A Reserved Tender Advance Facility (a “RTAF”) is a new type of credit enhancement vehicle that is specifically designed to create rating consistency, principal value support and certain liquidity when secured by investment portfolios of mixed grade securities, financial instruments, or other acceptable collateral. Every RTAF is constituted by a two-party credit agreement that sets certain terms and conditions under which credit will be granted to a Note Issuer at a future date upon first call therefore by a specifically authorized party – customarily the Note Trustee or fiduciary of an MVRDN Series. In this application, the RTAF both serves as a means of credit enhancement of the principal portion of the MVRDNs, and, in the event of the exercise of an optional tender that is not otherwise satisfied or upon any call for principal by the Note Trustee as permitted under the Note conditions, the RTAF provides liquidity to cover the purchase price of the principal portion of all or any portion of the Notes that may be repurchased on behalf of the Issuer.
When a high credit-quality RTAF is taken together with the enhancement afforded by an Interest Letter of Credit, these mechanisms enable the MVRDN to be deemed investment grade and qualified for purchase by the accredited money market institutional investor. Such an investment grade rating permits the MVRDN Issuer as Borrower to access debt capital sourced from the institutional capital markets on a non-leveraged and more cost effective basis than what may be customarily available to it when using traditional bank credit lines or leverage facilities. With specific regard to RTAF’s that are tailored to use with the MVRDN, there are two specific types of RTAFs that can be effectively utilized to both credit enhance the principal portion of the Notes and to provide short term liquidity as required; the Collateralized Reserved Tender Advance Facility ("Collateralized RTAF") and the Principal Reserved Tender Advance Facility ("Principal RTAF").
The MVRDN, through the incorporation of a Collateralized RTAF, constitutes an exceptional and cost-effective alternative to the issuance of a Collateralized Fund Obligation (“CFO”) by a qualified hedge fund or asset management firm. The efficient operation of the Collateralized RTAF is relied upon heavily as a cornerstone of the MVRDN when applied as a surrogate for a conventional CFO in the alternative investment market. The establishment of a Collateralized RTAF hinges on two issues:
(i) the Collateralized RTAF Provider’s evaluation and approval of the investment strategy of the MVRDN Issuer; and
(ii) the amount of equity available from the Issuer or other third party to cover first-losses resulting from a depletion of the net asset value under the MVRDN Issuer’s management or control pursuant to the approved investment strategy.
The former calls for the investment strategy to be reviewed, approved, and underwritten by the Collateralized RTAF Provider prior to the commencement of asset management operations such that all instruments, securities or investments that are or will be acquired by the Issuer as the Asset Manager meet certain investment eligibility criteria that have been agreed by the Collateralized RTAF Provider. The latter calls for those equity funds that, in the case of a conventionally operated CFO, would normally be posted in favor of a bank or other leverage capital provider be availed by the Issuer (via the establishment of an equity reserve) in favor of the Collateralized RTAF Provider. The equity reserve, when taken together with certain loss triggers that will be agreed, will mitigate principal risk or risk of ‘first losses’ to the Collateralized RTAF Provider in the operation of the Issuer’s investment portfolio.
The equity reserve can be as little as 5% of the total principal amount of MVRDNs outstanding in a given Note Series or as substantial as 25% of that total, dependent upon the Collateralized RTAF Provider’s assessment of principal loss risk stemming from the operation of the Issuer’s sanctioned investment strategy. The Collateralized RTAF allows the Collateralized RTAF Provider to credit enhance the full principal portion of the MVRDN Series issued without absorbing the principal risk associated with net asset value depletion on the Issuer’s portfolio. The credit enhancement constituted by a Collateralized RTAF is secured upon any call for a principal payment thereagainst by taking a first position on MVRDNs that are purchased with the proceeds of the Collateralized RTAF, which MVRDNs are ultimately supported by the corresponding, underlying investment value of the asset management portfolio plus, as and when needed, by all or any portion of the equity reserve.
A Collateralized RTAF Provider can benefit from underwriting the principal portion of a MVRDN Series with very little exposure to potential losses. Within a conservative risk management framework in which the MVRDN Issuer, as the Asset Manager, is assuming a position to absorb first-loss or principal risk on its investment portfolio, the Collateralized RTAF represents a new, lower risk, and sustainable revenue opportunity for suitable credit enhancement firms, financial institutions or insurance companies.
