02/12/2010

Fed Puts TALF Dealers Under Microscope

The Federal Reserve is increasing its scrutiny of banks that distribute bonds via its Term Asset-Backed Securities Loan Facility, on the eve of the program's expiration.

The reviews, focusing on adherence to "know-your-client" requirements among TALF agents, apparently kicked into high gear a few weeks ago as the Fed began a post-mortem on the program. Dealers found to be out of compliance will face audits and possible disciplinary actions from the central bank.

The final round of monthly TALF financing is set to go out March 4. For dealers of eligible bonds, the amped-up Fed inquiries they are receiving ahead of that date are creating a sense of relief that the program has almost run its course. "I personally can't wait for TALF to end. Most of us are thankful there's only one round left," one banker said, adding that he and many of his peers have been overwhelmed with paperwork related to the so-called KYC rules.

He said the Fed's requests have gone beyond the information dealers might reasonably expect to supply. For example, some agents have been asked to report investors' electricity costs.

Meanwhile, the fear of Fed audits and the negative publicity that would come with them is prompting many TALF agents to shut out what they call bottom-feeder investors from new offerings. Those shops include opportunistic buyers that formed over the last year. "It has become too risky to keep these guys in it for some agents," one underwriting professional said.

The reduced investor base likely explains why the most recent dose of TALF financing, on Feb. 4, saw deals price at slightly wider spreads than the past few rounds - backtracking on a tightening trend that had been taking shape for months. A total of $2.8 billion of bonds sold in TALF's February round, with buyers financing $987 million of that amount through the Fed.

The Fed set the know-your-client rules when it established TALF in March 2009 as a way to ensure only reputable investors would have access to its loans. All along, underwriters have been responsible for verifying buysiders' credentials. But they have complained the criteria are vague, giving the central bank too much leeway to request information. "That could mean just about anything," one underwriter said. "And believe me, they're throwing a lot of stuff at us. It's a constant uphill battle, more work than it's worth."

TALF counts 16 large investment banks as primary dealers. There are also four non-primary agents.

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