The ABS market welcomed the additional details disclosed on the Term Asset-Backed Securities Loan Facility (TALF), which the Federal Reserve and U.S. Treasury  Department announced on Tuesday.

“We view the current iteration of TALF’s terms and conditions as positive; most of the substantive changes will likely be beneficial to issuance volumes in general,” Barclays Capital analysts said.

Most TALF issuance will be coming from the auto sector, specifically independent finance firms and the Detroit Three, according to the analysts.They also think that there will be some pariticpation from foreign captives now that the executive compensation restrictions have been eliminated.

Announced Changes

Under the revised terms and conditions, borrowers can now receive one or more fixed-rate as well as one or more floating-rate TALF loan. This means that eligible borrowers may request an unlimited number of loans at each subscription date, according Merrill Lynch analysts.

An advantage of the revisions is they made it more cost-efficient to issue ABS deals. The changes include limiting the  interest rates and collateral haircuts for FFELP student loan as well as Small Business Administration (SBA) loan ABS. The difference between the general purpose and private label credit cards was also removed.

Aside from these, the new version of TALF offered increased clarity on the determination of average lives and prime versus subprime collateral, according to Merrill analysts.

The average life is used to determine collateral eligibility and the haircut level, while the prime/subprime distinction is utilized  to know the level of haircuts necessary.

More importantly, the Troubled Asset Relief Program (TARP) executive compensation restrictions no longer apply to ABS issuers under TALF.

Market Reaction

Doug Landy, head of regulatory practice at Allen & Overy, said that  from the inquiries he has been getting regarding the TALF,  market participants seem to be pleased about the revised haircuts applied to student, credit card and SBA loans.

According to Merrill’s report, the lower haircuts and financing rates for FFELP student loan ABS have improved the economics of TALF loans related to this asset class. For instance, analysts said that the spread on a two-year class would have to be around 130 to 135 basis points for a borrower looking to achieve a 15% return under the new terms. Previously, the spread would have needed to be 175 to 180 basis points.
The adjusted financing rates “make it more appropriate and economical” to issue TALF-eligible deals in these asset classes, Landy said. He added that the clarifications on how to fund TALF transactions and the new specifications on the appropriate assets that could fall under this program were also helpful.
Landy said that an issue that the Fed and the Treasury Department are dealing with is TALF’s expansion into other assets classes other than the ones currently covered by the program.
Both government agencies said that they are now looking at the appropriate terms and conditions for accepting CMBS as collateral for TALF and are evaluating various other types of newly issued triple-A for possible inclusion.
“They probably will expand the program, but the question is how are they going to handle the larger assets, how much can they actually spend specifically on these asset classes?” Landy said that various funding options are being explored at this point, including a Treasury-backed special purpose vehicle and increasing the TALF money to $800 billion to cover those assets.
The Fed and the Treasury also expect that rental fleet deals and fleet lease ABS as well as equipment loan lease ABS will be eligible for TALF’s April funding. The agencies’ current preoccupation is on securities that will have the most macro-level benefit and could be most efficiently accommodated into the TALF at a low and manageable risk to the government.

Near-Term Expectations

Merrill analysts think that issuers are going to start accessing the ABS market sometime next week to meet the Federal Reserve Bank of New York’s timetable. As a result, issuance volume is expected to slowly build as market players become more comfortable with the process.

However, analysts from both Barclays and Merrill think that credit card and FFELP student loan lenders still have alternative funding sources that are comparatively attractive to the ABS market.

Credit card issuers can fund more cheaply via deposits and the Federal Deposit Insurance Corp.’s Temporary Liquidity Guarantee Program (TLGP). In the same vein, student loan lenders can continue to access Department of Education’s funding.

However, Merrill analysts still believe that  “the ABS market has been a key funding source so at some level we expect them to participate in the TALF program as issuers of TALF-eligible ABS.”

Some Caveats

Although the market is generally happy with the changes, there were certain requests market participants sent to the Fed that were not answered. 

One request, according to Landy, has to do with disclosure requirements for investors. Since the TALF loans are non-recourse, it’s required under the reps and warranties to disclose that the assets in a deal fall under the program.

While issuers generally have to make this type of disclosure on their offering documents, investors have not been required to do so in the past. This has created some uncertainty regarding the use of TALF that market participants want the Fed to address, Landy said.

Barclays analysts said that the success of TALF will be based on the level of non-levered buyside participation.

Analysts think that a lot of traditional investors, specifically insurance firms, are able and willing to utilize TALF leverage and might probably be involved in the new issue market. This might, in turn, add downward pressure on new issue spreads as insurance firms are not likely to demand the high double-digit yield that hedge funds can, Barclays analysts said.

They do not foresee “significant participation from this segment in the near term, we may see it increase toward year-end if secondary market spread tighten sufficiently.”

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