On October 5, 2009, the Federal Reserve Board (the “Board”) announced changes to the Term Asset-Backed Securities Loan Facility (“TALF”), which is maintained by the Federal Reserve Bank of New York (“FRBNY”) as authorized on November 24, 2008, and is intended to aid market participants in meeting the credit needs of investors in highly rated asset-backed securities (“ABS”). Each change is with respect to non-mortgage ABS (“Non-Mortgage ABS”). First, the Board introduced a formal risk assessment program for Non-Mortgage ABS similar to the program already in place with respect to commercial mortgage-backed securities (“CMBS”) eligible for TALF. The program is to be effective with respect to Non-Mortgage ABS collateral starting with the November subscription. Additionally, the Board announced a proposed rule which would amend the Board’s Regulation A to establish criteria by which FRBNY may govern acceptance of credit ratings in connection with TALF-eligible Non-Mortgage ABS. The amendment could serve to expand the number of credit rating agencies accepted to provide ratings for the purposes of TALF eligibility.
Formal Risk Assessment
Starting with the November subscription of TALF, FRBNY intends to conduct formal risk assessments of all Non-Mortgage ABS collateral proposed for TALF financing. Similar risk assessments are already established with respect to CMBS and the Board’s announcement deems existing TALF collateral that is otherwise in compliance with eligibility requirements to have satisfied the new risk assessment criteria as of October 5, 2009; however, the announcement does not provide any assurance regarding future eligibility of bonds from an existing deal that are not yet pledged to FRBNY. The risk assessments are directed at enhancing FRBNY’s ability to ensure that TALF collateral satisfies the existing high standards with regard to credit quality, transparency and simplicity of structure. In determining if proposed TALF collateral meets such high standards, FRBNY “recognizes that appropriate structural and transactional features may differ significantly across asset categories” and it acknowledges that “bonds will be reviewed relative to generally accepted prudent market practices in the areas of: credit support; issuer and servicer strength; underwriting; diversification (geographic, borrower, or other); and simplicity of structure.”
The following three general standards guide the risk assessment process:
(1) Credit quality: The bond is of the highest credit quality with de minimis risk of default and a low probability of a material deterioration in credit quality;
(2) Transparency: Sufficient information is available to allow investors to make informed judgments about the credit risk of the collateral underlying the bond as well as the level of due diligence on the collateral performed by the issuer; and
(3) Simplicity of structure: The relationship between the performance of the underlying collateral and bond payments is clear and uncomplicated.
An issuer or sponsor bringing a TALF-eligible deal to market is required to provide FRBNY, at least three weeks prior to the related subscription date, information regarding the transaction, including but not limited to all data provided by the issuer to any credit rating agency. Additionally, an issuer or sponsor is required to provide each applicable credit rating agency with a waiver or consent in a form satisfactory to FRBNY, a copy of which the issuer or sponsor is required to provide FRBNY at least three weeks prior to the related subscription date, permitting each such credit rating agency to share with FRBNY any views with regard to the credit quality of the related Non-Mortgage ABS and the underlying exposures. The requirement to provide waivers or consents applies even if an applicable credit rating agency is not TALF-eligible or does not actually issue a rating on the related Non-Mortgage ABS. According to the Board’s announcement, an issuer or sponsor may expect an indication of acceptability with regard to FRBNY’s risk assessment analysis within two weeks of having provided any required information and any required credit rating agency waivers or consents.
The formal risk assessment program serves as a complement to the Board’s simultaneous expansion of FRBNY’s authority with respect to credit rating agency eligibility. Expansion of credit rating agency eligibility could increase credit risk in the TALF program by increasing the risk of less rigorous credit rating standards or by increasing the risk of “rate shopping;” however, the risk assessment program provides additional support by ensuring review of the credit quality of Non-Mortgage ABS.
The FRBNY’s risk assessment framework raises a number of issues including: (i) the confidentiality and securities law implications of the information provided, (ii) the timing of launching a TALF-eligible and FRBNY “approved” deal and (iii) the overall communication process with FRBNY. These and other issues could hinder the number of TALF-eligible deals coming to market and will need to be addressed by FRBNY and industry participants in a relatively short period of time.
Expansion of Credit Rating Agency Eligibility
Pursuant to its Notice of Proposed Rulemaking dated October 5, 2009, the Board intends to amend its Regulation A to establish FRBNY’s authority to determine the eligibility of nationally recognized statistical rating organizations (each, an “NRSRO”) and their related ratings with respect to Non-Mortgage ABS collateral proposed for TALF financing. The proposed rule is intended “to strike a balance between the goal of promoting competition among NRSROs and the goal of ensuring appropriate protection against credit risk for the U.S. taxpayer” and it is intended to serve as a complement to FRBNY’s new formal risk assessment program for Non-Mortgage ABS.
To be eligible to rate Non-Mortgage ABS, an NRSRO would be required to:
(1) be registered, pursuant to the Credit Rating Agency Reform Act of 2006, with the SEC as an NRSRO for issuers of ABS;
(2) satisfy certain experience-based criteria (including that the NRSRO must have issued ratings on at least ten transactions (denominated in U.S. dollars) within one of four enumerated categories of asset types (described below));
(3) have a current and publicly available credit rating methodology with respect to ABS in the particular TALF asset sector; and
(4) agree to share its views and provide related information with respect to credit risk associated with any proposed transaction regarding which the NRSRO is consulted or for which the NRSRO delivers a rating.
The four categories of asset types are as follows:
(1) Category 1 – auto, floorplan and equipment TALF sectors;
(2) Category 2 – credit card and insurance premium finance TALF sectors;
(3) Category 3 – mortgage servicing advances TALF sector (including ratings on residential mortgage-backed securities); and
(4) Category 4 – student loans TALF sector.
The proposed rule also sets forth procedural considerations for determining an NRSRO’s eligibility for a proposed TALF transaction. Generally, an NRSRO would be required to submit to FRBNY information evidencing the satisfaction of the criteria discussed above. According to the proposed rule, FRBNY would be required to notify the NRSRO within five days of any submission whether any additional information is to be submitted. In turn, FRBNY would be required to notify an NRSRO of any related eligibility determination within five days of receipt of all required information.
Naturally, the proposed rule could result in an expansion of TALFeligible NRSROs with respect to Non-Mortgage ABS. Comments from the public are requested within thirty days of publication in the Federal Register.