On November 25, 2008, the U.S. Federal Reserve Board (Federal Reserve) and the U.S. Department of the Treasury (Treasury) announced two separate new programs in an effort to ease the turmoil in the credit markets. In the Term Asset-Backed Securities Loan Facility (TALF) program, the Federal Reserve and the Treasury will participate in a facility to finance the issuance of nonmortgage related asset-backed securities. In the other program, the Federal Reserve will purchase both direct obligations and guaranteed obligations of the housing-related government sponsored enterprises.
The Term Asset-Backed Securities Loan Facility
The U.S. Federal Reserve Board, through the powers granted to it under Section 13(c) of the Federal Reserve Act, established the TALF program to provide liquidity to issuers of asset-backed securities (ABS) and to provide borrowers and small business owners access to financing. A summary of the terms and conditions of the TALF follows1.
The Federal Reserve Bank of New York (FRBNY) will lend up to $200 billion under the TALF program. The loans provided to participants in the TALF will be non-recourse loans secured by certain ABS meeting the requirements of the program. Each loan will have a maturity of one-year with interest payable monthly. Importantly, the loans will not be subject to mark-to-market rules or margin call requirements. However, any principal or interest received on the ABS must be used immediately to pay interest and principal of the TALF loan.
- Cash ABS. The collateral for the TALF loans must be U.S. dollar-denominated cash ABS,2 and such ABS collateral must be backed by auto loans, student loans, credit card loans, or small business loans guaranteed by the U.S. Small Business Administration.3
- Recent Originations/U.S.-Domiciled Obligors. The ABS collateral must represent newly or recently originated exposure to U.S.-domiciled obligors.
- Ratings. Eligible collateral includes ABS that have a long-term credit rating of “AAA” (the highest investment-grade rating category) from two or more nationally recognized statistical rating organizations (NRSRO) and do not have a long-term credit rating of below the highest investment-grade rating category from a major NRSRO.
- Haircuts. The FRBNY will determine an appropriate collateral value “haircut” based on price volatility of each class of eligible collateral.
- Executive Compensation Compliance. Originators of the collateral underlying the ABS must comply with the executive compensation requirements of Section 111(b) of the Emergency Economic Stabilization Act of 2008.
Any U.S. person that owns eligible ABS collateral may participate in the TALF. U.S. persons include a business entity that is organized under the laws of the United States, including an entity that has a non-U.S. parent company, or a U.S. branch or agency of a foreign bank.
Pricing and Allocation
The FRBNY will award loans to borrowers based on a monthly competitive sealed bid process. Each bid must include (i) the desired loan amount, and (ii) a specified interest rate spread over oneyear overnight index swaps. Any bid may be declared ineligible by the FRBNY in its discretion.
Borrowers are required to appoint a primary dealer to act as an agent for the borrower in order to access the TALF and any eligible collateral pledged under the TALF program must be delivered to a clearing bank.
Relationship to Treasury Department
The FRBNY will establish a special purpose entity (SPE) to purchase and manage the eligible collateral, to the extent received by the FRBNY in connection with any TALF Loans. The FRBNY will enter into a forward purchase contract with the SPE under which the SPE is obligated to purchase any assets securing a TALF loan that are received by the FRBNY at a price equal to the amount of the TALF loan (plus accrued but unpaid interest). Although the TALF is distinct from the Treasury’s Troubled Asset Relief Program (TARP), the TARP will provide credit support for the TALF loans by purchasing subordinated debt issued by the SPE to finance the first $20 billion of eligible collateral purchases by the SPE. If more than $20 billion of assets are purchased by the SPE, the FRBNY will lend additional funds to the SPE to facilitate the additional purchases. The money that the FRBNY loans to the SPE will be senior to the money provided through the TARP by the Treasury.
The TALF will stop making new loans on December 31, 2009, subject to the Board of Governors of the Federal Reserve System extending the program.
Purchase Of Debt Issued By, Or Mortgage-Backed Securities Guaranteed By, Government Sponsored Enterprises
The Federal Reserve will purchase up to $100 billion of the direct obligations of housing-related government sponsored enterprises, including Fannie Mae, Freddie Mac, and the Federal Home Loan Banks (GSEs). Additionally, the Federal Reserve will purchase up to $500 billion of mortgage-backed securities (MBS) guaranteed by the GSEs. The $100 billion purchase is to take place this week in a series of competitive auctions. The Federal Reserve’s stated goal is to begin the $500 billion MBS purchases prior to the end of 2008, and such purchases will be conducted by asset managers selected by the Federal Reserve. The Federal Reserve will provide further information regarding this program following consultation with market participants.