On March 23, 2020, the Federal Reserve Board (Fed) extended a vital lifeline to an asset-backed securities (ABS) market reeling from the economic dislocation brought about by the COVID-19 pandemic by announcing the establishment of the Term Asset-Backed Securities Loan Facility (TALF 2020). While more detailed terms and conditions of TALF 2020 (Detailed Terms) will not be released until a later date, the Fed has indicated that TALF 2020 will be primarily modeled after the terms and conditions of the TALF used during the financial crisis of 2007-2009 (Original TALF). In the meantime, the Fed has released a high-level TALF 2020 term sheet1, the terms of which are described below.
TALF 2020: AN OVERVIEW
Authorized by Section 13(3) of the Federal Reserve Act, TALF 2020 is intended to support the flow of credit to U.S. consumers and small businesses by facilitating the issuance of ABS and improving ABS market conditions. TALF 2020 will serve as a funding backup for eligible ABS issued on or after March 23, 2020.
According to the Fed’s announcement, the Federal Reserve Bank of New York (NY Fed) will make up to $100 billion of loans available to holders of certain ABS backed by newly and recently originated consumer and small business loans and other eligible debt. Using the Exchange Stabilization Fund, the United States Treasury Department (U.S. Treasury) will make an equity investment in the amount of $10 billion in the special purpose vehicle (TALF SPV) established for TALF 2020. The NY Fed will commit to lend to the TALF SPV on a recourse basis. Unless TALF 2020 is extended by the Fed, no new credit extensions will be made under the program after September 30, 2020.
WHO MAY BORROW UNDER TALF 2020?
All U.S. companies-defined as “a U.S. business entity organized under the laws of the United States or a political subdivision or territory thereof (including such an entity that has a non-U.S. parent company), or a U.S. branch or agency of a foreign bank”-that own eligible collateral (as described below) and maintain an account relationship with a primary dealer are eligible borrowers under TALF 2020. It is expected that the more detailed TALF 2020 terms and conditions will include a list of primary dealers. Importantly, the definition of eligible borrowers would not appear to preclude the formation by U.S. investment managers of TALF 2020 funds in the nature of those established in connection with Original TALF.
ELIGIBLE TALF 2020 COLLATERAL
To be eligible to be pledged under TALF 2020, collateral must:
- be U.S. denominated cash (not synthetic) ABS;
- have a credit rating in the highest long- or short-term investment grade rating category from at least two eligible nationally recognized statistical rating organizations (NRSROs);
- not have a credit rating below the highest investment-grade rating category from an eligible NRSRO;
- be issued on or after March 23, 2020;
- not bear interest payments that step up or step down to predetermined levels on specific dates;
- be ABS in respect of which all or substantially all of the underlying credit exposures are newly issued and have been originated by a U.S. company; and
- be ABS in respect of which:
- none of the underlying credit exposures are themselves cash or synthetic ABS;
- the underlying credit exposures are one of the following: (1) auto loans and leases; (2) student loans; (3) credit card receivables (both consumer and corporate); (4) equipment loans; (5) floorplan loans; (6) insurance premium finance loans; (7) certain small business loans that are guaranteed by the Small Business Administration; or (8) eligible servicing advance receivables.2
Assuming substantially identical eligibility criteria in the Detailed Terms, single-rating and non-rated ABS will be excluded from the program, as will commercial mortgage-backed securities (CMBS), which Original TALF was notably expanded to include. Moreover, the requirement that eligible ABS be issued on or after March 23, 2020 would mean that borrowers will not be able to use the program to finance their legacy ABS.
Further clarification in the Detailed Terms of the Fed’s statement that “all or substantially all of the underlying credit exposures must be newly issued” will be crucial. Original TALF allowed for the inclusion of underlying credit exposures originated within a specified period of time prior to the program’s launch. Absent similar guidelines in TALF 2020, its effectiveness in providing immediate relief to ABS issuers will be diminished.
