The effectiveness of the Term Asset-Backed Securities Loan Facility (TALF) is being questioned because of the so-called anemic interest in the program.
Clearly, in terms of the numbers, this perception seems accurate. The Federal Reserve Bank of New York received only $1.7 billion of loan requests in April during the program's second round. By contrast, $4.7 billion of loan requests were made in March.
Despite the somewhat unsatisfactory level of interest shown thus far, securitization players are gearing up for TALF's third round this month. Issuers such as CNH Capital America and Harley Davidson, among other firms, have amended their deal shelves to participate in the program.
Furthermore, different investment funds have been set up to take advantage of investment opportunities presented by TALF. PIMCO, Paramax Capital Partners, Princeton Advisory Group, Aladdin Capital Management, Belstar Group and Seer Capital Management are just some of the firms setting up these funds.
Anecdotal evidence abounds too about funds soliciting investors for commitments, experts said.
"I am personally aware of people who are putting together TALF fund structures and who are obviously soliciting investors for commitments," said David Audley, executive vice president of Beacon Capital Markets. "They are soliciting investors for commitments to get allocations to structure TALF-eligible ABS. However, it has taken these firms some time to gather information regarding opportunities under TALF and the risks to investors that these opportunities might present."
One of these firms, the Belstar Group, earlier in April launched the Belstar Credit Fund, L.P., following the launch of the Belstar Altair Credit Fund, L.P., to participate in the TALF.
According to the firm's release, the funds are designed to achieve attractive returns by investing in a portfolio of highly rated ABS that are eligible to be financed through the program. In this connection, it hired Simina Farcasiu to be the senior portfolio manager for the funds.
According to Farcasiu, TALF-enabled investments should be used to access the returns available to the providers of pure liquidity. "If you think of securitization in general, the senior tranches are supposed to be protected by being properly diversified, so that their chief source of return should not be taking credit risk, but providing liquidity," Farcasiu said. "What TALF should do is to attract money into the senior tranches in a deal to help solve the liquidity issue. TALF's purpose is not primarily to help any lower-rated tranches. TALF may ultimately help borrowers by compressing the spreads they have to pay."
Some say it's just a matter of time. "TALF might not have been a blockbuster in May, but it might take these firms a couple more months to participate," Audley said. "The program is gaining momentum, although there are still wary investors in this environment. There will be some good interest, but I just don't know about the size of it. There are a lot of strings that come along, as well as inherited problems from the Troubled Asset Relief Program (TARP)."
Audley added that investors that are thinking of participating in TALF want to make sure that they don't suffer unintended consequences from doing so. These include being subject to limitations under the TARP regarding foreign national firms.
Amy Moorhus Baumgardner, a partner at Morrison & Foerster, said that she has been dealing with private investors who are interested and who realize that TALF might be a good investment for them since it's a non-recourse loan. "You limit your exposure with even a high degree of leverage," she said. "Several private investors, either individually or together with friends, have expressed interest in the program since the subscription level begins with $10 million, which is an efficient size for private investors." However, she added that there is also the question of whether there will be enough issuance to cover these subscription levels.
Joseph Suh, a partner at Schulte Roth & Zabel, said that his firm is seeing interest from a range of buyers, from small friends-and-family funds to huge institutional fund investors, including mutual fund managers (although mutual fund regulation and leverage levels might limit these mutual funds' participation in TALF).
Christopher O'Connell, senior vice president at DBRS, said that there's a good number of names committed to the TALF program, despite a lot of issues associated with it. "The market is ultimately trying to find where it can fund subordinate loans," O'Connell said. He added that issuers are trying to find financing for the subordinate notes and the haircut notes at the TALF level. "Most issuers have the ability to fund the subordinate notes, but this uses precious free capital, so it is a tough situation."
Existing Problems
There are a number of problems stopping market players from fully participating in TALF.
O'Connell said that one issue for issuers, specifically in subprime autos, is getting a triple-A rating from the agencies. "Although we like subprime auto paper, we will not rate the subprime auto paper if we are uncomfortable with the issuer and they do not have a viable business," he said. "DBRS has always approached ABS issuers this way."
There are also relationships developed under TALF that have not existed before. "I still think the program has potential, but one of the issues is the complexity in the new relationship between the investor and the underwriter or primary dealer," Moorhus Baumgardner said. "There are new contracts that need to be evaluated, and that is taking some time." Investors would now need to submit publicly registered legal opinions in order to buy securities under TALF, something they didn't have to in the past.
"From the investor's perspective, if there are no time constraints to invest for their funds, there's an interest in waiting," Moorhus Baumgardner said. This is why it will help the process along if the Federal Reserve, "makes the process of participating in TALF simpler and more standardized."
Schulte's Suh said that it was surprising to him that the second round of TALF was not as well subscribed as the first one, since the number of deals that Schulte worked on in connection with the April funding actually tripled compared to March.
