Term Asset-Backed Securities Loan Facility (US)

The Fed announced the creation of the program on November 25, 2008. It described TALF as a facility that would help meet the credit needs of households and small businesses by supporting the issuance of ABS collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the SBA (FRBNY 2008). The Fed initially committed to provide up to $200 billion of loans to investors to purchase eligible securities (Ashcraft, Malz, and Pozsar 2012). The Fed subsequently expanded its commitment up to a potential $1 trillion on February 10, 2009.

The Fed relied on its emergency powers under Section 13(3) of the FRA to extend loans to investors under TALF. Treasury also committed funds under the Troubled Assets Relief Program of the EESA. It provided $20 billion of credit protection to the FRBNY in connection with the TALF. 

Although originally announced to be an auction facility, the TALF was changed to be a standing facility with borrowers submitting subscriptions to buy at preannounced rates set by the Fed.

The FRBNY was the Fed entity responsible for managing the TALF, but it required several parties to assess values of collateral eligibility of borrowers and to manage the loans once entered into.

• TALF agents were primary dealers or other designated agents that handled certain administrative activities between the FRBNY and the borrowers. Agents paid TALF loan principal and interest from the proceeds of collateral sales and paid the excess to the borrower.
• Bank of New York Mellon Corporation, the program custodian, was responsible for holding collateral, collecting and distributing payments and administrative fees, verifying the data provided by the TALF agents, and validating the pricing and ratings submitted for pledged securities. 
• Collateral monitors,^FNPacific Investment Management Company LLC (PIMCO), Trepp, LLC (Trepp), and BlackRock Financial Management, Inc. (BlackRock) were selected to serve as collateral monitors for the FRBNY. Each collateral monitor assisted the FRBNY by providing valuation, modeling, analytics, and reporting. PIMCO performed a broad role that encompassed the entire TALF portfolio. Trepp focused on both newly issued and legacy CMBS, and BlackRock focused on legacy CMBS. CWCapital Investments LLC provided underwriting advisory services with regard to certain commercial mortgage loans backing newly issued CMBS. However, the collateral monitors did not make decisions for the FRBNY (FRBNY, n.d.-b). selected by the FRBNY, provided data and modeling services used in risk assessments and validated collateral pricing and ratings.

The TALF program relied on the purchase of ABS by private investors rather than directly by the Federal Reserve. In view of the long term to maturity of the loans, and wide variety of newly issued spreads and credit quality across the ABS market, it was desirable to have private investors’ scrutiny. This involvement also avoided undercutting market mechanisms for allocating credit to borrowers by relying on private structuring and pricing of new securitizations (Ashcraft, Malz, and Pozsar 2012)

Relying on private investors in newly issued ABS and CMBS also provided benchmark pricing to the market. Even a small number of transactions informed market participants about where securitization liabilities would tend to price. This reduced market and funding liquidity risk by diminishing uncertainty about the funding cost of the underlying loans and the feasibility of a securitization exit, easing a key constraint on willingness to lend to creditworthy borrowers. Additionally, with a first-loss position, investors had skin in the game, incentivizing them to screen collateral for credit quality (Ashcraft, Malz, and Pozsar 2012).

An entity was defined as a US company if it was: (1) a business entity or institution that was organized under the US law and conducted significant operations or activities in the USA; (2) a US branch or agency of a foreign bank that maintained reserves with the Fed; (3) a US insured depository institution; or (4) an investment fund that was organized under the US law and managed by an investment manager that had its principal place of business in the USA. Any foreign-government-controlled entity or institution was excluded (FRBNY, n.d.-b).

Specifically, for item (4), investment fund included pooled investment vehicles such as hedge funds, private equity funds, and mutual funds, and single-investor vehicles. These funds did not need to exclusively invest in TALF-eligible ABS but could be multistrategy funds. The financing subsidiaries of a public-private investment fund (PPIF) established pursuant to the Legacy Securities Public-Private Investment Program (PPIP) could participate only in legacy CMBS and if the PPIF was receiving Treasury-supplied debt financing equal to or less than 50% of the PPIF’s total equity (FRBNY, n.d.-b). This was to prevent double leveraging (Ashcraft, Malz, and Pozsar 2012). For more information on PPIP, please refer to the Yale Program on Financial Stability (YPFS) case study on that program (Henken, 2020).

