On May 19, 2009, the Federal Reserve Board (the “Board”) announced that, starting in July, certain high-quality commercial mortgage-backed securities (“CMBS”) issued before Jan. 1, 2009, (“legacy CMBS”) will become eligible collateral under the Term Asset-Backed Securities Loan Facility (“TALF”). In addition, the Board released revised terms and conditions and frequently-asked-questions documents for the TALF program in general and to specifically cover the TALF’s expansion to legacy CMBS.
TALF, initially launched in November 2008, is a government loan facility designed to address the credit crisis by encouraging private investment in a variety of asset-backed securities (“ABS”), including CMBS, using leverage provided by government financing at favorable rates. Under the TALF, the Federal Reserve Bank of New York (the “New York Fed”) will provide up to $200 billion (and potentially up to $1 trillion if the facility is expanded) of non-recourse financing to eligible borrowers owning eligible collateral. On fixed days each month, borrowers may request one or more three year or, in certain cases, five-year TALF loans (minimum size $10 million). The next subscription date for non-mortgage-backed ABS is June 2, 2009, and the first subscription date for newly issued CMBS is June 16, 2009. The initial legacy CMBS subscription date will be in late July. Loan proceeds will be disbursed to the borrower, contingent on receipt by the New York Fed’s custodian bank of the eligible collateral and an administrative fee. The New York Fed will stop making new loans under the TALF program on Dec. 31, 2009, unless this date is extended by the Board.
An eligible borrower that owns eligible collateral and maintains an account relationship with a primary dealer may borrow from the TALF program. An entity is an eligible borrower for purposes of the TALF if it is:
- A business entity or institution that is organized under the laws of the U.S. or territory of the U.S. (“U.S.-organized”) and conducts significant operations or activities in the U.S., including an entity that is owned by a non-U.S. entity and any U.S.-organized subsidiary of such an entity;
- A U.S. branch or agency of a foreign bank (other than a foreign central bank) that maintains reserves with a Federal Reserve Bank;
- A U.S. insured depository institution; and
- An investment fund that is U.S.-organized and managed by an investment manager that has its principal place of business in the U.S.
For TALF purposes, an investment fund includes any type of pooled investment vehicle (e.g., hedge fund, private equity fund or mutual fund) or single-investor vehicle that is organized as a business entity or institution. Eligible business entities or institutions include entities organized as limited liability companies, partnerships, banks, corporations, and business or other non-personal trusts. Newly formed investment funds may also qualify.
However, a borrower may not be a business entity or investment fund controlled by a foreign government or managed by an investment manager controlled by a foreign government. U.S. branches or agencies of foreign banks and U.S.-insured depository institutions controlled by a foreign government do qualify as eligible borrowers.
Eligible collateral includes non-mortgage-backed ABS and CMBS (newly issued and legacy). Non-mortgage-backed ABS includes U.S. dollar-denominated cash (that is, not synthetic) ABS that are issued on or after Jan. 1, 2009. For eligible ABS, the underlying credit exposures must be auto loans, student loans, credit card loans, equipment loans, floorplan loans, insurance premium finance loans, small business loans fully guaranteed as to principal and interest by the U.S. Small Business Association (“SBA”), or residential mortgage servicing advances. An ABS with a redemption option (other than pursuant to a customary clean-up call) is not eligible as collateral unless it has been approved by the New York Fed. Newly issued CMBS are eligible for the program if they are U.S. dollar-denominated cash (that is, not synthetic) CMBS issued on or after Jan. 1, 2009. As indicated above, legacy CMBS includes U.S. dollar-denominated cash (that is, not synthetic) CMBS issued before Jan. 1, 2009. The set of permissible underlying credit exposures of eligible ABS may be expanded later to include private-label residential mortgage-backed securities and assets collateralized by corporate debt, which presumably could include collateralized loan obligations (“CLOs”).
In addition, all or substantially all of the credit exposures underlying eligible ABS and CMBS must be exposures that are both originated by U.S.-organized entities or U.S. branches or agencies of foreign banks and made to U.S.-domiciled obligors or with respect to real property located in the U.S. Eligible collateral must not be backed by loans originated or securitized by the borrower or by an affiliate of the borrower (subject to an exception relating to small business loans).
- Credit Ratings. The ABS must have the highest long-term or short-term investment-grade rating from at least two rating agencies (and not have a lower credit rating from a major agency). (U.S. government guaranteed SBA loan pools are not required to have a rating.) ABS will not be eligible if the credit ratings are based on a third-party guarantee or if a major rating agency has placed the rating on review or watch for downgrade. TALF-eligible rating agencies are Fitch Ratings, Moody’s Investors Service and Standard & Poor’s.
