Hedge Fund Returns

2009 No. 3 Participating in TALF – Pros and Cons for Investors

Hedge Fund Returns is published By John J. Dedyo ([email protected]), Germaine Gurr ([email protected]) by Weil, Gotshal & Manges LLP, and Kristen Buppert ([email protected]) 767 Fifth Avenue, New York, NY 10153, +212-310-8000. The Term Asset-Backed Securities Loan Facility (“TALF”) is a joint program of the Weil Gotshal’s multidisciplinary hedge fund practice group spans Federal Reserve and the United States Treasury that falls under the U.S. government’s the United States, Europe and Asia. Consumer and Business Lending Initiative. TALF aims to improve the availability We represent blue chip hedge fund of credit to consumers and businesses by stimulating the securitization markets. managers around the globe as well Specifically, TALF provides an opportunity for certain investors, including eligible as investors in hedge funds. hedge funds and other financial investors (“Eligible Borrowers”),1 to borrow from the We provide seamless service and unparalleled transactional advice Federal Reserve Bank of New York (“FRBNY”) in order to purchase or finance asset- to hedge fund managers. Our backed securities (“ABS”) backed by certain eligible assets (“Eligible Collateral”). hedge fund manager clients benefit from our substantial expertise Under TALF, the FRBNY will initially lend up to $200 billion to Eligible Borrowers and reputation in fund formation, that seek to invest in AAA-rated securities backed by Eligible Collateral, including mergers & acquisitions, leveraged finance, real estate and structured auto loans (including leases), credit card loans, public and private student loans, finance transactions as well as our and small business loans guaranteed by the Small Business Administration.2 Eligible pre-eminent restructuring practice. Borrowers who are accepted by the FRBNY may request a minimum of $10 million Our representation frequently in three-year non-recourse funding for the purchase of ABS backed by Eligible includes the following: Collateral. The U.S. Treasury and the Federal Reserve are currently analyzing and n establishing hedge funds, hybrid evaluating other types of ABS for eligibility under TALF, including commercial and funds, special situation funds residential mortgage-backed securities, vehicle fleet leases, equipment loans and and distressed debt funds and seeding new hedge fund leases, and collateralized loans and debt obligations. Such an expansion of eligible managers ABS could lead to an increase in lending under TALF of up to $1 trillion. n strategic transactions involving TALF has been structured to induce financial investors, such as hedge funds, to hedge fund managers, including the acquisition or sale of invest in new ABS as a way to reopen the securitization market. For hedge funds, controlling and minority stakes TALF provides an opportunity to make a highly-leveraged investment in ABS in in hedge fund managers which the FRBNY and the United States Treasury assume the risk of loss on the ABS n control and non-control beyond the capital the hedge fund is required to put at risk. acquisitions and dispositions and investments in senior and The advantages to hedge funds and other financial investors of participating in subordinated debt and structured TALF include the following: products n AAA-Rated ABS Backed by Recently Originated Assets – ABS financed with n leveraged lending transactions and debtor-in-possession financing TALF loans must generally have been issued after January 1, 2009, and must be rated AAA by two or more nationally recognized statistical rating organizations n advice with respect to the management of CLOs and CDOs (“NRSROs”) at the time the TALF loan is borrowed. Such credit ratings cannot be obtained by means of a third-party guarantee. As noted in Note 2 below, the n out of court and in court workouts and restructurings of debt assets underlying such ABS must be of recent vintage.

The members of our hedge fund n Available Leverage – Subject to a minimum borrowing demand of $10 million, the practice group are listed on the last page of this publication. FRBNY will lend the Eligible Borrower an amount equal to (x) the lesser of par or

 Hedge Fund Returns

the market value of the pledged ABS; In addition, TALF borrowers are executive compensation restrictions provided that if the market value required to pay an administrative put into place in 2008 under exceeds par, the FRBNY will lend an fee of 0.05% of the loan amount to Section 111(b) of the Emergency amount equal to the market value the FRBNY on the settlement date Economic Stabilization Act. (with a cap of 110% of par value) less of each TALF loan secured by such However, this requirement has been (y) the required percentage of risk borrower. removed, and the FRBNY also has capital that an Eligible Borrower must made clear that such executive contribute. An Eligible Borrower’s n Loans Non-Recourse to Borrower – compensation restrictions will not risk capital can range from 5% to The borrower’s risk on the be imposed on TALF borrowers as a 16% of the total ABS investment investment is generally limited to result of their participation in TALF. (as detailed in the table below), and the amount of its risk capital. If a The disadvantages to hedge funds and may increase beyond such range for borrower does not or cannot repay other financial investors of partici- ABS with an average life beyond five the TALF loan, the collateral must pating in TALF include the following: years. The risk capital requirement be surrendered, but there is no

depends on the type of Eligible additional recourse against the n Approval by FBRNY – An Eligible Collateral backing the ABS and the borrower unless the borrower Borrower must be approved by the expected life of the ABS. breached certain representations, FRBNY in its sole discretion.

