United States: The Rubber Hits the Road for the Term Asset-Backed Loan Facility

Originally published March 17, 2009

Keywords: Term Asset-Backed Loan Facility, TALF, Master Loan, Security Agreement, FRBNY, ABS, TARP,

Marketing is almost complete for the first funding under the Term Asset-Backed Loan Facility (TALF). Key dates for the first and second fundings are:

This update summarizes the terms and conditions currently applicable to the program.¹

Overview

TALF is designed to restart primary issuance in the asset-backed securities (ABS) markets, which have played a critical role in funding consumer finance in recent years but have been "virtually shuttered"² since October. It is hoped that reopening these markets as a source of funding and liquidity for lenders will increase the availability of credit to consumers and small businesses and, in turn, stimulate the broader economy. To do this, the Federal Reserve Bank of New York (FRBNY) will encourage investment in high quality ABS by offering up to $200 billion in secured, non-recourse, three-year loans to finance these investments on terms that are meant to be attractive to investors. Up to $20 billion of funds under the Troubled Asset Relief Program (TARP) will be available to absorb losses that the FRBNY might otherwise incur with respect to ABS that are pledged as collateral for TALF loans. As part of the Financial Stability Plan announced by President Obama, the US Department of the Treasury (Treasury) agreed to allocate an additional $80 billion of funds to TALF. This recent allocation will allow the FRBNY to lend up to $1 trillion.

The Contractual Framework

FRBNY has entered into a Master Loan and Security Agreement (MLSA)³ that will govern all of the loans made under TALF. Also party to that agreement are The Bank of New York Mellon (BNY Mellon), which will act as FRBNY's administrator and custodian for the ABS pledged to secure TALF loans, and some or all of the Federal Reserve's 16 primary dealers. Each primary dealer wishing to participate in TALF becomes a party to the MLSA by executing and delivering a letter of agreement in the form attached to the MLSA. Although TALF loans are non-recourse as to credit and market value risk on the pledged ABS, borrowers (and the primary dealers acting as their agents) are required to make representations about the eligibility of the collateral and the borrower, as well as some other matters, and are responsible to FRBNY if those representations are inaccurate (subject to a reasonable care defense in some circumstances). Primary dealers that also acted as underwriters on the pledged ABS are required to represent as to the accuracy and completeness of the offering materials. On March 11, FRBNY issued conflict-of-interest guidance⁴ and a borrower eligibility and due diligence policy⁵ for primary dealers. These documents are intended to provide specific guidance to primary dealers participating in TALF.

Investors that wish to obtain TALF loans will enter into a Customer Agreement with a primary dealer. FRBNY did not dictate the form of the Customer Agreement, but the MLSA specifies minimum contents, including that the customer must authorize the primary dealer to act as the customer's agent in taking various actions under the MLSA. The primary dealer community cooperated, through the Securities Industry and Financial Markets Association (SIFMA), in producing a form Customer Agreement to be used by participating primary dealers, but the form is subject to negotiation at the discretion of each primary dealer that uses it.

Issuers that wish to make their ABS eligible as TALF collateral will be required to:

• Include a Certification as to TALF Eligibility⁶ in the applicable prospectus or similar offering document and
• Deliver an Indemnity Undertaking to FRBNY covering any losses that FRBNY may incur as a result of the certification being false.

Beyond these TALF-specific documents, it is likely that underwriting agreements and closing deliveries for TALF-eligible ABS will be adjusted in some ways to reflect and react to TALF requirements.

Eligible Collateral

In order to meet the program's goal of increasing the availability of credit to US consumers and businesses, ABS that are to be funded under TALF must meet various eligibility requirements relating to the characteristics of the underlying receivables, including their date of origination. Other eligibility criteria are meant to limit the credit risk taken by FRBNY and the Treasury through TALF. In summary, to be eligible as TALF collateral, ABS must:

• Be US dollar-denominated cash (that is, not synthetic) ABS with credit ratings in the highest long-term or short-term investment-grade rating category from two or more of Fitch, Moody's and S&P, and no lower credit ratings from any of those entities. The credit ratings must not be based on a third-party guarantee and must not have been placed on review or watch for downgrade.
• • There is an exception to the rating requirement for small-business loan ABS that are, or for which all of the underlying credit exposures are, fully guaranteed as to principal and interest by the full faith and credit of the US government.
• Be backed by auto loans,⁷ student loans,⁸ credit card loans⁹ or small business loans fully guaranteed as to principal and interest by the US Small Business Administration (SBA), which meet the following additional requirements:
• • 95 percent or more of the obligors (by dollar amount) must be domiciled in the United States.
  • For auto loan ABS (except auto dealer floorplan ABS), at least 85 percent of the underlying loans or leases (by dollar amount) must have been originated on or after October 1, 2007.
  • For student loan ABS, at least 85 percent of the underlying loans (by dollar amount) must have had a first disbursement date on or after May 1, 2007.
  • SBA Pool Certificates and Development Company Participation Certificates must have been issued on or after January 1, 2008, regardless of the dates of the underlying loans or debentures. The SBA-guaranteed credit exposures underlying all other eligible small business ABS must have been originated on or after January 1, 2008.
• Not be backed by any underlying credit exposures that are themselves cash or synthetic ABS. While presumably intended to avoid funding CDOs of ABS and other resecuritizations, this requirement creates some uncertainty for credit card structures that use multiple trusts, as well as auto lease titling trust structures.
• In the case of credit card ABS or auto dealer floorplan ABS, be issued to refinance such existing ABS that mature in 2009 (meaning they cannot be issued in amounts greater than the amount of the maturing ABS). FRBNY has published some interpretive FAQs relating to this calculation.
• Be issued on or after January 1, 2009 (except for SBA Pool Certificates or Development Company Participation Certificates) in a public offering or private placement and cleared through DTC.
• In the case of auto loan ABS and credit card ABS, have an average life of no more than five years.