For all four categories of US companies, they could not have a material economic interest in the underlying collateral pool of ABS they were posting against the TALF loans. This was to prevent conflicts of interest that could lead to collateral being presented at inflated prices (Ashcraft, Malz, and Pozsar 2012).

Minimum loan amount was $10 million, and there was no maximum. To avoid undercutting market mechanisms of risk monitoring and due diligence regarding the creditworthiness of the loans, the program imposed haircuts on the TALF loans by lending an amount against the bonds that was materially smaller than the value of the bonds taken as collateral. Haircut was a key risk mitigant for the Fed since the TALF loans were nonrecourse (Ashcraft, Malz, and Pozsar 2012).

Haircuts were risk sensitive, varying by the underlying asset class and the security’s weighted average life, as seen in Figure 1. The average life of a security is the average timing of principal repayment, which in turn depends on assumptions about prepayment for ABS. In order to prevent issuers from gaming TALF haircuts by asserting high prepayment rates and thus shortening the average lives for the securities they wished to pledge, the program set standardized prepayment assumptions by asset class, as shown in Table 2. This permitted the issuer to calculate the TALF average life of each security and the investors to know the haircut on a TALF loan.

The weighted average life of a legacy CMBS was calculated on the basis of: (1) the current composition of the mortgage pool, as reflected in recent servicer and trustee reports; (2) the entitlement of the legacy CMBS to distributions; (3) the assumption that “anticipated repayment dates” are maturity dates; and (4) a 0% conditional payment rate and the absence of future defaults. Loans in default or special servicing were considered as if they had not defaulted, and previously modified loans were considered according to their terms as modified (FRBNY, n.d.-b).

The haircut was measured as a percent of market value for newly issued ABS and CMBS and as a percent of par for legacy CMBS. A haircut measured as a fraction of par instead of price implies a market-value haircut that is higher for lower-value collateral, adding another protection against adverse selection in the legacy program (FRBNY, n.d.-b).

The loan amount for newly issued ABS and CMBS was calculated by subtracting a haircut from the market value of the pledged collateral. The loan amount for legacy CMBS was determined by subtracting a haircut from the lesser of the dollar purchase price on bond trade date, the market price as of loan subscription date, or a value based on the FRBNY’s risk assessment (FRBNY, n.d.-b).

Underwriters of TALF-eligible ABS generally set the issue date close to the TALF subscription date. Otherwise, between the issue and subscription dates, investors would have to seek alternative financing and face the risk of securing lower TALF loan proceeds if the bond price dropped. While the value of a newly issued ABS or CMBS bond for purposes of determining the loan amount was based on its price on the subscription date, the value of a legacy CMBS was the dollar purchase price of the CMBS at subscription less the base dollar haircut from par, exposing the TALF investor to a larger market risk in the period between the bond purchase date and the loan subscription date (Ashcraft, Malz, and Pozsar 2012).

In addition to the haircut, an administrative fee of 10 basis points of the loan amount was applied to loans secured by nonmortgage ABS and a fee of 20 basis points was applied to TALF loans backed by CMBS collateral (Ashcraft, Malz, and Pozsar 2012).

TALF loans were originally announced to be a three-year loan. However, there was a mismatch between the three-year maximum loan term and the five-year maximum range of the underlying assets backing the loans. As pointed out in the May 2009 Congressional Oversight Panel report, this mismatch meant the nonrecourse financing through TALF would expire before the underlying debt securities fully matured, leaving the investors to take on the full risk of those debt securities for the rest of two years (COP 2009). Therefore, the Fed announced on May 1, 2009, that it was extending the TALF loan to five years for certain class of ABS (Federal Reserve 2009b).

One of the designers of TALF emphasized that the nonrecourse feature was key to TALF design. Nonrecourse meant that if the market price of ABS declined, whether because of risk aversion in the market or because of mounting credit losses, the borrowers would not take the capital loss and could exit the loan, leaving the collateral ABS with the Fed. This highlights the purpose of TALF, which was to heal the market and keep the investors active in the market.