ABS Expected Life (years) n Inspection Rights – An Eligible Sector Subsector 0-1 1-2 2-3 3-4 4-5 5-6 6-7 Auto Prime retail lease 10% 11% 12% 13% 14% Borrower must subject itself to Auto Prime retail loan 6% 7% 8% 9% 10% inspection by the FRBNY, which Auto Subprime retail loan 9% 10% 11% 12% 13% may include visits, audits and Auto Floorplan 12% 13% 14% 15% 16% inspection of its financial records, as Auto RV/motorcycle 7% 8% 9% 10% 11% well as access to officers, employees, Credit Card Prime 5% 5% 6% 7% 8% Credit Card Subprime 6% 7% 8% 9% 10% directors and independent accoun- Student Loan Private 8% 9% 10% 11% 12% 13% 14% tants to discuss the finances, affairs Student Loan Government guaranteed 5% 5% 5% 5% 5% 6% 6% and condition of the borrower. Small Business SBA loans 5% 5% 5% 5% 5% 6% 6% However, in response to hedge fund TALF loans will not be subject to warranties or covenants in industry objections, the FRBNY mark-to-market or re-margining connection with the TALF loan. The recently modified its form of TALF loan agreement to specify that, as requirements; however, when the FRBNY has revised the TALF loan they relate to the borrower, such FRBNY lends against a market value agreement to clarify that an Eligible inspection right will relate only that is greater than par, the borrower Borrower is only required to to the borrower’s TALF loans, ABS will be required to make periodic represent that, at the time the TALF underlying such loans and the prepayments calculated to adjust loan is made, the assets underlying borrower’s TALF loan obligations. for the expected reversion of market the ABS are Eligible Collateral based value to par as the ABS mature. on the borrower’s knowledge after n Restrictions on Assignment – An Eligible Borrower must receive the n Costs of TALF Financing – Borrowers its review of the prospectus or will generally have the option of offering documents for such ABS. prior written consent of the FRBNY choosing from TALF loans that require prior to assigning any of its obliga- n Borrowers Not Subject to TARP such borrowers to pay either fixed or tions under a TALF loan to another floating interest rate payments to the Executive Compensation Limits – party. However, the FRBNY will not FRBNY on such TALF loans, as detailed The initial proposals for TALF consent to any assignment after below, which remains subject to suggested that ABS sponsors would December 31, 2009, unless such adjustment by the Federal Reserve. be required to adhere to the date is extended by the Board of Sector Subsector Fixed Floating Governors of the Federal Reserve. Auto 3-year LIBOR swap rate + 100 bps 1-month LIBOR + 100 bps Unless potential investors of ABS Credit Card 3-year LIBOR swap rate + 100 bps 1-month LIBOR + 100 bps securing a TALF loan have other Student Loan Private NA 1-month LIBOR + 100 bps sources of financing available, this Student Loan Gov’t guaranteed NA 1-month LIBOR + 50 bps Small Business SBA loans 7(a) NA Fed Funds Target + 75 bps restriction on assignment will limit Small Business SBA loans 504 3-year LIBOR swap rate + 50 bps NA a borrower’s ability to transfer the