However, he acknowledged that there are certain issues with the current version of TALF that might hinder investor interest from fully materializing, including, as mentioned above, the issues raised by TALF customer agreements required by dealers.
"It takes two to three weeks to do everything that needs to be done to get one of these TALF deals done for a new client," Suh said. For instance, he said that although there are only three groups of forms of customer agreements under the program, each dealer might have a different variation of each of these. There are also burdensome legal opinion requirements under these customer agreements that raise the costs for TALF borrowers.
Suh also mentioned that the issue sizes of TALF deals may have been limited by the overall weakness in the economy and the resulting diminished ability of consumers to make payments on the consumer obligations that are securitized in connection with TALF. When combined with the increasingly conservative rating agency criteria for getting 'AAA' ratings on ABS, it may not be surprising that the size of ABS issued in connection with TALF was smaller than expected. "It is possible that the government will need to lower the TALF minimum rating requirement for some types of ABS (perhaps to 'AA' levels) to substantially increase participation in the program."
One legal issue that remains a concern for investors is that TALF was created under legislation that requires TALF money recipients be subject to H1-B restrictions, which do not allow them to take in H1-B employees unless they meet certain requirements. Investors are concerned that if they invest in TALF securities, they would be subject to restrictions on their ability to hire non-U.S. workers.
"Most of the funds don't have employees. The investment managers handling the affairs of the funds have employees, but not the fund themselves," Suh said. There is substantial uncertainty about whether or not the H1-B visa restrictions would apply to managers even if they don't have substantial ownership stake in the TALF funds they manage.
Future Changes by Congress
Investors are still concerned about future changes to TALF. "Although investors understand the economic benefits of the program, there's this feeling that Congress, although not doing it intentionally, could make unrelated changes to legislation that could affect the program in unexpected ways, coming from the left field," Moorhus Baumgardner said.
She gives credit to the Federal Reserve, which seems very interested in making the program work, as shown by its wanting to add more assets into the program, among other things.
"The Fed has shown its belief in the banking and financial system through its support of this program," she said. "The Fed has been good about being receptive to comments and feedback and getting the program up and running."
The element of political risk, according to Suh, comes with investors getting substantial returns using leverage funded by taxpayer money. "Many investors are worried that Congress may come after investors with targeted taxes like those they have considered for certain AIG executives, and many managers are worried about being dragged through the mud of a Congressional hearing about profits made by funds using TALF leverage."
Belstar Group's Farcasiu believes that retroactive changes to TALF loans would run counter to the objective of attracting new capital to make up for the liquidity gap in U.S. securitization markets.
"Congress can do anything," Farcasiu said. "But I think from a policy point of view, TALF is useful, and the political system should realize that."
Moorhus Baumgardner said that there is also the issue exit strategy. "Will there be a market to sell the remainder of the ABS when the three-year period under TALF is over?"
Farcasiu said that in any investment, exit strategies are important, but so are current cash flow, mark-to-market volatility, underlying asset performance and leverage terms. "If in three years we are still relying on the government's preferential leverage, that's going to be an issue. One would hope not, but it could go either way," Farcasiu said.
What TALF Brings to the Table
Despite these hindrances, Suh said that he is optimistic that TALF participation will pick up once participants can get their arms around the program. "There are a number of both dealers and investors that are ready to do these deals, and as far as I can tell, that number is increasing," Suh said. "Moreover, ABS that have been done under TALF could not have been gotten done without the program. In addition, in today's economy, there's no other source of virtually guaranteed 15% to 25% returns at 'AAA' risk levels, including most private equity or other hedge fund investments."
Analysts said that people are missing the bigger picture in terms of TALF. "Deals are fully subscribed and pricing well," said Glenn Schultz, a managing director at Wachovia Securities. He added that TALF is currently approximately 46% of the ABS market, which means that more than half of the market so far this year has been represented by cash buyers. "If 46% of the market is TALF and spreads have come in, I will call that a success," Schultz said. "This is not meant to be a hedge fund giveaway or bailout."
TALF brought into the market buyers and sellers that are able to get their deals done; that's good, all things considered."
Furthermore, Schultz said TALF participants may not give their submissions for funding immediately after the subscription period. "There's a possibility that people just have not gotten their paperwork done," Schultz said.
Other market participants are opposed to the fact that the 18% return gained from TALF securities might serve as a disincentive to participants in the program to look at credit. However, Schultz said that this follows the trajectory of how the ABS had to come before the market had confidence enough to invest in triple-Bs.
Also, with the distortions in the market, the recovery of subordinated bonds is less likely. "From an issuer's perspective, you're probably better off financing triple-Bs with equity," Schultz said.
"TALF is the only game in town right now, and it's reopening the ABS market," DBRS' O'Connell said. "The Fed has been responsive to the markets' feedback regarding the program, and we continue to expect this as the program develops. There are a number of issues associated with the program though: they deal with the customer agreements, primary dealer's role, lack of non-petition language in the master loan and security agreement and maturities of the TALF program."
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