The Fed further noted that substitution of collateral during the term of the loan will be generally prohibited.
ADDITIONAL TALF 2020 TERMS
Collateral Valuation. Eligible pledged collateral will be valued and assigned a haircut based on sector, weighted average life and historical volatility of the subject ABS. The Fed has indicated that the haircut schedule will be published in the Detailed Terms and will be “roughly in line” with the haircut schedule used in Original TALF.
Loan Pricing and Fees. For eligible ABS with underlying credit exposures that are not government guaranteed, the interest rate will be 100 bps over the 2-year LIBOR swap rate for securities with a weighted average life under two years, or 100 bps over the 3-year LIBOR swap rate for securities with a weighted average life of two years or greater. The pricing for other eligible ABS will be included in the Detailed Terms. If necessary, the Fed has indicated that the pricing structure would be updated to account for the expected transition away from LIBOR. The TALF SPV will assess an administrative fee equal to 10 bps of the loan amount on the collateral settlement date.
Maturity and Prepayment; Non-Recourse. Each TALF 2020 loan will have a maturity of 3 years and be pre-payable in whole or in part at the borrower’s option. Loans will be made without recourse to the borrower, provided that the requirements of TALF 2020 are met.
A PAST SUCCESS REVIVED
As we await the release of Detailed Terms, it is instructive to reflect on the program upon which TALF 2020 will be based. Conceived in response to a deep and persistent recession that crippled credit markets and halted ABS issuance completely by October 2008, Original TALF sought to restore access to credit for U.S. households and small businesses and to stimulate economic activity by facilitating the issuance of ABS backed by specified types of consumer and small business loans and other eligible debt. Under Original TALF, the Fed (backed by the U.S. Treasury) made loans to eligible investors for the purpose of investing in eligible ABS. It is expected that TALF 2020 will be a substantial reboot of what ultimately proved to be a powerful and effective crisis-era tool.
Original TALF, which commenced lending operations in March 2009 and authorized new loan extensions through March 2010 (June 2010 for loans backed by CMBS), has been widely lauded as an unqualified success. It effectively resuscitated the ABS new issue market, restoring soaring ABS spreads to historical levels and providing crucial liquidity to badly weakened sectors of the U.S. economy. It also generated $1.2 billion of interest income for U.S. taxpayers without incurring a single dollar of loss. All Original TALF loans were paid in full on or prior to their maturity dates, the final outstanding loan having been paid in full in October 2014.
TALF 2020 NEXT STEPS: ROOM FOR MODIFICATION?
While the Detailed Terms are expected to be primarily modeled after Original TALF, the Fed was careful to reserve the right to review and adjust such Detailed Terms (including program size, pricing, loan maturity, collateral haircuts, and asset and borrower eligibility requirements) “consistent with the policy objectives of the TALF.” More specifically, the Fed indicated an express willingness to consider adding other asset classes to TALF 2020 in the future.
The Fed’s statements would suggest an openness to entertaining requests by industry participants and trade associations for more expansive terms and conditions than those set forth in the TALF 2020 term sheet, which requests may include expanding eligible ABS collateral to include other popular asset classes (such as unsecured personal loans, commercial and residential mortgage loans, wireless device payment receivables, rental car receivables and transportation assets) and relaxing ABS ratings requirements.
Seward & Kissel will continue to monitor TALF 2020 and keep clients apprised of any material developments. If you would like additional information about this or any other matter, or wish to discuss TALF 2020 further, please feel free to contact Greg B. Cioffi cioffi@sewkis.com or Jeff Berman bermanj@sewkis.com.
______________________________________________________
1 See https://www.federalreserve.gov/newsevents/pressreleases/files/monetary20200323b3.pdf.
2 According to the Fed, the definitions of eligible underlying credit exposures will be included in the Detailed Terms and are expected to be broadly consistent with those of Original TALF.