The loan term was a key design element of the TALF program. Investors were eager to avoid the refinancing risk associated with funding longer-dated collateral with a shorter-dated loan. Most TALF collateral was eligible only for a three-year loan term, but longer-dated collateral (such as ABS secured by student loans, loans guaranteed by the SBA, or commercial real estate loans) was eligible for a five-year loan term (Ashcraft, Malz, and Pozsar 2012).

For example, credit card ABS was commonly issued by revolving master trusts, which accepted new credit card loans to the ABS’ asset pool as the investment qualities of this underlying pool changed. Credit card securitizations differed from other ABS since the underlying credit card loans had a relatively short life, typically eight to 10 months, whereas ABS typically had three-year or longer maturities. As a result of this maturity mismatch, each series of securities issued out of the master trust was structured to have a revolving period. The revolving period was for a predetermined period that was established at the time the series of securities was structured, and the maturities of the longest senior tranches of most credit card ABS were close to three years. Therefore, three-year TALF loans were offered for credit card ABS.  

On the other hand, Small Business Administration loans, student loans, and commercial real estate sectors had longer maturities of seven to 10 years, 15 years, and 10 years, respectively. Therefore, five-year loans were offered for these ABS under TALF; and while the TALF loan term was shorter than the terms of these ABS, the government explained that investors could reasonably assume that market conditions would have normalized by the time the TALF loan matured (five years), permitting them to either finance their positions in the private market or unwind them in an orderly way (Ashcraft, Malz, and Pozsar 2012).

The loans under TALF were nonrecourse. While recourse is a significant risk mitigant for a secured lender, the government reasoned that it could have been expensive for the borrower given the volatility in securitization markets. Not only would this have reduced the number of borrowers willing to participate in TALF, but it would have prompted these borrowers to demand higher returns to ABS issuers to compensate for refinancing risk associated with the ABS it was investing in. This ultimately would have reduced the program’s efficacy. Moreover, a meaningful recourse provision was in any event impractical without a regime, which the Fed lacked the ability and resources to institute, to verify the financial condition of ABS issuers (Ashcraft, Malz, and Pozsar 2012).

Brian P. Sack of the FRBNY emphasizes that the combination of these two elements—long maturities and nonrecourse—was critical to the success of the program. Without one or the other, investors would have had exposure to short-term swings in risk premiums in a time of extreme volatility, which would have likely limited participation and thus reduced the program’s effectiveness (Sack 2010).

The interest rate on TALF loans was generally high relative to the historical coupon rate on ABS and CMBS. This high rate served two important purposes. First, it was an important source of credit enhancement to the public sector. Second, the high loan rate was also an important part of the exit strategy. The loan rate made the program uneconomic as the spreads for newly issued ABS and CMBS reverted toward their historical norms, and thus, the demand for the program diminished as the markets recovered. TALF borrowers also had an incentive to repay loans prior to maturity (Ashcraft, Malz, and Pozsar 2012).

A designer of TALF also explains that this was the “penalty rate” from the Bagehot dictum, and once spreads tightened below 100 basis points, the program size did not matter and TALF achieved what it was set to achieve.

The TALF loan rate was set as a spread, fixed over the life of the program but varying by asset class and loan term, over an index, as shown in Table 3. The indexes were chosen to correspond to bond pricing conventions at issue, thus minimizing the interest rate risk for the borrower in case it decided to exit from the TALF loan. The index for fixed-rate loans was the Libor^FNLibor is the London interbank offered rate. swap rate, generally with a maturity equal to that of the TALF loan. For most asset classes, the index for floating-rate loans was the one-month Libor rate, but for some, the index was the prime rate or target federal funds rate (Ashcraft, Malz, and Pozsar 2012).