- Loan Origination and Refinancing Date Restrictions. The New York Fed has established loan origination or refinancing date restrictions relating to auto loans, credit card receivables, floorplan loans, and insurance premium finance loans.
- Maturity Limits. There is no maximum maturity limit for ABS, with the exception of credit card, auto, equipment, floorplan, premium finance, or servicing advance receivable loan ABS, which cannot have an average life greater than five years. However, the haircut (equity contribution) by the borrower increases with the average life of the ABS.
- Newly Issued CMBS. Newly issued CMBS are eligible for TALF financing beginning in June. The underlying loan must have been originated on or after July 1, 2008, and the security issued on or after Jan. 1, 2009. Each mortgage loan backing a CMBS must be secured by a fee or leasehold interest in one or more income-generating commercial properties. Each property must be located within the U.S. or a U.S. territory.
- Legacy CMBS. An important expansion to the TALF program for CMBS is that, beginning in July, eligible collateral will include CMBS issued before Jan. 1, 2009. Earlier this month, the New York Fed had indicated that only CMBS issued this year would be eligible for TALF financing, but it now has agreed to broaden the program since the majority of CMBS is seasoned debt. Each mortgage loan backing a CMBS must be secured by a fee or leasehold interest in one or more income-generating commercial properties. As of the TALF loan subscription date, at least 95% of the properties must be located in the U.S. or a U.S. territory.
- Quality and Risk. For newly issued and legacy CMBS, the security must be high quality, meaning that it must have at least two triple-A ratings from the following rating agencies: DBRS, Fitch Ratings, Moody’s Investors Service, Realpoint or Standard & Poor’s. The CMBS must not have a rating below triple-A from any of these rating agencies. The CMBS must also be senior in payment priority. The New York Fed reserves the right to reject any CMBS based on the performance of the mortgage loan pool and/or a risk assessment of the debt. Factors indicating risk include CMBS mortgage pools with concentrations of loans that are delinquent, in special servicing or on servicer watch lists, or CMBS mortgage pools lacking diversification with respect to geography, borrower sponsorship or property type.
- Voting Rights. The borrower must give the New York Fed consent over the exercise of voting rights under the CMBS.
- Payment Terms. The CMBS must entitle securityholders to payments of principal and interest (and cannot be an IO or a PO security). Each CMBS being purchased must bear interest at a pass-through rate that is fixed or is based on the weighted average of the underlying fixed mortgage rates.
- “Turbo” of Interest Income. Generally, a borrower will receive from the New York Fed’s custodian bank, The Bank of New York Mellon (“BONY”), (through the primary dealer) on a monthly basis the excess interest on the ABS (after the interest on the TALF loan is paid). However, for any five-year loan, a portion of the excess interest will be applied to prepay the principal of the TALF loan under a formula which increases the amount of interest diverted to prepay the loan after the first three years.
- Valuations of Legacy CMBS. The New York Fed has not explained how it will value legacy CMBS on the date on which the TALF loan is made, in order to determine the amount of the TALF loan. The New York Fed is expected to use an outside valuation agent to review each CMBS proposed as collateral. The New York Fed also will require that the CMBS have been sold in a recent secondary market transaction between unaffiliated parties on arms’ length terms.
Transaction Structure and Pricing
TALF loans will be non-recourse to the borrower and will be secured by the ABS or CMBS financed by the loan. Each TALF loan will have a three-year maturity, except that TALF loans secured by SBA Pool Certificates, SBA Development Company Participating Certificates, ABS backed by student loans or CMBS will have a five-year maturity if the borrower so elects. Interest on TALF loans will be payable monthly, and TALF loans will not be subject to mark-to-market or re-margining requirements. TALF loans will be pre-payable in whole or in part at the option of the borrower, but substitution of collateral during the term of the loan is generally not permitted. Unless otherwise provided in the Master Loan and Security Agreement (“MLSA”), any remittance of principal on eligible collateral must be used immediately to reduce the principal amount of the TALF loan in proportion to the loan’s haircut (i.e., if the borrower was required to pay a 15% haircut and received TALF financing for 85% of the ABS purchase price, 85% of each principal payment on the ABS will be applied to prepay the TALF loan). For ABS that is financed based on a market value in excess of par, the borrower is required to make additional prepayments of principal to amortize the premium.
- Rates. Borrowers will choose either a fixed or floating rate on each TALF loan as indicated below:
- Federally guaranteed student loans: 50 basis points over 1-month LIBOR.
