United States: The Federal Reserve´s Term Asset-Backed Securities Loan Facility ("TALF") Update

In April 2009, Jones Day issued Commentaries on the Term Asset-Backed Securities Loan Facility ("TALF") and the Public-Private Investment Program ("PPIP"). Since then, there have been several important developments in these programs. Industry participants continue to shape TALF, the PPIP, and other government "stimulus" programs. We encourage you to provide comments on these programs to the appropriate agency.

First, on May 1, the Board of Governors of the Federal Reserve System ("Federal Reserve") announced that beginning in late June, commercial mortgage-backed securities ("CMBS") and securities backed by insurance premium finance loans used to finance property and casualty insurance will be eligible collateral under TALF. The Federal Reserve also authorized up to $100 million of TALF loans with maturities of up to five years to finance purchases of CMBS, ABS backed by student loans, and ABS backed by the Small Business Administration.

Eligible collateral for a TALF loan will include U.S. dollar-denominated, cash (not synthetic) CMBS issued on or after January 1. Each CMBS must evidence an interest in a trust fund consisting of fully funded, first-priority fixed-rate mortgage loans that are current in payment at the time of securitization. All of the mortgage loans must have been originated on or after July 1, 2008, and the security for each must include a mortgage or similar instrument on a fee or leasehold interest in one or more income-generating commercial properties located in the United States.

Borrowers may elect either a three-year or five-year maturity for each TALF loan secured by CMBS. A three-year TALF loan will bear interest at an annual fixed rate of 100 basis points over the three-year LIBOR swap rate, and a five-year TALF loan is expected to bear interest at an annual fixed rate of 100 basis points over the five-year LIBOR swap rate.

The collateral haircut for each CMBS with an average life of five years or less will be 15 percent. For CMBS with average lives beyond five years, collateral haircuts will increase by one percentage point for each additional year of average life. No CMBS may have an average life beyond 10 years.

As with many other governmental programs, there are details that the Federal Reserve has not finalized. For example, the Federal Reserve Bank of New York is currently reviewing the rating methodologies of all rating agencies interested in rating TALF-financed CMBS. The eligible agencies and specific rating requirements have not been finalized but are expected to be released prior to the initial CMBS subscription date. In addition, the Federal Reserve is still developing specific criteria for TALF-eligible CMBS. We hope these requirements will be announced shortly and will facilitate issuance of TALF-eligible CMBS.

The commercial real estate industry had been encouraging the Federal Reserve to authorize TALF loans with maturities of five years (currently all TALF loans have maturities of three years), since a record amount of CMBS will come due in the next three years, and most commercial real estate loans are made for more than five years. A five-year term for TALF loans will enable borrowers to better match the maturity of TALF funding to the maturities of the CMBS, thereby eliminating refinancing risks. The Federal Reserve has been reluctant to extend the term of the loans, however, because it prefers to make short-term loans and has been concerned that longer-term loans will make it difficult for the Federal Reserve to quickly withdraw the TALF credit it has injected into the economy and raise interest rates when the economy improves.

Second, in connection with the PPIP's Legacy Loans Program, the Federal Deposit Insurance Corporation ("FDIC") may offer investors financing to purchase the legacy loans without requiring them to share in the equity component with the United States Department of the Treasury ("Treasury"). Investors have encouraged this change to the Legacy Loans Program in an effort to reduce governmental limits on compensation. The FDIC and the Treasury, with input from potential investors and market participants, are still discussing the specific terms of this arrangement.

We expect that the FDIC will adopt for the Legacy Loans Program certain terms it has developed as receiver for selling toxic assets of failed banks as part of its structured sales program.

Third, TALF completed its second round in mid-April, which received only $1.71 billion in loan applications, down from $4.71 billion in March. It is projected that six transactions in an aggregate amount of $10 billion will be sold on May 5, the deadline for the Federal Reserve's latest offering of nonrecourse loans under TALF. On May 4, JP Morgan Chase & Co. announced a $5 billion credit card securitization backed by TALF-eligible credit card loans, which may be upsized to $7.5 billion. General Electric Co., a large player in the private label and cobranded retailer credit card market, which has not traditionally securitized its credit card receivables, announced a $1 billion credit card securitization that will be TALF-eligible. Also, CNH Capital America LLC increased its TALF-eligible securitization of loans secured by agricultural equipment to more than $1 billion. These issuances should increase demand for TALF loans.

William Dudley, President of the Federal Reserve Bank of New York, spoke at Vanderbilt University Owen Graduate School of Management in April and noted that certain Troubled Asset Relief Program ("TARP") restrictions, particularly with respect to executive compensation, may have scared borrowers from applying for TARP programs. He noted that these fears are "misplaced" and, for TALF, the Federal Reserve acts as a "middleman" between the Treasury and borrowers. He also noted that investors should not be concerned that the Federal Reserve's ballooning balance sheet will trigger inflation.

Fourth, the Secretary Inspector General for the Troubled Asset Relief Program ("SIGTARP") delivered his second report to Congress and had several criticisms of the various TARP programs. He asserted in this report that the Treasury needs to develop better conflict-of-interest rules and oversight, particularly in the PPIP. He also criticized TALF for relying on major credit-rating agencies for determining whether securities are safe for taxpayers. It has not been determined how the Treasury will respond to the deficiencies noted in the SIGTARP's report.

Fifth, the Federal Reserve is considering and seeking more tools to manage monetary policy and drain reserves from the system as the economy recovers in light of the large amounts and long term of TALF and other lending.

Sixth, the Federal Reserve recently stated that it expects to release guidance to clarify the legal and compliance standards applicable to investment funds that seek to participate in the TALF. See April 1 Letter from the Chairman of the Federal Reserve and the President of the Federal Reserve Bank of New York to the Congressional Oversight Panel Responses.

Last, the United Services Automobile Association's USAA FSB on April 16 announced pricing information for a $1.13 billion securitization of motor vehicle loans. This deal was not structured to be TALF-eligible, but it is indicative of increased activity in the ABS market. According to SNL Financial, the Securities Industry and Financial Markets Association reported that while ABS issuance during the first quarter of 2009 was down 71 percent as measured against the first quarter of 2008, it represents a significant increase from the fourth quarter of 2008. Auto ABS issuance was responsible for 51.4 percent of the first quarter's securitization volume, while it was responsible for only 25 percent of 2008's deal volume.

For more information on TALF and the PPIP, please visit Jones Day Commentary, "The Federal Reserve's Term Asset-Backed Securities Loan Facility ("TALF")—Expanding New Credit for Consumers and Businesses," at http://www.jonesday.com/pubs/pubs_detail.aspx?pubID=S6069 , and Jones Day Commentary, "The Public-Private Investment Program," at http://www.jonesday.com/pubs/pubs_detail.aspx?pubID=S6070 .

Jones Day will continue to update you as developments occur.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Chip F. MacDonald
 
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