Minimum loan amount was $10 million, and there was no maximum. To avoid undercutting market mechanisms of risk monitoring and due diligence regarding the creditworthiness of the loans, the program imposed haircuts on the TALF loans by lending an amount against the bonds that was materially smaller than the value of the bonds taken as collateral. Haircut was a key risk mitigant for the Fed since the TALF loans were nonrecourse (Ashcraft, Malz, and Pozsar 2012).

Haircuts were risk sensitive, varying by the underlying asset class and the security’s weighted average life, as seen in Figure 1. The average life of a security is the average timing of principal repayment, which in turn depends on assumptions about prepayment for ABS. In order to prevent issuers from gaming TALF haircuts by asserting high prepayment rates and thus shortening the average lives for the securities they wished to pledge, the program set standardized prepayment assumptions by asset class, as shown in Table 2. This permitted the issuer to calculate the TALF average life of each security and the investors to know the haircut on a TALF loan.

The weighted average life of a legacy CMBS was calculated on the basis of: (1) the current composition of the mortgage pool, as reflected in recent servicer and trustee reports; (2) the entitlement of the legacy CMBS to distributions; (3) the assumption that “anticipated repayment dates” are maturity dates; and (4) a 0% conditional payment rate and the absence of future defaults. Loans in default or special servicing were considered as if they had not defaulted, and previously modified loans were considered according to their terms as modified (FRBNY, n.d.-b).

The haircut was measured as a percent of market value for newly issued ABS and CMBS and as a percent of par for legacy CMBS. A haircut measured as a fraction of par instead of price implies a market-value haircut that is higher for lower-value collateral, adding another protection against adverse selection in the legacy program (FRBNY, n.d.-b).

The loan amount for newly issued ABS and CMBS was calculated by subtracting a haircut from the market value of the pledged collateral. The loan amount for legacy CMBS was determined by subtracting a haircut from the lesser of the dollar purchase price on bond trade date, the market price as of loan subscription date, or a value based on the FRBNY’s risk assessment (FRBNY, n.d.-b).

Underwriters of TALF-eligible ABS generally set the issue date close to the TALF subscription date. Otherwise, between the issue and subscription dates, investors would have to seek alternative financing and face the risk of securing lower TALF loan proceeds if the bond price dropped. While the value of a newly issued ABS or CMBS bond for purposes of determining the loan amount was based on its price on the subscription date, the value of a legacy CMBS was the dollar purchase price of the CMBS at subscription less the base dollar haircut from par, exposing the TALF investor to a larger market risk in the period between the bond purchase date and the loan subscription date (Ashcraft, Malz, and Pozsar 2012).

In addition to the haircut, an administrative fee of 10 basis points of the loan amount was applied to loans secured by nonmortgage ABS and a fee of 20 basis points was applied to TALF loans backed by CMBS collateral (Ashcraft, Malz, and Pozsar 2012).

A designer for TALF comments that there were two main debates on the design of collateral: (1) whether to open the program to legacy securities or keep it only for the newly issued ones; and (2) whether to open the program to residential mortgage-backed securities.

The TALF program avoided undercutting market mechanisms for allocating credit to different sectors of the economy by defining eligible collateral broadly within these three general classes of underlying loans. However, ABS asset classes with historically poor performance (for example, timeshares, aircraft leasing, and manufactured housing) were excluded as they were considered not central to the goal of averting a deeper recession. Also, nonagency residential mortgage-backed securities and securitizations of corporate loans were excluded, in part because of risk considerations but also because the TALF program’s approach of providing funding liquidity for senior bonds would not address the problems facing those sectors (Ashcraft, Malz, and Pozsar 2012).

Eligible collateral had to have AAA credit ratings from two eligible nationally recognized statistical rating organizations (NRSROs) and have no lower rating from any NRSRO.^FN12 C.F.R. Part 201 provided the FRBNY with the process by which it determined the eligibility of credit rating agencies for TALF. NRSROs for newly issued non-mortgage-backed ABS included Moody’s, Fitch, and Standard and Poor’s, and beginning with the February 2010 subscription, DBRS was also included in this list. SBA Pool Certificates or Development Company Participation Certificates had an issuance cutoff date of January 1, 2008, and were exempt from the ratings requirements. For newly issued and legacy CMBS, eligible credit rating agencies included Moody’s, Fitch, Standard and Poor’s, Realpoint, and DBRS (Federal Reserve 2009a).
 The AAA rating had to be attained on the strength of the securitization collateral and structure itself, rather than through a financial guarantee or “wrap” provided by an insurance company or other third party (Ashcraft, Malz, and Pozsar 2012). In case of a downgrade of an ABS, TALF loans backed by such ABS were not affected, but it could not be used as a collateral for any new TALF loans until it regained its status as eligible collateral.

