Alert December 02, 2008

Troubled Asset Relief Program Developments FRB and Treasury Create Program to Purchase Asset-Backed Securities and Treasury Issues Guidelines for the Systemically Significant Failing Institutions Program

Term Asset-Backed Securities Loan Facility

The FRB announced the creation of the Term Asset-Backed Securities Loan Facility (“TALF”), a facility that will support the issuance of asset-backed securities (“ABS”) collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration (“SBA”).  The set of permissible underlying credit exposures of eligible ABS may be expanded to include commercial mortgage-backed securities, non-Agency residential mortgage-backed securities, or other asset classes.  Under the TALF, the Federal Reserve Bank of New York (“FRB-NY”) will lend up to $200 billion on a non-recourse basis to U.S. holders of certain AAA-rated ABS backed by newly and recently originated consumer and small business loans.  The FRB-NY will lend an amount equal to the market value of the ABS less a haircut and will be secured at all times by the ABS.  The Treasury will provide $20 billion of credit protection under the Troubled Assets Relief Program (“TARP”) to the FRB-NY in connection with the TALF.  In the event that a participating investor cannot repay a loan, or does not repay a loan because the collateral has declined in value to the point that it is worth less than the loan payoff amount, that investor will incur no financial obligation beyond the loss of the collateral.  The loss by the TALF will be absorbed first by the haircut on the collateral, second by the Treasury contribution, third by TALF program fees and finally by the FRB.

The FRB-NY will offer a fixed amount of loans under the TALF on a monthly basis.  TALF loans will be awarded to borrowers each month based on a competitive, sealed bid auction process.  Each bid must include a desired amount of credit and an interest rate spread over the one-year Overnight Index Swaps.  The FRB-NY will set minimum spreads for each auction and will reserve the right to reject or declare ineligible any bid, in whole or in part, in its discretion.  In this regard, the FRB-NY will develop and implement procedures to identify for further scrutiny potentially high-risk ABS that a borrower proposes to pledge to the FRB-NY under the TALF.  The FRB-NY will assess a non-recourse loan fee at the inception of each loan transaction.  Each borrower under the TALF must use a primary dealer, which will act as agent for the borrower, to access the TALF and must deliver eligible collateral to a clearing bank.  Originators of the credit exposures underlying eligible ABS (or, in the case of SBA guaranteed loans, the ABS sponsor) must have agreed to comply with, or already be subject to, the executive compensation requirements of the Emergency Economic Stabilization Act of 2008 (“EESA”).  For a discussion of the executive compensation requirements, see the October 14, 2008 Alert and the October 27, 2008 Alert.  The terms and conditions of the TALF are subject to change based on discussions with market participants in the coming weeks.  The TALF will cease making new loans on December 31, 2009, unless the FRB extends the facility.

Purchases of Direct Obligations and Mortgage-backed Securities of Government-Sponsored Enterprises

The FRB also announced that it will initiate a program to purchase the direct obligations of housing-related government-sponsored enterprises (“GSEs”)–Fannie Mae, Freddie Mac, and the Federal Home Loan Banks–and mortgage-backed securities (“MBS”) backed by Fannie Mae, Freddie Mac, and Ginnie Mae.  Purchases of up to $100 billion in GSE direct obligations under the program will be conducted with the FRB’s primary dealers through a series of competitive auctions and began during the week starting December 1, 2008.  Purchases of up to $500 billion in MBS will be conducted by asset managers selected via a competitive process with a goal of beginning these purchases before year-end.  Purchases of both direct obligations and MBS are expected to take place over several quarters.  The FRB stated that further information regarding the operational details of this program will be provided after consultation with market participants.

Systemically Significant Failing Institutions Program Guidelines

The Department of the Treasury issued guidelines for the Systemically Significant Failing Institutions Program (“SSFI”), which is a part of the TARP.  Financial institutions will be considered for participation in the SSFI on a case-by-case basis.  There is no deadline for participation in the SSFI.  The Treasury highlighted four considerations for participation in the SSFI:

  1. The extent to which the failure of an institution could threaten the viability of its creditors and counterparties because of their direct exposures to the institution;
  2. The number and size of financial institutions that are seen by investors or counterparties as similarly situated to the failing institution, or that would otherwise be likely to experience indirect contagion effects from the failure of the institution;
  3. Whether the institution is sufficiently important to the nation’s financial and economic system that a disorderly failure would, with a high probability, cause major disruptions to credit markets or payments and settlement systems, seriously destabilize key asset prices, significantly increase uncertainty or losses of confidence thereby materially weakening overall economic performance; or
  4. The extent and probability of the institution’s ability to access alternative sources of capital and liquidity, whether from the private sector or other sources of government funds.

The Treasury will determine the form, terms, and conditions of any investment made pursuant to the SSFI on a case-by-case basis.  The Treasury may invest in any financial instrument, including debt, equity, or warrants, that the Secretary of the Treasury determines to be a troubled asset, after consultation with the Chairman of the Board of the FRB and notice to Congress.  The Treasury will require any institution participating in this program to provide the Treasury with warrants or alternative consideration, as necessary, to minimize the long-term costs and maximize the benefits to taxpayers in accordance with the EESA.  The Treasury will also require any institution participating in the program to comply with the limitations on executive compensation applicable to SSFIs as set forth in Treasury Notice 2008‑PSSFI.  Please see the October 14, 2008 Alert and the October 27, 2008 Alert for additional discussion of the executive compensation limitations.  In addition, the Treasury will consider other measures, including limitations on the institution’s expenditures or bonuses, or any corporate governance requirements, to protect the taxpayers’ interests or reduce ongoing risks to the financial system.

Extension of FRB Liquidity Facilities

The FRB has extended the Primary Dealer Credit Facility, the Asset-Backed Commercial Paper Money Market Fund Liquidity Facility, and the Term Securities Lending Facility through April 30, 2009.  These facilities had previously been authorized through January 30, 2009.  The extension of these facilities is consistent with the term authorized for several other liquidity-related facilities: the Commercial Paper Funding Facility, the Money Market Investor Funding Facility, and the temporary reciprocal currency arrangements (swap lines) with 14 other central banks.  Please see the September 23, 2008 Alert, the September 30, 2008 Alert, the October 14, 2008 Alert, the October 21, 2008 Alert, the October 28, 2008 Alert, and the November 25, 2008 Alert for further discussion of these liquidity facilities.