Vol 6 (2009) - Issue 3

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TALF: The Road to Recovery

By now, most industry participants have some familiarity with the Term Asset-Backed Securities Loan Facility (TALF). TALF is a financing program established by Federal Reserve Board to increase credit availability by facilitating issuance of consumer and business asset backed securities. Under the program, the New York Fed will make up to USD 200 billion of nonrecourse loans for terms of three years, secured by eligible ABS. The program may eventually grow in size to between USD 500 billion and USD 1 trillion with the categories of eligible collateral being expanded to encompass other types of newly issued AAA-rated asset backed securities, such as commercial mortgage-backed securities and private-label residential mortgagebacked securities. Additionally, a key element of the recently-announced Public-Private Investment Funds program is the expansion of the TALF program to include legacy securities. Through this expansion of the TALF, non-recourse loans will be made available to investors to fund purchases of legacy securitisation assets. Eligible assets are expected to include certain non-agency residential mortgage-backed securities that were originally rated AAA when they were issued, and outstanding commercial mortgage-backed securities and other asset-backed securities that are currently rated AAA. The terms and conditions for the expanded collateral classes, including applicable haircuts, lending rates, minimum loan sizes, and loan durations are still to be determined. The New York Fed has noted that it is taking into consideration the duration of the underlying assets in determining the TALF loan duration (RMBS and CMBS market participants have expressed concern that the TALF program’s current three-year loan duration would prove unworkable with respect to these longer duration assets).

To succeed, the TALF program will need to attract investors back to the ABS market. In the first funding under TALF, completed on 25 March 2009, USD 4.7 billion was disbursed by the New York Fed, of which USD 1.9 billion was secured by auto loan ABS and the remaining USD 2.8 billion was secured by credit card ABS. The USD 7 billion total of ABS sold at the end of March 2009 was more than the total amount of ABS sold in the fourth quarter of 2008 and in the year to date combined. This promising start makes us optimistic about TALF’s prospects for attracting further investment. We see at least three different paradigms for investments funded by TALF. Each presents its own set of issues and structuring considerations.

The simplest format for TALF investment (and the one that we have seen the most of so far) is a direct holding by a hedge fund or institutional investor. Hedge funds are attracted by the prospect of leveraged returns on highly rated ABS. Although returns to investors will depend on the type of ABS collateral and the size of the haircut applicable thereto as well as the spread between the TALF loan and the pricing of such eligible asset, investors that participated in the initial funding should achieve returns of 15% or more. Under TALF, the eligible ABS must be rated in the highest investment grade rating category from two or more major nationally recognised statistical ratings organisations and not have a lesser rating from any other NRSRO. Of course, even the most highly rated ABS is subject to market value risk. The New York Fed will protect itself against market risks by imposing a collateral haircut for each type of eligible collateral based on its maturity and riskiness. The haircut is not subject to mark-tomarket or re-margining requirements. As such, the haircut represents the equity required to acquire an eligible ABS financed via TALF. Because all principal remitted on the eligible ABS is required to be applied ratably to reduce the TALF loan and the equity investment, the amount of effective leverage over the life of the investment will remain constant and depend on the size of the haircut and the amount of principal, if any, paid on the eligible ABS. At present, interest rates on all but one category of TALF loans are expressed as a spread on LIBOR (loans on certain ABS backed by small business loans are expressed as a spread on the Federal Funds Target Rate) and lie between the spreads applicable in normal market conditions and when markets are illiquid and spreads are historically wide.