Moreover, in order to address the potential risk and problem with program effectiveness posed by the use of credit rating agencies’ ratings, the Fed conducted internal credit reviews before accepting bonds as collateral. This review provided a layer of due diligence beyond that of the credit rating agencies and investors, putting the public sector in a better position to manage adverse selection. It also was an important check on adverse selection by TALF borrowers, despite the low rejection rate of 13 percent (Ashcraft, Malz, and Pozsar 2012).

(1) Newly Issued Non-Mortgage-Backed ABS

At inception, eligible collateral that was accepted under the TALF was US dollar–denominated non-mortgage-backed ABS issued on or after January 1, 2009. (FRBNY TALF Terms and Conditions)

This included ABS backed by:

• Retail auto loans;
• Federally guaranteed and private student loans;
• Credit card receivables; and
• Small-business loans, fully guaranteed as to principal and interest by the US government, originated under the SBA’s 7(a) (Pool Certificates) and 504 (Development Company Participation Certificates) programs.

On February 10, 2009, the Fed announced that it was prepared to take expansion under TALF. The objective of the expansion was to provide additional assistance to financial markets and institutions in meeting the credit needs of households and businesses (FRBNY 2009).

On March 19, 2009, the Fed announced that TALF-eligible collateral would expand to include ABS backed by loans related to:  

• Commercial, rental car company, and government fleet leases;
• Business equipment loans and leases;
• Floor plan loans, by which, for example, auto dealers finance inventories; and
• Servicing advance receivables, which arise from residential mortgage servicing advances.

On May 1, 2009, the Fed again expanded the categories of TALF-eligible collateral to include securities backed by:

• Insurance premium finance loans, by which businesses finance lump-sum insurance premium payments.

(2) Newly Issued CMBS

On May 1, 2009, the Fed further expanded TALF-eligible collateral to include newly issued CMBS. At the same time, the Fed also authorized five-year loans (up to $100 billion) to purchase newly issued CMBS, and ABS backed by student loans and by SBA loans. Extension to the five-year term brought TALF loan maturities closer to the longer average of these types of securities (FRBNY n.d.-a).

(3) Legacy CMBS

Beginning with the subscription held on July 16, 2009, the TALF accepted conduit CMBS issued before January 1, 2009, that was structurally senior to all other interest in the underling pool of mortgages and that had two AAA rating from NRSROs. Since the purchase price factored into the determination of the loan amount, borrowers had to have purchased the legacy CMBS in recent secondary-market transactions between unaffiliated parties, executed on an arm’s-length basis at prevailing market prices. This was to prevent conflicts of interest that could lead to collateral being presented at inflated prices (Ashcraft, Malz, and Pozsar 2012). The FRBNY independently reviewed and rejected any CMBS that did not meet the stated criteria or that otherwise posed unacceptable risk (FRBNY n.d.-a).

Minimum loan amount was $10 million, and there was no maximum. To avoid undercutting market mechanisms of risk monitoring and due diligence regarding the creditworthiness of the loans, the program imposed haircuts on the TALF loans by lending an amount against the bonds that was materially smaller than the value of the bonds taken as collateral. Haircut was a key risk mitigant for the Fed since the TALF loans were nonrecourse (Ashcraft, Malz, and Pozsar 2012).

Haircuts were risk sensitive, varying by the underlying asset class and the security’s weighted average life, as seen in Figure 1. The average life of a security is the average timing of principal repayment, which in turn depends on assumptions about prepayment for ABS. In order to prevent issuers from gaming TALF haircuts by asserting high prepayment rates and thus shortening the average lives for the securities they wished to pledge, the program set standardized prepayment assumptions by asset class, as shown in Table 2. This permitted the issuer to calculate the TALF average life of each security and the investors to know the haircut on a TALF loan.

