TALF Underway – Help for ‘Main Street’

On March 3, the Federal Reserve announced the revisions to the Term Asset-Backed Securities Loan Facility (TALF). The TALF component of the Consumer and Business Lending Initiative (CBLI) is designed to provide up to $1.0 trillion in lending capacity to consumers and small businesses. Traditional consumer financing, credit card loans, auto loans, student loans, Small Business Association loans rely heavily on the Asset Backed Security (ABS) facilities for funding. The Fed estimates that roughly one-quarter of all non-mortgage consumer loans are financed through ABS SPVs.

Importantly for the March revision, the hair cut and interest rates on the student loans and SBA-guaranteed loans was reduced. Interestingly, the Government’s collateral on the TALF loans are loans which carry and explicit government guarantee. The TALF loans are non-recourse, in the event of default, the Government has the right to seize the collateral (the loans) in order to make good on the TALF loan. Interestingly, as the loan default trickles down the chain, the Government will effectively be paying the left pocket from money in the right pocket. This government guarantee was the rationale for the reduction in rates and haircuts; hopefully we do not see the left-to-right pocket exchange. The potential for a trillion in financing should help expand the economy; as currently drafted, the TALF will provide $200 billion in loans.

Protection for the Tax Payer
As previously mentioned, a few loans carry explicit guarantees, SBA and student loans; loans that do not carry the guarantee must be rated AAA by two approved credit rating agencies. Substantial criticism has been given to the rating agencies handling of the securitized pools of loans; however, absent a better risk assessment system, the AAA rating provides some assurance for tax payers. Second, the “haircut” mentioned above in effect over-collateralizes the TALF loans. For example, a student loan with a 2-3 year ABS life carries a 10% haircut. In order to receive a $90 million dollar loan under TALF, the investor must pledge $100 million in collateral. Lastly, the Government receives an interest rate that corresponds with the risk of the underlying assets. The prime student loan above would be priced at LIBOR plus 50 basis points.

TALF Underway
On March 19, the Fed announced nearly $4.7 billion in loan requests. Requests were linked to $1.9 billion in auto-loan securitization and $2.8 billion in credit card related facilities. Interestingly, no student loans or SBA guaranteed loans were pledged in conjunction with loan requests. As noted, loans need to carry a AAA rating; however, loans downgraded after initial funding remain eligible. Thus, financial institutions accessing TALF funds will likely pledge loans which they perceive to be riskiest, mispriced, or incorrectly rated. Financial institutions are likely most concerned with the state of the over-levered general consumer, pledging credit card and auto loans.

In conjunction with the announcement of initial funding, the Fed announced four additional categories eligible under TALF: (i) ABS backed by mortgage servicing advances; (ii) ABS backed by loans or leases relating to business equipment; (iii) ABS backed by leases of vehicle fleets; (iv) ABS backed by floorplan loans As the pool of eligible loans expands, so does the Feds balance sheet. The exploding balance sheet is a little less daunting when an organization is back stopped by a printing press, not to say the US should or will inflate its way out of the debt problem.

A Scaffolding of Cards for the House of Cards?
Interestingly, the off balance sheet SPVs that appear to have created the credit crisis will be the primary tool for supporting TALF. The Federal Reserve Bank of New York (FRBNY) will create an SPV to hold all ABS collateral received. The SPV will be funded with up to $100 billion on subordinated loans from the Treasury through the TARP and the FRBNY will fund the SPV with a senior loan. In a similar structure to other securitization facilities or CDOs, the investors are ranked and prioritized. The FRBNY holds the most senior position and claims first priority to all cash flows to the SPV, the Treasury holds second priority (mezzanine position), and the residual third priority (equity position) is shared by the Treasury and FRBNY. The scaffolding of cards should hold up, securitization and pooling of assets was not the problem, pricing of the pools was the problem.



On balance TALF should spark consumer and small business lending and is a start down a long, winding road to recovery. Access to credit will enable small businesses to grow and employ Americans. The credit is necessary for capital equipment purchases to create goods and provide services for export and domestic consumption. Purposed slogan: TALF - a $200 billion spark plug for autos.