Timothy Lopes, Executive, Vinod Kothari Consultants
Measures to maintain and strengthen credit flow to consumers is an important part of regulatory initiatives to contain the effects of the COVID crisis. Asset-backed securities and structured finance instrument are recognised as important instruments that connect capital market resources with the market for loans and financial assets. Underscoring the relevance of securitization to the flow of credit to consumers, the US Federal Reserve has set up a USD 100 billion loan facility, called Term Asset-backed Securities Loan Facility, 2020 [TALF] for lending against asset backed securities, issued on or after 23rd March, 2020.
Note that equivalent of TALF 2020 was set up post the Global Financial Crisis (GFC) as well, in 2008.
It is also notable that global financial supervisors have attempted to help financial intermediaries stay firm, partly by helping structured finance transactions. The example of the Australian regulators setting up a Structured Finance Support Fund (SFSF) is one such regulatory measure. Another example is the Canada Mortgage Bond Purchase Program initiated by the Bank of Canada.
How does TALF operate?
TALF funding pool has been set up as a special purpose vehicle. The SPV is funded with an equity of $ 10 billion from the US Govt; the New York Fed will provide the remaining amount by way of a loan. The Federal Reserve had also announced that the terms and conditions will be similar to that of TALF 2008 which had an aggregate size of up to $200 billion.
Under the TALF an eligible originator (which must be a US Company) will be eligible to obtain a loan under this facility for newly and recently originated collateral. That is to say, with the exception of commercial mortgage-backed securities (CMBS), eligible ABS must be issued on or after March 23, 2020 to obtain a loan under TALF. Further, CMBS issued on or after March 23, 2020, will not be eligible.
The underlying collateral can be CMBS or ABS, explicitly mentioned as eligible collateral by the Federal Reserve. However, RMBS, whole business and other asset classes seem to be excluded from the list of eligible collateral since it is treated as a separate asset class altogether.
In case of CMBS, the underlying credit exposures must be to real property located in the United States or one of its territories.
In case of ABS, eligible collateral must be ABS where the underlying credit exposures are one of the following:
- Auto loans and leases;
- Student loans;
- Credit card receivables (both consumer and corporate);
- Equipment loans and leases;
- Floorplan loans;
- Insurance premium finance loans;
- Certain small business loans that are guaranteed by the Small Business Administration;
- Leveraged loans; or
- Commercial mortgages.
The above collateral must be supported by credit rating, being highest short-term or long-term rating level by at least two eligible nationally recognized statistical rating organizations (NRSROs).
Each loan provided under this facility will have a maturity of three years only, similar to the TALF 2008 which had maturity of 3 years for ABS and 5 years for CMBS.
SFA proposal to the Federal Reserve
TLFA has been a success in the past and is intended to benefit the economy in crisis times such as these. However, since the coverage of the TLFA 2020 is limited to certain asset classes only, the Structured Finance Association (SFA) has urged the Federal Reserve to include other asset classes under the TALF 2020, including–
- Private Label RMBS
- Unsecured Personal Loans
- Renewable Energy
- Whole Business
- Transportation (aircraft, rail, shipping)
- Credit Risk Transfer
- Handset Device
- Re-performing & Seasoned Mortgages
- Triple Net Leases
The idea being that the larger the Federal Reserve’s willingness to provide liquidity assistance, the more effective the result will be for the US economy.
Outcome of TALF 2008
The TALF 2008 facility was announced on November 25, 2008, and began lending operations in March 2009. As per the loan data of TALF 2008 more than 2300 loans were extended under the program that amounted to $70 billion in loans spread across 200 different borrowers.
As of September 30, 2010, more than 60 percent of the TALF loans were repaid in full, with interest, ahead of their legal maturity dates. All loans which were not repaid in full early were current in their payments of principal and interest and no collateral has been surrendered in lieu of repayment. This reflects the success of the TALF, 2008.
Further, the Structured Finance Association (SFA) states that TALF 2008 was a great success on all counts, serving to backstop market uncertainty and helping to generate new issuance in an otherwise disrupted market.
As per a report made to the US Congress, since the ABS markets historically have funded a substantial share of credit to consumers and businesses, continued disruption of these markets could further squeeze the liquidity and balance sheet capacity of financial institutions, thereby significantly limiting the availability of credit to households and businesses of all sizes and amplifying the current economic disruption.
The TALF looks to mitigate these effects while simultaneously facilitating the issuance of ABS and stabilize ABS markets.
Post the GFC in 2008, the financing provided through the TALF was intended to enhance demand for ABS and thereby spur new issuance of ABS in order to increase the flow of credit to households and businesses. TALF 2020 also has a similar goal in the wake of disruption caused by the pandemic.