The weighted average life of a legacy CMBS was calculated on the basis of: (1) the current composition of the mortgage pool, as reflected in recent servicer and trustee reports; (2) the entitlement of the legacy CMBS to distributions; (3) the assumption that “anticipated repayment dates” are maturity dates; and (4) a 0% conditional payment rate and the absence of future defaults. Loans in default or special servicing were considered as if they had not defaulted, and previously modified loans were considered according to their terms as modified (FRBNY, n.d.-b).

The haircut was measured as a percent of market value for newly issued ABS and CMBS and as a percent of par for legacy CMBS. A haircut measured as a fraction of par instead of price implies a market-value haircut that is higher for lower-value collateral, adding another protection against adverse selection in the legacy program (FRBNY, n.d.-b).

The loan amount for newly issued ABS and CMBS was calculated by subtracting a haircut from the market value of the pledged collateral. The loan amount for legacy CMBS was determined by subtracting a haircut from the lesser of the dollar purchase price on bond trade date, the market price as of loan subscription date, or a value based on the FRBNY’s risk assessment (FRBNY, n.d.-b).

Underwriters of TALF-eligible ABS generally set the issue date close to the TALF subscription date. Otherwise, between the issue and subscription dates, investors would have to seek alternative financing and face the risk of securing lower TALF loan proceeds if the bond price dropped. While the value of a newly issued ABS or CMBS bond for purposes of determining the loan amount was based on its price on the subscription date, the value of a legacy CMBS was the dollar purchase price of the CMBS at subscription less the base dollar haircut from par, exposing the TALF investor to a larger market risk in the period between the bond purchase date and the loan subscription date (Ashcraft, Malz, and Pozsar 2012).

In addition to the haircut, an administrative fee of 10 basis points of the loan amount was applied to loans secured by nonmortgage ABS and a fee of 20 basis points was applied to TALF loans backed by CMBS collateral (Ashcraft, Malz, and Pozsar 2012).

TALF LLC, a special purpose vehicle, was established specifically for the purpose of managing any collateral surrendered by TALF borrowers to the FRBNY. Treasury purchased $20 billion of subordinated debt in TALF LLC. If loans under TALF were not repaid and the proceeds from the sale of the related collateral could not be recouped, Treasury bore the loss up to a specified amount. The Fed then bore any losses exceeding such amount (Ashcraft, Malz, and Pozsar 2012).

TALF LLC held any collateral surrendered by a borrower with respect to a TALF loan and entered into lending transactions with eligible investment funds wishing to purchase eligible ABS. It was initially funded by a $100 million drawing on the Treasury’s $20 billion commitment.

TALF LLC also held the accumulated interest from TALF loans in excess of the interest earned by the FRBNY. The Fed retained a portion of TALF loan interest equal to its cost of funds that was calculated as the overnight indexed swap (OIS) rate plus 25 basis points. The accumulated excess interest from TALF loans and the Treasury funding was invested to earn interest income (Ashcraft, Malz, and Pozsar 2012).

The reasoning behind this exemption was that the principle in executive compensation restrictions need not apply to TALF borrowers. Executive compensation restrictions were to ensure that executives of institutions that received government support did not unjustly enrich themselves at the expense of taxpayers. On the other hand, the goals of the TALF was to encourage securitization of privately originated loans in important asset classes to consumers and businesses. It provided support to ABS sponsors, who provided credit to consumers and businesses, and to ABS investors, who brought new capital to this frozen market. Therefore, the restrictions did not apply to TALF sponsors, underwriters, and borrowers as a result of their participation in the TALF (FRBNY n.d.-b). Additionally, the Office of the Special Inspector General for the Troubled Asset Relief Program (SIGTARP) included correspondence demonstrating that because the executive compensation restrictions “would not enhance the effectiveness of TALF in restoring consumer credits,” Treasury and FRBNY decided to remove these restrictions (SIGTARP 2009).