The U.S. Department of the Treasury and the Federal Reserve announced last Tuesday a program meant to inject liquidity into the beleaguered financial system.
The initiative, which is called the Term Asset-Backed Securities Loan Facility (TALF) will create a $200 billion one-year facility to offer non-recourse loans, under The Federal Reserve Bank of New York (FRBNY), to holders of triple-A ABS that are backed by newly and recently originated auto, student and credit card loans, as well as Small Business Administration (SBA) loans made to U.S. borrowers.
The program will be carried out through monthly auctions. Companies will be submitting bids that have a size and an interest rate spread over a one-year overnight index swap (OIS).
This is why bidders will have no certainty of access, unlike, for instance, the Fed's commercial paper facility, where issuers had certainty as to their ability to tap the government, according to Stephen Stanley, chief economist at RBS Greenwich Capital. He said another interesting question is whether the Fed will evaluate the bids in different buckets (i.e. for autos, credit cards, etc.), or will simply fill the cheapest bids. If this latter is the case, the Fed will probably end up funding the lowest-quality triple-A product.
The facility might be expanded to other eligible asset classes, such as CMBS and non-agency RMBS. The program should be operational by February 2009.
Uncertainty Regarding the Specifics
Details on how TALF will operate remain murky. "At this stage, it is unclear what the uptake will be; there are very few details on specific program economics and as currently outlined, the FRBNY and Treasury have latitude to adjust many of the terms as they deem appropriate," Deutsche Bank Securities analysts said in a recent report.
One factor that is unsure at this point, for instance, is the cut-off date for recently originated loans. This will be established in the upcoming weeks or even months, Merrill Lynch analysts said in a report.
Also, while it's definite that the loans made under TALF will have a one-year term, it's unclear how this could be applied to autos, credit cards, student and SBA loans.
"I think one of the things that will be interesting is how the TALF will be utilized, considering it will be using one-year loans to borrowers," said Amy Moorhus Baumgardner, an Of Counsel at the law firm Morrison & Foerster. For instance, she said, credit card master trusts, which fund short-term 30-day assets, can issue shorter-term funding. Because of this, it might be easier to apply the TALF to credit card receivable securitizations than to ABS backed by auto loans or student loans, which have longer terms. She said that this might compel people to "structure their ABS to include a tranche that has a turbo pay or other structural features to create triple-A paper that will pay down in one year. This would facilitate funding under this facility, although it would create a lot of subordinated securities for which there has not been a ready market."
Meanwhile, Moorhus Baumgardner said that the market is waiting to see how effective TALF will be. "People will find a way to use this program. The one-year term is going to require some creative thinking in terms of deals' structural components."
Impact on Consumer Assets
In a recent report, Barclays Capital projected the outstanding dollar amount for the different ABS sectors that are eligible under TALF, including the yearly issuance volume in each sector for the last four years.
Analysts said that aggregate outstandings reached $811 billion, a number that does not include SBA securitizations since there is no reliable data available. ABS issuance in aggregate in the eligible segments averaged just above $220 billion over the 2005 to 2007 period. However, 2008 issuance is off considerably because of the securitization market freeze. Basing their findings on this data, Barclays analysts think that the $200 billion TALF fund could significantly benefit the ABS new issue market "at a minimum helping new issues for the better part of the year."
How this money will be distributed among the eligible sectors remains to be seen. Moorhus Baumgardner said that TALF will likely affect the consumer sectors in various ways. In credit cards for instance, TALF will probably benefit private label credit card debt more than financial institutions that have alternative sources of funding, such as deposits. For instance, private label issuer Circuit City noted, as it filed for bankruptcy protection, the inability of its customers to finance larger purchases. Meanwhile, in autos, a significant portion of lending traditionally comes from the captive auto lenders as opposed to banks, and these companies have experienced a shortage in liquidity, making them potential beneficiaries of a program like TALF, Moorhus Baumgardner said.
