Yesterday the Board of Governors of the U.S. Federal Reserve System ("Federal Reserve") announced the unveiling of two new programs that are designed to help thaw the current freeze of the U.S.'s consumer and housing credit markets.
Term Asset-Backed Securities Loan Facility
The Federal Reserve announced the establishment of a credit facility referred to as the Term Asset-Backed Securities Loan Facility, or "TALF," and issued a term sheet providing additional information about the program. Under the TALF, the Federal Reserve Bank of New York ("FRBNY") will make available up to $200 million in non-recourse loans to holders of certain eligible AAA-rated asset-backed securities ("ABS") that are themselves backed by newly or recently originated consumer and small business loans. The TALF's objective is to help market participants meet the credit needs of households and small businesses by supporting the issuance of ABS that are collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the U.S. Small Business Administration ("SBA"). To support the TALF, the U.S. Treasury Department ("Treasury") announced that it will provide $20 billion of credit protection to the FRBNY from funds that Congress allocated to Treasury for the Troubled Asset Relief Program ("TARP") under the Emergency Economic Stabilization Act of 2008 ("EESA"). The TALF will stop making new loans on December 31, 2009, unless the Federal Reserve extends the program.
The Federal Reserve's term sheet lists significant provisions of the TALF, including those described below.
"Eligible Collateral"
Access to the TALF facility is available only to holders of certain "eligible collateral," which the Federal Reserve's term sheet defines to include U.S. dollar-denominated cash (i.e., not synthetic) ABS that have a long-term credit rating in the highest investment-grade rating category (e.g., AAA) from two or more major, nationally-recognized statistical rating organizations ("NRSRO"), and do not have a long-term credit rating of below the highest investment-grade rating category from a major NRSRO. Moreover, the term sheet requires that all, or substantially all, of the credit exposures underlying an eligible ABS must be newly or recently originated exposures to U.S.-domiciled obligors, and they must be auto loans, student loans, credit card loans, or SBA-guaranteed small business loans. In addition, originators of credit exposures underlying eligible ABS collateral (or, in the case of SBA-guaranteed loans, the ABS sponsor) must agree to comply with, or already be subject to, the executive compensation requirements of Section 111(b) of the EESA. View client alert on this subject here. According to the Federal Reserve's term sheet, collateral "haircuts" will be set by the FRBNY for each class of eligible collateral, based on the price volatility of each class of eligible collateral.
"Eligible Borrower"
U.S. persons that own eligible collateral are "eligible borrowers" who may participate in the TALF. The Federal Reserve's term sheet defines "U.S. person" to mean a (1) natural person who is a U.S. citizen, (2) business entity that is 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 (3) U.S. branch or agency of a foreign bank.
Transaction Structure
Loans made under the TALF program will be non-recourse to the borrower and secured by only eligible collateral. The TALF will not permit substitution of eligible collateral during the life of any loan, which will have only a one-year term, with interest payable on a monthly basis. TALF loans will not be subject to mark-to-market or re-margining requirements. Any remittance of principal or interest on eligible collateral must be used immediately to pay interest due on, or reduce the principal amount of, a TALF loan.
Pricing And Auction Allocation
According to the Federal Reserve's term sheet, the FRBNY will offer a fixed amount of loans under the TALF on a monthly basis that will be awarded pursuant to a competitive, sealed bid auction process. Each bid must set forth a desired amount of credit and an interest rate spread over one-year OIS. The FRBNY will establish minimum spreads for each auction. In implementing the TALF, the FRBNY will put in place procedures to identify for further scrutiny potentially high-risk ABS that a borrower seeks to pledge to the FRBNY. The FRBNY may reject or declare ineligible any bid, in whole or in part.
Role Of The Treasury Department
To implement the TALF, the FRBNY will create a special-purpose vehicle ("SPV") to purchase and manage any assets received by the FRBNY in connection with any TALF loans. According to the Federal Reserve's term sheet, the FRBNY will enter into a forward purchase agreement with the SPV under which the SPV will commit, for a fee, to purchase all assets securing a TALF loan that are received by the FRBNY at a price equal to the TALF loan amount plus accrued but unpaid interest. Treasury's TARP will purchase subordinated debt issued by the SPV to finance the first $20 billion of asset purchases. If the SPV purchases more than $20 billion in assets, the FRBNY will lend additional funds to the SPV to finance them. The FRBNY's loan to the SPV will be senior to the TARP subordinated loan, with recourse to the SPV, and secured by all the SPV's assets. All cash flows from SPV assets will be used, first, to repay principal and interest on the FRBNY senior loan until it is repaid. Second, cash flows from assets will be used to repay principal and interest on the TARP subordinated loan until it is repaid. Residual returns from the SPV will be shared between the FRBNY and Treasury.
Direct Purchase Program
The Federal Reserve also announced that it is initiating a new program to purchase up to $100 billion in direct obligations of housing-related, government-sponsored enterprises ("GSEs"), i.e., Fannie Mae, Feddie Mac, and the Federal Home Loan Bank. Starting next week, these purchases by the Federal Reserve will be conducted with the Federal Reserve's primary dealers through a series of competitive auctions.
As part of its new direct purchase program, the Federal Reserve announced that it also will buy up to $500 billion in mortgage-backed securities ("MBS") that are themselves backed by Fannie Mae, Freddie Mac, and Ginnie Mae. These MBS purchases will be conducted by asset managers selected through a competitive process who will aim to begin these purchases before the end of 2008.
The Federal Reserve explained that its program to purchase direct obligations of GSEs and MBS is being implemented to reduce the cost and increase the availability of credit to purchase homes which, in turn, should support housing markets and promote better conditions in financial markets, generally. The Federal Reserve anticipates that its purchases of direct obligations of GSEs and MBS will take place over several quarters. The Federal Reserve said that further information about the operational details of this program will be forthcoming after consultation with market participants.
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