Earlier this week, the U.S. Treasury and Federal Reserve announced the commencement of the Term Asset- Backed Securities Loan Facility (TALF), a highly anticipated program aimed at stimulating consumer lending.1 The goal of TALF is to bring together public and private investment to help revive the securitization market, a primary source of funding consumer credit purchases that, in its late-2007 peak, totaled hundreds of billions of dollars. Since the collapse of the world credit markets in late 2008, the U.S. securitization market has seen little to no activity.
Since the Federal Reserve’s initial TALF announcement on November 25, 2008,2 the program has undergone a series of tweaks and revisions, culminating in a new set of Terms and Conditions issued this week.3 These Terms and Conditions reflect many revisions that (to the delight of many industry participants) are more user-friendly than prior iterations of the program. For example, all restrictions on executive compensation for officers of sponsoring organizations have been removed. In addition, collateral haircuts have been lowered, and the option for multiple loans with fixed or floating rates now exists. However, there still remain questions about the potential success of TALF. In particular, is the current scope of the program sufficient to stimulate consumer lending, and how must the program expand to be successful?
What is TALF?
TALF, a cornerstone of the Obama administration’s Financial Stability Plan,4 “has the potential to generate up to $1 trillion of lending for businesses and households.”5 Under TALF, the Federal Reserve Bank of New York will make available up to $200 billion in loans to U.S. borrowers that own “eligible” asset-backed securities (ABS).6
Each TALF loan will be made on a non-recourse basis to owners of eligible ABS, which will collateralize the loans. In connection with the program, the Federal Reserve will create a special purpose vehicle (SPV) to acquire and manage the ABS it receives in connection with a TALF loan. If a borrower fails to repay its TALF loan, the SPV will enforce its rights in the collateral. Treasury will use funds available under the Troubled Asset Relief Program to purchase subordinated debt issued by the SPV to capitalize the SPV. To the extent that the SPV purchases more than $20 billion in assets, it will receive a loan from the Federal Reserve to fund such purchases.
What Constitutes “Eligible Collateral” for Purposes of TALF Loans?
Eligible collateral includes U.S. dollar-denominated cash ABS that have the highest investment-grade rating from two or more nationally recognized statistical rating organizations (NRSRO) and do not have a credit rating below the highest investment-grade rating from any NRSRO.7 ABS will not be eligible collateral if it is on review or watch for downgrade,8 or if it receives its highest investment-grade rating due to the benefit of a third-party guarantee. Eligible collateral will include only ABS that is cleared through the Depository Trust Company. Synthetic ABS will not qualify as eligible ABS under TALF.
At least 95 percent of the credit exposures underlying eligible ABS must be exposures to U.S.-domiciled obligors.9 Approved asset classes currently include (i) auto loans; (ii) student loans; (iii) credit card loans; or (iv) small business loans fully guaranteed as to principal and interest by the SBA.10 Eligible collateral does not, however, include loans originated or securitized by the borrower or an affiliate of the borrower.
Except for two specific asset classes—SBA Pool Certificates and Development Company Participation Certificates—eligible ABS must be issued on or after January 1, 2009.11 Further, at least 85 percent of each pool of collateral underlying eligible ABS must satisfy the following (depending on the asset class):
Auto loan ABS12 (except auto dealer floorplan ABS) must have been originated on or after October 1, 2007;
- Student loan ABS must have had a first disbursement date on or after May 1, 2007;
- SBA-guaranteed credit exposures underlying all other eligible small business ABS must have been originated on or after January 1, 2008; and
- Eligible credit card and auto dealer floorplan ABS must be issued to refinance existing credit card and auto dealer floorplan ABS, respectively, maturing in 2009, and must be in amounts no greater than the amount of the maturing ABS.13
Who Can Borrow Under TALF?
TALF is open to any U.S. company owning eligible collateral, as long as that company maintains an account relationship with a primary dealer. “U.S. company” is defined to include (i) a business entity or institution organized under U.S. state or federal law that conducts significant operations in the United States (regardless of the location or organization status of any parent company); (ii) a U.S. branch or agency of a foreign bank (other than a foreign central bank) that maintains reserves with the Federal Reserve; or (iii) an investment fund14 organized under U.S. state or federal law and managed by an investment manager with its principal place of business within the United States.