The U.S. government has also raised the prospect of applying TALF to CMBS and non-agency MBS, although there are no specifics as to when and how such an expansion might be implemented. "The decision of whether the TALF would extend to other sectors aside from consumer assets is probably going to be based both on the success of the program and the goals of the new administration," Moorhaus Baumgardner said. She explained that TALF's implementation would depend on the new administration, which is holding information on how it will be deploying TARP funds close to its chest for now.
Comparisons to Other Fed Programs
Barry Metzger, a partner at Baker & McKenzie, said that TALF is being used to approach the problems in the consumer finance market in the same way a number of facilities were utilized to unfreeze the commercial paper market a few weeks ago. Examples of these facilities include the Commercial Paper Funding Facility (CPFF) and the Money Market Investor Funding Facility (MMIFF).
"These commercial paper programs facilitated the return of the commercial paper market, in part by providing funding to money market funds to permit them to invest in commercial paper, thus allowing corporates and other issuers to sell their commercial paper," said Metzger. "The Fed is trying to do the same for consumer-related ABS," he continued. "Investors can now borrow directly from the Fed through this facility, using new consumer-related ABS as collateral."
Metzger explained that the borrowing is going to occur through a bid/auction process where investors indicate how much they want to borrow and what interest rate they are prepared to pay. According to Metzger, depending on how the process works for consumer assets, the Fed could add non-agency mortgage securities and CMBS to the program as eligible collateral.
While the Troubled Asset Relief Program (TARP) was originally intended to buy troubled assets, by definition these are not the ABS that qualify under TALF, Metzger said. "Under this program, the eligible collateral is basically triple-A rated or the top slice of ABS consumer assets," Metzger said. "What this suggests is that, if TALF is extended to mortgages and CMBS, it will be to top-rated mortgage and CMBS assets. It would be used to buy securitized assets which are simply illiquid, for which there is effectively no market. The Fed itself is interested in having TALF investors repay their loans, much like it is when banks borrow at the Fed's discount window. TALF is structured so that investors can get a non-recourse loan from the Fed that is backed by top quality consumer paper and, maybe ultimately, mortgage paper."
In short, Metzger said that much like the Fed's MMIFF program is targeted toward money market funds as investors in commercial paper, TALF is aimed at investors in high quality consumer securities and Small Business Administration guaranteed business loans. As such, it is seeking to create liquidity in the market for those securities, without the Fed taking much credit risk with the assets it is accepting as collateral.
Speaking specifically about Treasury Secretary Henry Paulson's refusal to help auto issuers, which he expressed before the TALF announcement was made, Metzger said that the program helps issuers such as auto companies indirectly. "An originator would not directly be a borrower, but would be a beneficiary, as TALF would give investors an outlet for the triple-A product that these firms originate."
The switch in TARP's direction from a focus on troubled mortgage assets to top-rated consumer assets and possibly non-agencies and CMBS is understandable, in light of the enormity of the problems facing the existing market. "A silver bullet response to the current crisis is not possible, given the wide ranging set of problems with financial assets and institutions that the Fed and the Treasury have to address," Metzger said. "Having a focused response to a particular problem, such as TALF addressing the frozen consumer credit market, will be criticized because it is a narrow, limited response. But in the nature of a crisis is the need for a series of narrow responses, addressing in turn elements of the wider crisis. A crisis also requires immediate responses, without a lot of time to study and analyze the problem. This is why second guessing and criticism is inevitable, such as the criticism to which TARP and the various Fed crisis-response programs are being subjected."
Despite the uncertainty still surrounding TALF, industry participants mostly welcome the program.
An advantage of TALF is that it hits on the main complaint against TARP. "I think one of the most consistent complaints when TARP came out was that it was used as a way to bail out Wall Street," said Moorhus Baumgardner. "The money from TARP was used to capitalize large financial institutions without imposing any requirements on the use of funds. Although we don't know the details underlying the program yet, TALF was designed - since it targets recently originated credit card debts and other consumer loans - to relieve some of the economic downturn on Main Street."
And as Deutsche Bank Securities analysts notably said: "One certain positive take-away is the recognition by policy makers of the importance of restarting the ABS market and recognition of the market's role in making credit available to consumers."
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