The Term Asset-Backed Securities Loan Facility (TALF) has kick-started U.S. primary market issuance, but the flurry of activity won't tempt European governments to follow with a European version of TALF. Market analysts said that governments, in particular the U.K., have worked on several initiatives that separately touch upon many similar points housed under TALF.
According to figures reported by Merrill Lynch, the Federal Reserve completed its second TALF funding with $1.71 billion of loans in April versus $4.71 billion of loans in the March funding.
Similar to the first funding, four consumer-related transactions qualified for TALF funding, and analysts said that some of these deals would have priced at much wider spreads and, perhaps, issued as smaller transactions if they were not TALF eligible.
"TALF seems to have reopened the U.S. ABS primary market," said Jean-David Cirotteau, an analyst at Societe Generale. "It is not only attractive for the liquidity guarantee provided to eligible issued bonds; it also strengthens the standards of underlying portfolios, and thus provides confidence to the investor base. There are still problems from an operational and a credit perspective, and some investors remain reluctant to re-enter the consumer finance arena at current levels. But the diversity of the U.S. investor base does create the potential to restart the market. The situation is much more problematic in Europe and remains blocked."
Still, the U.K. government in particular has not waned in its attempts to try and kick-start issuance and has been equally active launching at least five initiatives that provide several types of relief to the market. TALF can be compared to other initiatives such as the Bank of England's (BoE) Asset Purchase Facility (APF). Both initiatives were established to reduce funding pressure on issuers, although TALF is focused especially on the structured credit sector while the APF focuses on helping the issuers in problematic situations in exchange for commercial paper as collateral.
Both initiatives, however, are in place to provide liquidity to the market. The APF is also there for monetary policy purposes. Both initiatives come at a relatively small price. However, U.K. issuers are allowed to allocate ABS and less liquid instruments to other initiatives such as repo facilities as well as BoE's Discount Window Facility (DWF). The Special Liquidity Scheme was closed in January this year.
"Participating in such initiatives implies also accepting eventual restrictions," said James Zanesi, a Unicredit analyst. "TALF was well known for the eventual compensation and hiring policies' restriction, which are also the main reasons for the silent start of the program. Also, the APF implies that the participating issuers are obliged to provide appropriate lending volumes."
Zanesi said that the U.K. market is dealing with the same issues as in the U.S., albeit on a more moderate level. But the first concern for both markets is to provide funding. "You want the central banks to provide funding, but you don't want it to bear the downside risk, and the best way to do this is by having it obtain collateral," he said.
"In some cases, central banks are not legally allowed to give funding via unsecured debt - this in Europe and the U.K. has been executed via different schemes," Zanesi said. "However, funds like TALF allocate distressed debt that no one wants, and in Europe, the central banks haven't yet gone that far. While U.S. initiatives are taking into consideration to include more risky assets (e.g., CMBS), in Europe, changes in eligibility criteria have generally focused to eliminate such structures from the eligible assets."
The second concern for both markets, Zanesi said, was the asset overhang that has been created in the stagnant securitization market. "While you can use the several central bank initiatives for ECP eligibility, unlike TALF, you have more strict limitations of what type of assets will be eligible," he said. "In the U.K., government initiatives are intended to avoid considerable direct exposure to the risk of the collateral, but the government still bears the issuer's credit risk."
The U.S. government has also pushed the liquidity aspect of the ABS market to the forefront by using the TALF. There is no guarantee of the quality of the collateral at this stage. The government has required all parties involved in the structuring of the deals to make extra efforts to ensure that portfolio performances remain in line with their ratings. Investors have responded very positively to the liquidity scheme, which has been predominant in restarting the ABS market so far.
Cirotteau said that such a scheme could be envisaged in Europe. But, at the moment, the investor base's capacity to absorb European ABS paper, should it be enhanced by a similar liquidity scheme, is somewhat doubtful.
Hans Vrensen, Barclays Capital's director of securitization research, estimates that presently there is approximately E1 trillion ($1.29 trillion) of mostly retained ABS sitting with the BoE and European Central Bank. ABS issued to investors amounts to E1.1 trillion in outstanding, with some overlap likely.
"The initiative in the U.S. is for the Fed to buy bonds straight off the market," he explained. "The role of central banks in Europe has been focused on providing repo funding to banks secured by retained ABS collateral. In the U.S., the Fed's TALF program is compared by some to government-sponsored term repo, as investors get financing to buy ABS by pledging the ABS bonds to be purchased as collateral against the loan."
Vrensen said that Europe needs to come to a point where securitization's role is accepted as a fundamentally positive one for banks' funding and the economy at large, while embracing sufficient reforms to the way the industry operates. "Only then can government and industry start working together on reviving ABS in Europe," he said. "We might see some positive announcements in the upcoming U.K. budget."
To be certain, the U.K. government recently unveiled plans for two guarantees under its proposed U.K. 2009 Asset-Backed Securities Guarantee Scheme. Under the scheme, the U.K. government will guarantee the timely payment of all amounts contractually due under the issued RMBS. This will effectively cover a credit risk above 'AAA' given the underlying rating requirement. Fitch Ratings said it had received feedback from investors indicating they are generally willing to take on good-quality credit risk of U.K. prime RMBS.
The second guarantee attempts to miti-gate extension risk, which seems to be the primary concern of investors currently as prepayment rates have dropped lower than the level at which transactions have initially been priced. Investors will have the opportunity to utilize a put option that allows them to sell RMBS back to the issuer. Issuers will also be able to call notes after a certain date as well. Both options will backed by a government guarantee.
At press time, the terms on which the government guarantee is offered and its cost were still uncertain, but Zanesi said that, at first look, the proposed scheme more closely resembled the terms set out in the TALF initiative. Fitch analysts said that the degree to which the scheme will spark new lending by improving funding conditions is uncertain because other schemes - such as the Credit Guarantee Scheme - currently offered by the U.K. government might result in competing funding options for eligible financial institutions.
"On the U.S. side, a much stronger political case has been made for ABS, perhaps because securitization is better established and more widely accepted," Vrensen said. "The government has gone into quite a lot of detail on how to bring the market back, working together with industry. Especially in continental Europe, politicians and policy makers remain focused on blame allocation and whether or not securitization should continue in the future."
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