Weil, Gotshal & Manges llp  Hedge Fund Returns

ABS unless it is prepared to repay It has also been reported that certain hedge funds, private equity funds, mutual funds, and any vehicle designed to invest the TALF loan in connection with of the primary dealers participating in Eligible Collateral to borrow from TALF) such transfer. in the TALF program are creating organized and managed in the United States with a United States investment manager. vehicles to pool investments by Entities organized outside the US (without n Restrictions on Hedging – The investors in the TALF program that a US subsidiary) or controlled in part by a borrower is not allowed to enter foreign government or managed by a non-US either want to participate in smaller investment manager will not be eligible for into any hedging contracts with the amounts than the $10 million TALF loans. primary dealer that underwrote or minimum borrowing or are reluctant 2 TALF imposes limitations to the assets backing the ABS funded under TALF, including: sold the related ABS or the sponsor to participate due to the FBRNY’s (i) Eligible Collateral must not be backed of such ABS (or any affiliate of such inspection rights or concern over the by loans originated or securitized by the primary dealer or sponsor) in order limitations to the non-recourse provi- borrower applying for TALF funds or by an affiliate of the borrower. to protect the borrower against any sions of TALF or TALF’s limitations (ii) At least 95% of the collateral underlying losses specific to its TALF financing. on assignment and hedging of ABS the ABS must be exposure to US-domiciled obligors, and must be auto loans, student The borrower may, however, hedge purchased using TALF loans. loans, credit card loans, or small business its general portfolio of invest- loans fully guaranteed by the Small Initial subscriptions for TALF loans will Business Administration, or another asset ments, which may include securities be accepted until March 19, 2009, and type approved by the FRBNY. purchased with TALF loans. This (iii) The average life for credit card or auto the funding for such subscriptions is loan ABS cannot be greater than five years. restriction may limit a participant’s currently scheduled for disbursement (iv) At least 85% of all of the credit exposure ability to hedge its investment in on March 25, 2009. Afterward, the for auto loans and student loans under- lying the ABS must have been originated ABS purchased using TALF loans. FRBNY will accept monthly subscrip- or been first disbursed on or after October tions for additional or new borrowings 1, 2007 and May 1, 2007, respectively. n Limited Term for TALF Loans – Each SBA-guaranteed small business loan under TALF on the first Tuesday of collateral must have originated on or TALF loan must be repaid after its every month until December 31, 2009, after January 1, 2008. Credit card and three-year term regardless of the auto dealer floorplan ABS must be issued unless otherwise extended by the to refinance existing credit card and auto maturity of the related ABS. In the Federal Reserve Board. dealer floorplan ABS maturing in 2009 and event that the related ABS mature must be issued in amounts no greater than the maturing ABS amount (unless, in the case of auto dealer floorplan ABS, substan- after the three-year term of the TALF 1 Borrowers who seek TALF financing must tially all of the underlying floorplan be (i) businesses or subsidiaries organized loan, the borrower will be forced to lines of credit were originated on or after and with primary operations in the United January 1, 2009). sell the ABS, surrender the collateral States, (ii) United States branches or agencies to the FRBNY or refinance the TALF of a foreign bank (other than a central Other limitations likely will apply to the bank), or (iii) investment funds (defined extent the types of eligible underlying assets loans at that time. as pooled investment vehicles, such as are expanded.

Weil, Gotshal & Manges llp  Hedge Fund Returns

AUSTIN Back Issues of Hedge Fund Returns are available online at www.weil.com BEIJING Recent Articles:

Credit Derivatives Determinations Committees: A Way Forward in a BOSTON Developing Marketplace Survival of the Fittest BUDAPEST

DALLAS

DUBAI

FRANKFURT

HOUSTON

HONG KONG

LONDON

MIAMI

MUNICH

NEW YORK

Hedge Fund Practice Group Members PARIS (all lawyers based in New York except where otherwise noted) Capital Markets Mergers & Acquisitions Restructuring PRAGUE Todd Chandler Craig Adas – Silicon Valley Philippe Druon – Paris James Cole – London David Aknin – Paris Lori Fife PROVIDENCE Alex Lynch Joe Basile – Boston Marcia Goldstein David Meredith – Hong Kong David Dederick – Budapest Uwe Hartmann – Frankfurt Peter Schwartz – London Peter Feist – Hong Kong Gary Holtzer SHANGHAI Fund Formation Michael Francies – London Tony Horspool – London Stephen Karotkin Shukie Grossman Jeffrey Hitt – Dallas SILICON VALLEY Jeffrey Hitt – Dallas Jane McDonald Structured Finance/ Karel Muzikar – Prague Derivatives David Kreisler – Boston WARSAW Jonathon Soler Gerhard Schmidt – Frankfurt Conrad Bahlke Jeffrey Tabak Joe Tortorici – Dubai Robert Chiperfield Barry Wolf Doug Warner Jacky Kelly – London WASHINGTON, DC Glenn West – Dallas Frank Nocco Leveraged Finance James Westra – Boston Tax WILMINGTON Dan Dokos Michael Weisser Juergen Boerst – Frankfurt Stuart Hills – London Artur Zawadowski – Warsaw Michael Nicklin – London Robert Frastai Elaine Stangland Real Estate Joseph Newberg – Boston Doug Urquhart Philip Rosen Martin Pollack Sarah Priestley – London Stan Ramsay

Editors: Doug Warner ([email protected]), +1-212-310-8751 Joe Basile ([email protected]), +1-617-772-8834

©2009. All rights reserved. Quotation with attribution is permitted. This publication provides general information and should not be used or taken as legal advice for specific situations that depend on the evaluation of precise factual circumstances. The views expressed in these articles reflect those of the authors and not necessarily the views of Weil, Gotshal & Manges LLP. If you would like to add a colleague to our mailing list or if you need to change or remove your name from our mailing list, please log on to http://www.weil.com/weil/subscribe.html or e-mail [email protected]. www.weil.com

Weil, Gotshal & Manges llp