03/20/2009

Dealers, Conduits Join Investor Gold Rush

An ever-widening variety of investors are seeking to participate in the Federal Reserve's Term Asset-Backed Securities Loan Facility.

Among the latest to emerge as prospective buyers of bonds that qualify for the government-lending program are big Wall Street dealers, including Barclays, Deutsche Bank and J.P. Morgan. At the same time, commercial-paper conduit operators are talking to lawyers about purchasing TALF-eligible securities.

In both cases, the investments would entail the creation of special-purpose entities that would hold pools of eligible bonds. For the conduit operators, those vehicles would essentially serve as intermediaries for their own portfolios. But the dealers are pitching theirs to third-party players.

Barclays and J.P. Morgan already have such vehicles up and running, although it's unclear whether they were among an estimated 15 buysiders that met the March 19 deadline to apply for an initial round of TALF loans that goes out next week. Deutsche's vehicle is still in the works.

All three banks are also signed up to underwrite deals that qualify for TALF, which seeks to bolster demand for triple-A-rated asset-backed securities by offering Fed loans to buyers of such products. That means the institutions would receive two layers of fees: their initial underwriting discounts, plus management charges equal to an estimated 1.5% of their investment vehicles' holdings.

Why set up the intermediary vehicles? Many investors are eager to obtain TALF loans, but are put off by "customer agreements" that the Fed is requiring of the institutions involved. Those contracts include provisions that might subject participants to random audits and could prohibit them from hiring foreign workers to replace laid-off Americans.

By buying bonds and then issuing securities backed by those holdings, the dealer-run entities - as opposed to the investors or the banks themselves - would be the ones subject to those conditions.

Meanwhile, Blackstone Group and Pimco are said to have signed the customer agreements as part of an initial wave of TALF investors consisting largely of asset managers. Some hedge fund managers expressed interest, although it's unknown how many of them are on board at this point.

As for the conduits, their plans appear to entail offering funding to clients by buying TALF-eligible bonds from those shops, while paying for the purchases with proceeds from a combination of commercial-paper sales and Fed loans. In part, their interest reflects a desire to line up new forms of government support in anticipation of the October 2009 expiration of the Fed's separate Commercial Paper Funding Facility (CPFF).

That program aims to inject liquidity into the short-term debt market by buying 3-month securities directly from issuers, but has been criticized for placing too many restrictions on eligible deals. TALF, which will be around for the next three years, offers more expansive funding options.

The leveraged nature of TALF purchases would also allow conduits to issue smaller amounts of securities and employ less liquidity support than they would for comparable assets. The problem is that conduits are typically prohibited from using leverage, which means they would have to set up special vehicles to serve as go-betweens in borrowing from the Fed.

Mayer Brown attorney Stuart Litwin is among those working with the conduits. Details on the efforts are sketchy, but the intermediary vehicles would be similar to one that a group of unleveraged "hard-money" investors began creating earlier this year to serve as a proxy for TALF borrowing.

Hard-money buyers, including insurers and pension systems, are simultaneously exploring other ways to get in on TALF. They include MetLife and Prudential. In an unexpected twist, a few hard-money buyers have been agreeing to buy TALF-eligible bonds in the program's opening round, without plans to turn them over to the Fed - at least not initially. "That's extremely positive for the market," an analyst at an investment bank said, adding that the presence of those investors is a sign that confidence is returning to the downtrodden securitization business.

The buying of TALF-eligible deals this week could also reflect a desire to pick up deals at the current high yields, as the program is expected to cause spreads to tighten as more investors emerge amid additional rounds of funding in the months ahead.

There is also talk that for every investor who opts to buy triple-A-rated bonds with TALF in mind, there are several more waiting to snatch up lower-rated tranches that don't qualify for the program. However, it remains to be seen whether issuers will be inclined to sell those bonds at presumably high yields, or retain them.

An initial spurt of TALF offerings was pricing March 19, breaking several months of stalled issuance activity. Many of the deals are backed by prime-quality auto loans, including a $1.5 billion transaction from Huntington National Bank, with Barclays running the books; a $3 billion issue from Ford, led by Bank of America; and almost $1.5 billion of bonds from Nissan, via J.P. Morgan and BofA.

Pricing on the deals is shaping up a bit better than non-TALF-eligible paper. For example, a 1-year class of triple-A-rated bonds from Nissan's issue priced at 175 bp over Libor (see Initial Pricings on Page 10). A similar piece of a Feb. 19 deal from Nissan that didn't qualify for TALF sold at a spread of 265 bp.

A 1-year tranche of Ford's transaction was set to price at 200 bp over swaps, with some traders saying that most TALF issues are attracting far more demand than they can accommodate. Other sources are more bearish, claiming that deals are moving more slowly than expected. Either way, spreads remain wider than they were before last year's financial-market calamity. In May 2008, for instance, Ford sold a batch of 1-year bonds for 90 bp over Libor.

By stoking demand for asset-backed bonds, TALF aims to create funding for credit cards, auto loans, student loans and small business loans. It initially has $200 billion of lending capacity, but is expected to hit $1 trillion while adding mortgage-related deals.

Participating investors put down 5-16% of the purchase price for qualifying deals. The Fed then loans them the balance, taking the securities as collateral.

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