In addition, eligible collateral for a particular borrower must not be backed by loans originated or securitized by the borrower or its affiliate. "Affiliate" is broadly defined to include any company that controls, is controlled by, or is under common control with the borrower. Control exists if, among other things, the company has the power to vote 25 percent or more of any class of voting securities of the company, or consolidates the company for financial reporting purposes.

The facts that determine whether ABS are eligible TALF collateral are mostly within the knowledge or control of the sponsor of the ABS transaction, and the issuer certification mentioned above covers this issue. In the MLSA, FRBNY requires both the borrower and the primary dealer acting as agent for the borrower to represent and warrant as to the eligibility of the collateral. In addition, FRBNY will not accept any ABS as collateral for a TALF loan unless a registered accounting firm provides FRBNY with a Form of Auditor Attestation¹⁰ that opines that the issuer and sponsor certification with respect to certain collateral eligibility requirements is fairly stated in all material respects.

Eligible Borrowers

The following entity types are eligible to borrow under TALF (if they comply with the other terms and conditions):

• Business entities that are organized under the laws of the United States or one of its political subdivisions or territories, and that conduct significant operations or activities in the United States (regardless of whether any such entity has a parent company that is not US-organized);
• US branches or agencies of foreign banks (other than foreign central banks) that maintain reserves with a Federal Reserve Bank; and
• Investment funds¹¹ that are US-organized and are managed by an investment manager with a principal place of business in the United States.

Notwithstanding the foregoing, no entity that is controlled by a foreign government or is managed by an investment manager controlled by a foreign government is eligible to obtain TALF funding. This prohibition, which is not mandated by statute, raises issues with respect to the treatment of US operations of foreign banks that may be owned or controlled by their home country governments under the principles of national treatment and treaty obligations of the United States as well as being inconsistent with the purpose of TALF to restore the ABS market. It also raises interpretive issues concerning when a potential borrower will be deemed to be controlled by one or more sovereign wealth funds and ineligible to participate in TALF.

Haircuts and Pricing

The initial haircuts applicable to different categories of TALF collateral are currently as follows:

TALF loans will not be subject to mark-to-market or re-margining requirements, will be pre-payable in whole or in part at the option of the borrower, and will not permit substitution of collateral. The pledged ABS will be held by BNY Mellon, as FRBNY's custodian, and principal payments received will be applied to the TALF loan consistent with the original haircut. A borrower may elect to surrender collateral to FRBNY in lieu of repaying outstanding principal or interest by delivering a Collateral Surrender and Acceptance Notice.

The interest rate on TALF loans depends on the nature of the underlying receivables:

FRBNY will also charge an administrative fee of 5 bps of the initial loan amount at settlement.

Footnotes

1. The terms and conditions for TALF are set out at http://www.newyorkfed.org/markets/talf_terms.html and supplemented with responses to "frequently asked questions" at http://www.newyorkfed.org/markets/talf_faq.html.

2. Joint Press Release by the Department of the Treasury and the Federal Reserve Board, March 3, 2009, available at http://www.federalreserve.gov/newsevents/press/monetary/20090303a.htm.

3. Available at http://www.newyorkfed.org/markets/TALF_MLSA.pdf.

4, Available at http://www.newyorkfed.org/markets/TALF_Conflict_of_Interest.pdf.

5. Available at http://www.newyorkfed.org/markets/TALF_FRBNY_Due_Diligence_Policy.pdf.

6. The form of certification and related indemnity undertaking are available at http://www.newyorkfed.org/markets.

7. For this purpose, "auto loans" includes retail loans and leases relating to cars, light trucks, recreational vehicles or motorcycles, as well as auto dealer floorplan loans.

8. Eligible student loans include Federally guaranteed student loans (including consolidation loans) and private student loans.

9. Receivables under both consumer and commercial cards are eligible. The releases to date do not appear to address charge cards, as distinct from credit cards.

10. Available at http://www.newyorkfed.org/markets/TALFAuditorAttestationForm.pdf.

11. This term includes any type of pooled investment vehicle, including hedge funds, private equity funds and mutual funds, including a vehicle that primarily or exclusively invests in eligible collateral and borrows through TALF.

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