07/31/2009

Fed Weighing Revisions for TALF Haircuts

The Federal Reserve is thinking about increasing the down payments it requires from investors that buy certain types of bonds with financing from its Term Asset-Backed Securities Loan Facility.

The new policy would apply to securities backed by auto loans and leases, and possibly credit cards. The intent would be to wean the strongest issuers in the most liquid asset classes off the program, while re-directing the central bank's resources to the areas in greatest need of help.

For auto lenders, such a move would appear to have the most dramatic impact on foreign issuers, like Honda and Nissan, that are seen as being on a better footing than U.S. rivals Chrysler, Ford and General Motors. But the Fed is taking a cautious approach, as efforts to discourage TALF issuance by the most stable automakers could also make it harder for their shakier peers to access the market.

A securitization professional who used to work for one of the Detroit Three said the Fed might simply increase down payments for bonds whose underlying borrowers have the highest average credit scores, as those accounts are most prevalent among the healthiest automakers. The down payments, expressed as haircuts, currently take several forms based on duration and asset type. For example: 9% of the amount purchased for three-year securities backed by prime-quality loans, 12% for three-year subprime-loan bonds and 13% for comparable prime leases.

But changes to those formulas would be lined with potential pitfalls. "The Fed cannot be viewed as targeting just Honda and Nissan . . . Any measure they come up with has to be objective," the former automaker official said, adding that tipping the scales in favor of subprime issues would create an inaccurate reflection of risk and raise the Fed's exposure to potential losses.

Top-tier issuers could also circumvent such an approach by excluding higher-quality borrowers from their securitization pools. Or they might decide that the necessary contortions wouldn't be worthwhile, thus fulfilling the Fed's goal of swaying them toward non-TALF funding.

Honda and Nissan have each issued TALF-eligible bonds twice. But before the program launched, Honda completed a deal in January and Nissan pulled off an issue in February - indicating that securitization buyers are willing to deal with both companies without Fed assistance.

Chrysler Financial and Ford, on the other hand, have only issued auto-loan or lease bonds this year via TALF - Chrysler once and Ford four times, with Ford also pricing one non-eligible securitization of dealer-floorplan loans. GM's GMAC unit hasn't issued asset-backed bonds since May 2008.

The notion that the Fed might fiddle with TALF's haircuts isn't sitting well with investment bankers. "Seems perverse," one deal-structuring specialist said. "It would cause the Fed to be primarily making loans . . . to riskier asset classes and names."

Still, TALF was created with the goal of prompting issuers to lend to individuals and businesses across the credit-quality spectrum, and not just the ones with the best scores. For that reason, it makes sense that the agency would make adjustments if it thinks the program's benefits aren't filtering down to weaker borrowers, another industry participant said.

As for potential changes to the Fed's haircuts for credit-card bonds, similar moves may be in store. However, many card lenders are already issuing outside the program due to advantageous funding costs.

Several other TALF-eligible asset classes have seen little or no issuance, and the Fed would like to see more of its financing prop up production of bonds in those areas. For instance, the agency has loaned just $3.5 billion to buyers of student-loan securities since launching the program in March. Another $1.1 billion has gone to investors in equipment loan or lease issues, and $1.3 billion to purchasers of securities backed by insurance-premium loans, mortgage-servicer advances or small-business loans. There have been no qualifying dealer-floorplan issues.

Half of all TALF loans, or $16.9 billion, have been tied to credit-card bonds. Another third, or $11 billion, have entailed auto loans or leases. Spreads on both types of issues have fallen sharply since TALF was introduced. Of the $6.6 billion of qualifying auto transactions that priced earlier in July during the program's most recent monthly funding round, about $2.8 billion were purchased with TALF financing. The only credit-card deal to occur under TALF in July, a $1.5 billion offering from Discover, went almost entirely to government-financed buyers.

TALF is set to offer its final funding round in December, but many market players believe the initiative will be extended into 2010.

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