/monetary20200323b3.pdf .
7 See "US Treasury and Federal Reserve Announce Two Corporate Credit Facilities for Large Employers," cited at footnote 1.
8 U.S. CLOs in the Time of Coronavirus, S&P Global Ratings, March 27, 2020. S&P reports that the airline sector represents 1% of CLO assets.
9 At https://www.mayerbrown.com/en/perspectives-events/publications/2020/03/legal-update-on-section-4003-of-the-cares-act-liquidity-for-eligible-businesses-states-and-municipalities.
10 See Sections 4003(c)(2)(H); 4003(c)(3)(C); and 4003(d)(i)(6).
12 Section 4002 of the CARES Act provides that a "covered loss" includes losses incurred directly or indirectly as a result of coronavirus, as determined by the Secretary.
13 It is a condition to funding for mid-sized businesses that the borrower makes a good-faith certification that the uncertainty of economic conditions as of the date of the application makes necessary the loan request to support the ongoing operations of the recipient.
Visit us at mayerbrown.com
Mayer Brown is a global legal services provider comprising legal practices that are separate entities (the "Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP and Mayer Brown Europe – Brussels LLP, both limited liability partnerships established in Illinois USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales (authorized and regulated by the Solicitors Regulation Authority and registered in England and Wales number OC 303359); Mayer Brown, a SELAS established in France; Mayer Brown JSM, a Hong Kong partnership and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.
© Copyright 2020. The Mayer Brown Practices. All rights reserved.
This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.