A candidate Collateralized RTAF Provider would:
be a bank, financial institution, insurance company or corporate guarantor that has a minimum A1 rating of its long-term deposits or debt obligations;
have the availability of certain minimum amounts of funds to provide short-term liquidity against a draw upon the Collateralized RTAF with a maximum of 7-days’ notice;
be engaged actively as a commercial lender, structured products specialist or financier in the marketplace with an understanding of the general nature of the investment strategy employed by the Asset Manager;
be willing to act as a source of credit enhancement to its customer-base rather than expressly a traditional “lender”; and
price the Collateralized RTAF based upon the assessment of an establishment fee and draw fee.
The Principal RTAF is an innovative means of enabling an institution that seeks to gain investment exposure into the alternative investment market to do so by taking up a role as the Principal RTAF Provider and thereby participating in selected investment fund opportunities on a non-cash basis. As had been described in the previous section with regard to the operation of a Collateralized RTAF, the Principal RTAF secures the principal portion of an MVRDN while the Interest Letter of Credit secures the payment of monthly interest due. When taken together, these mechanisms enable the Issuer as Borrower and investment manager to access debt capital sourced from the institutional capital markets on a non-leveraged and more cost effective basis than what may be customarily available.
The establishment of a Principal RTAF in support of an MVRDN Series hinges on two issues:
(i) the Principal RTAF Provider’s evaluation and approval of the investment strategy of the MVRDN Issuer; and
(ii) the profile of the MVRDN Issuer as the asset or investment manager.
In contrasting the Collateralized RTAF to the Principal RTAF, there is a difference which goes expressly to where the principal risk rests in the event of a net asset value loss on the underlying investment portfolio. In a Collateralized RTAF, the MVRDN equity reserve as raised from third party investors or the Issuer’s own resources, when taken together with certain loss triggers, will provide a back-stop against actual first loss risk in the operation of the Issuer’s investment portfolio. Thus, in the operation of a Collateralized RTAF, the MVRDN Issuer is directly responsible for ‘first’ portfolio losses and the Collateralized RTAF Provider is at all times fully covered for the full principal value drawable under its operation.
In the context of the Principal RTAF, however, there is no third party equity reserve set aside for the benefit of the Principal RTAF Provider. The lack of equity to cover first losses transfers the principal risk in the operation of the investment portfolio squarely to the Principal RTAF Provider. This is not an untenable risk for parties that otherwise would have been willing to participate as a source of equity to the equity reserve that is set aside under the operation of the Collateralized RTAF. Under standard practices, these equity investment participants are bearing principal risk in relation to the performance of the Issuer’s investment portfolio, and for that right, they have contributed hard cash with a view to potential preferential gains. They are actively seeking exposure to the investment strategy being manned by the MVRDN Issuer as an Asset Manager with a view to participating in the portfolio’s future yield. Against this backdrop, the role of Principal RTAF Provider can be superior to that of a traditional equity investor in an investment fund or strategy. Specifically, in the establishment of the Principal RTAF, the Principal RTAF Provider assumes no more principal risk than it normally would in effecting a direct equity investment, and the Principal RTAF neither requires a full principal value deposit or allocation of funds to a third party nor a principal value pledge of funds or assets as the basis to activate the facility. The Principal RTAF is a purely contingent obligation of the Principal RTAF Provider in support of the MVRDN Issuer’s successful issuance of the MVRDNs against which the Principal RTAF Provider is able to participate in performance-based yield at a negotiated percentage of profits generated by the investment manager after deduction for MVRDN interest payable and agreed expenses.
A candidate Principal RTAF Provider would:
- be a bank, financial institution, insurance company or corporate guarantor that has a minimum A1 rating of its long-term deposits or debt obligations;
- have the availability of certain minimum amounts of funds to provide short-term liquidity against a draw upon the Principal RTAF with a maximum of 7-days’ notice;
- be seeking investment exposure in the alternative investment market or in a given investment strategy to be underwritten;
- be able to sustain certain principal risk or net asset value losses resultant from its participation;
- be engaged actively as a commercial lender, structured products specialist or financier in the marketplace with an understanding of the general nature of the investment strategy employed by the Asset Manager;
- be willing to act as a source of credit enhancement to its customer-base rather than expressly a traditional “lender” or “equity investor”, as the case may be;
- price the Principal RTAF based upon the assessment of an establishment fee, draw fee, and participating investment performance fee; and
- be willing to consider acting as the Interest Letter of Credit Issuer pursuant to the above as the basis to better control default conditions in the event of a net asset value loss or draw down.
The Principal RTAF represents an exceptional and innovative surrogate for a Principal RTAF Provider’s conventional cash-based investment in approved Asset Managers or investment strategies.
More information about the operation of RTAFs can be found in each of the “Document” sections under CVRDN, MVRDN and Institutional applications.
Please take a moment to contact us if you feel your institution might benefit from learning more about either of these RTAF structures.