Specifically excluded from participation in TALF are entities controlled by, or managed by an investment manager controlled by, a foreign government. Control by a foreign government exists where the foreign government owns, controls or holds with the power to vote 25 percent or more of a class of voting securities of the company or investment manager. This last restriction may well exclude the U.S. offices of large and otherwise internationally active institutions, such as RBS.15
The Federal Reserve has published a list of approved primary dealers participating in the TALF program.16
How Do TALF Fundings Work?
The initial TALF subscription date is set for Tuesday, March 17, 2009, and the initial loan settlement date will be Wednesday, March 25, 2009. Funding of TALF loans may occur simultaneously with the funding of the collateral ABS. However, the borrower must be able to provide the relevant CUSIP numbers for the ABS to the Federal Reserve on the subscription date, and provide the Federal Reserve with applicable disclosure documentation (such as the final prospectus) no later than four days prior to funding.
TALF loans will have a three-year maturity, at the end of which the loan must be repaid. The TALF loan will not be subject to mark-to-market or re-margining requirements. The Federal Reserve will review and, if appropriate, adjust the TALF interest rate spread and haircuts for new loans, but there is no indication that these adjustments will affect TALF loans that have already been made. The Federal Reserve will also assess an administration fee of five basis points of the loan amount on the settlement date of each TALF loan. Interest on the loan will be payable monthly at the following rates (based on the underlying asset for the ABS):
- Federally guaranteed student loans—50 basis points over the one-month LIBOR.
- SBA Pool Certificates—75 basis points over the federal funds target rate.
- SBA Development Company Participation Certificates—50 basis points over the three-year LIBOR swap rate.
- Other eligible fixed-rate ABS—100 basis points over the three-year LIBOR swap rate.
- Other eligible floating-rate ABS—100 basis points over the one-month LIBOR.17
There is no restriction on a borrower’s ability to prepay the principal amount of the TALF loans, and no penalty will be assessed to borrowers deciding to do so. Regulatory approval from the Federal Reserve or Treasury does not appear to be necessary for a borrower to prepay the TALF loan, unless otherwise required under laws or regulations separate and distinct from the TALF program. Generally, a borrower will not be permitted to substitute collateral during the term of the loan. Borrowers must request a minimum of $10 million for each loan. The TALF will discontinue making new loans on December 31, 2009 (the Termination Date), unless otherwise extended by the Federal Reserve.
The Termination Date is significant inasmuch as a borrower may assign all of its obligations with respect to a TALF loan to another eligible borrower with the prior consent of the Federal Reserve, but such consent will not be granted after the Termination Date. Additionally, for TALF loans secured by ABS maturing after the three-year TALF loan term, a borrower has the option of either (i) repaying the loan, at which time the Federal Reserve would release the ABS collateral to the borrower; or (ii) arranging for the sale of the collateral and instructing the Federal Reserve to deliver the ABS to the counterparty against payment.
Details related to the second round of TALF funding are expected to be announced on March 24, 2009, and subscriptions for the April funding will be recorded on April 7, 2009, with disbursements to be made the following week.
What Issues Remain to Be Addressed?
Many industry participants are hopeful about TALF, but insist that its scope needs to be broadened. In this week’s announcement, the Federal Reserve indicated that April’s subscription and funding would likely include additional eligible asset classes, such as vehicle fleet leases and commercial and farm equipment. In addition, the Federal Reserve is currently exploring the program’s expansion into ABS backed by commercial real estate loans and private (i.e., jumbo) residential mortgages, with a potential borrowing base of up to $1 trillion.
A point that is particularly controversial is whether the limits on origination should be expanded to include assets originated prior to January 1, 2009. As noted previously, since the fall of 2008, the securitization market (and, consequently, the consumer-lending sector) has seen dramatically decreased activity. Part of the problem is the log-jam of consumer credit currently on the books of many originating companies that would have securitized these assets on or after September 2008, when the credit markets froze. By failing to create a mechanism to remove these assets, many argue whether TALF will realize its full potential to re-initiate consumer lending. As of yet, the Federal Reserve has not indicated any movement toward including ABS backed by these seasoned assets as eligible collateral for TALF.