- SBA Pool Certificates: Federal funds target rate plus 75 basis points.
- SBA Development Company Participation Certificates: 50 basis points over the 3-year LIBOR swap rate for three-year TALF loans and 50 basis points over the 5-year LIBOR swap rate for five-year TALF loans.
- All other fixed-rate ABS: 100 basis points over the 1-year LIBOR swap rate for securities with a weighted average life less than one year, 100 basis points over the 2-year LIBOR swap rate for securities with a weighted average life greater than or equal to one year and less than two years, or 100 basis points over the 3-year LIBOR swap rate for securities with a weighted average life of two years or greater.
- All other floating-rate ABS: 100 basis points over 1-month LIBOR.
- Haircuts. Haircuts vary across asset classes and securities’ average lives, but all borrowers are subject to the same haircuts. The current haircut schedule for each ABS asset type is: pleaseclick here to view table.
The haircut schedule is updated periodically and may be found at http://www.newyorkfed.org/markets/TALF_Terms_print.html.
- Rates. TALF loans secured by CMBS will either have a three year or five year maturity. Three year TALF loans will bear interest at a fixed rate per annum equal to 100 basis points over the three year Libor swap rate. Five year TALF loans will bear interest at a fixed rate per annum equal to 100 basis points over the five year Libor swap rate.
- Haircuts. The haircut will be 15% for CMBS with an average life of five years or less. For CMBS with an average life beyond five years, haircuts will increase by one percentage point for each additional year of average life beyond five years, but no newly issued CMBS may have an average life that exceeds ten years.
Role of Primary Dealers and Custodian Bank
The New York Fed makes TALF loans under the MLSA among the New York Fed, BONY, as the New York Fed’s custodian bank, and the primary dealers participating in TALF. Borrowers do not sign the MLSA, but are bound by its terms. Instead, borrowers must enter into a customer agreement with a primary dealer that will act as agent for the borrower in the TALF program.Typically, a borrower will enter into customer agreements with multiple primary dealers to access collateral underwritten by each of the dealers. All collateral purchased by a borrower with TALF financing will be held by BONY and such collateral will be released to the borrower (in whole or in part) only to the extent that the loan is repaid by the borrower (in full or in part). In addition, BONY will receive all interest payments and principal payments on the collateral purchased by the borrower and will distribute such payments to the New York Fed and the primary dealer in accordance with the MLSA. The borrower will receive its share of such interest payments and principal payments on the collateral from its primary dealer. The borrower has no recourse to the New York Fed or BONY for such payments if the dealer does not forward such payments to the borrower.
Issuer Certifications and Auditor Assurances
The issuer and sponsor must execute a certification indicating, among other items, that the ABS is eligible and an undertaking to the New York Fed indemnifying it from any losses it may suffer if such certifications are untrue. In addition, for non-mortgage-backed ABS, the sponsor must retain an accounting firm to provide an attestation indicating that the ABS is TALF eligible. For newly-issued CMBS, the sponsor must hire a nationally recognized certified public accounting firm that is registered with the Public Company Accounting Oversight Board to provide assurance that newly issued CMBS is TALF eligible. The form and level of assurance for newly issued CMBS and legacy CMBS are currently under review.
The issuers and sponsors of ABS, and their affiliates and the primary dealers are prohibited from entering into hedging arrangements intended to protect borrowers against losses on securities purchased with TALF funding. The New York Fed has stated that this prohibition “extends to both direct hedges, such as credit default swaps, and correlative hedges, such as short-selling the ABX index.” However, hedges on a borrower’s broader portfolio, which may include securities purchased with TALF funding, are permissible.
No Executive Compensation Requirements
Executive compensation restrictions will not be applied to TALF sponsors, underwriters, and borrowers as a result of their participation in the TALF.
Restrictions on Hiring H-1B Nonimmigrant Status Employees
The restriction in the Employ American Workers Act (“EAWA”) on H-1B visas applies to all borrowers under the TALF. In addition, if the borrower is an investment fund, the EAWA also applies to any entity that owns or controls 25% or more of the total equity of the investment fund. Although the New York Fed’s FAQs on this topic do not expressly discuss whether a manager of a special purpose vehicle borrower or a manager of a fund that owns such a borrower is subject to the EAWA restrictions, there is support in the FAQs for the position that a manager should not be subject to the restriction if it does not own (directly or indirectly) 25% or more of the voting securities or equity of the borrower or the fund that owns the borrower. There is less guidance on the question of whether or not investors that own 25% or more of a fund that owns a special purpose vehicle borrower would be subject to the EAWA restrictions.