A few words from a reader on TALF mechanics
In my post TALF: A bailout if one reads the fine print, I did not make any comments about the quality of the assets to be used as collateral or the mechanics of the operation. While much of this information has already been supplied by the Federal Reserve Bank of New York on their website, a comment from reader Brian addresses the most salient points:
- “Eligible ABS must be issued on or after January 1, 2009.” – Big difference from the ‘toxic waste’ most people seem overly concerned is going to end up in this program and given that very little ABS issuance, of any type, was actually going on pre-TALF 2009 most issuance will be post-February.
- My reading suggests that CDOs are not eligible collateral given that the direct collateral of a CDO is other debt obligations not a car, house, etc…
- Haircuts range from 5% to 16%, so every investor/borrower is going to need to bring some capital to play. Higher credit quality and shorter average lives mean lower haircuts. A 3-year loan collateralized by the ‘AAA’ tranche of a subprime securitization with a 5-year average life will cost a borrower 10% of their own money. It is unlikely they are going to earn a spread (ABS interest – TALF interest) sufficient to cover the loss of that 10% in a three year period so repayment had best be the exit strategy of a borrower at origination. Any principal payments received must be proportionately remitted to the New York Fed.
Key in Brian’s statement are the credit quality and the ‘haircuts’ given to protect the Fed’s balance sheet. While I tend to take a skeptical view as to the value of ALL assets in the ABS market, Brian’s statements represent an accurate view of the mechanics of the situation.
One should also note that the Fed has designed this program to be for what it considers higher-quality assets rather than toxic waste. Reasonable people can disagree as to how high the quality of those assets is, whether they really are toxic waste, and whether the Federal Reserve should take them onto its balance sheet. However, the Fed is trying to arrange a facility on terms that it considers prudent. There are much dodgier assets that the Fed is not considering for this program.
I am not going to take a view on that position in this particular post. I will attempt to be more ‘neutral’ here. However, I did want to pass on this information.
More regarding the specifics are available at the NY Fed links below and in the video of Ben Bernanke’s speech at the LSE in January, also linked below.
Sources
Term Asset-Backed Securities Loan Facility: Frequently Asked Questions – NY Federal Reserve
Bernanke speech at the LSE
Term Asset-Backed Securities Loan Facility: Terms and Conditions – NY Federal Reserve
Ed,
I hear you saying that the new issuance will have much more prudent underwriting. However, is this still true given the Fed’s massive demand? In other words, say there’s not enough product to feed the TALF under current auto loan underwriting standards. So what should the originator/issuer do? Relax the standards, as long as they are not required to keep part of the securitization on balance sheet.
The reason I ask is that, back in the old subprime days, underwriting standards were a function of ABS demand. If the bankers asked for more product, you just moved the underwriting needle to deliver it to them. Isn’t the whole point of TALF to go back to those good ol’ days?
OK, I’m sitting in a bank with a lot of toxic assets from pre-2009. I re-package those assets in a new ABS and have one of the rating agency lapdogs call it “AAA.” I can’t sell it in the private market (& I really didn’t expect to), so I take a 15% haircut as collateral to the FED and get real capital in return, and a 15% haircut is better than a 100% scalping.
Why wouldn’t that meet the FED’s criteria of ABS issued in 2009?