CLIENT ALERT: Overview of TALF Program

On November 25, 2008, the Board of Governors of the Federal Reserve System (“Board”) and the U.S. Treasury jointly announced plans to create a $200 billion Term Asset Backed Securities Loan Facility (“TALF”). By providing liquidity to institutions that buy newly issued securities backed by consumer and small business loans, it is hoped that TALF will encourage additional lending in the crucial consumer sector of the economy. TALF is designed to help stabilize the market for newly issued AAA-rated securities backed by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration (“Eligible Securities”). Under this innovative new facility, which will take some time to set up[1], the Federal Reserve Bank of New York (“FRBNY”) has been authorized to make up to $200 billion in non-recourse fully secured loans. A special purpose vehicle (“SPV”) will, in turn, be created to purchase the loan collateral from FRBNY. The Treasury’s Troubled Asset Relief Program (“TARP”) will initially fund the vehicle by purchasing $20 billion in subordinated debt issued by the SPV.

While the range of securities eligible to be pledged under the program will initially be limited, the program is expected to eventually include other types of asset-backed securities (“ABS”), including commercial mortgage backed securities (“MBS”) and residential MBS. Treasury Secretary Henry Paulson stated at a news conference announcing the program that TALF may very well be expanded to include other asset classes: “It’s going to take a while to get this program up and going, and then it can be expanded and increased over time. It could be expanded to include new commercial mortgage-backed securities that are highly rated or new highly rated residential mortgage-backed securities.”

Unless extended, the TALF will cease making new loans on December 31, 2009.

Discussion of Key Elements

The following is a summary of the key elements of the TALF program, including: (1) the legal authority under which TALF was created; (2) TALF’s legal structure; (3) eligible borrowers; (4) eligible securities and (5) restrictions on executive compensation that must be adopted by borrowers.

(1) Federal Reserve & Treasury Legal Authority and TALF’s Purpose

TALF is being established pursuant to section 13(3) of the Federal Reserve Act which grants the Federal Reserve Board broad authority to make loans in unusual or exigent circumstances.[2] The Treasury’s authority to fund the first $20 billion in securities purchases by the SPV derives from Section 101 of the Emergency Economic Stabilization Act. In creating the TALF, officials hope to head off deleveraging process and ensure a healthy securitization market for consumer loans.

(2) TALF Transaction Structure

Once established and funded, FRBNY will be able to lend up to $200 billion on a non-recourse basis to holders of newly issued AAA-rated ABS for a term of one year. The FRBNY will offer to the market a fixed amount of loans under the TALF on a monthly basis, with the U.S. primary dealers acting agents for any potential or actual borrower. TALF loans will be awarded to borrowers each month based on a sealed bid auction process. Each bid must include a desired amount of credit and an interest rate spread over one-year OIS.[3] The FRBNY will lend an amount equal to the market value of the Eligible Security less a haircut, and repayment of the loan will be secured at all times solely by the pledged security. The haircut applicable to any pledged security will be determined at the inception of the loan and based on the price volatility of each class of Eligible Securities.

The SPV will both purchase and manage assets received by FRBNY in connection with a TALF loan. The SPV will contractually commit up front, for a fee, to purchase all assets securing a TALF loan that are received by the FRBNY at a price equal to the TALF loan amount plus accrued and unpaid interest. Once the SPV purchases more than $20 billion in assets, the FRBNY will lend additional funds to the SPV to finance such additional purchases.

Significantly, TALF loans will not be subject to mark-to-market or re-margining requirements nor will collateral substitutions be allowed.

(3) Eligible Borrowers

All “U.S. persons” that own Eligible Securities may borrow against such securities under the TALF. To qualify a borrower must be (1) a natural person that is a U.S. citizen, (2) a business entity that is organized under the laws of the United States or a political subdivision or territory thereof (even if that entity has a non-U.S. parent), or (3) a U.S. branch or agency of a foreign bank.

(4) Eligible Collateral: Underlying Exposures Must be Auto Loans, Student Loans, Credit Card Loans, or Small Business Loans

Eligible Securities must also be: (i) U.S. dollar-denominated; (ii) have a long-term credit rating in the highest investment-grade rating category from two or more major nationally recognized statistical rating organizations (“NRSROs”) and (iii) not have a long-term credit rating of below the highest investment-grade rating category from a major NRSRO. As noted earlier, the Treasury has indicated that the range of Eligible Securities under TALF may ultimately be expanded to include other asset classes. Also, all or substantially all of the credit exposures underlying the eligible ABS must be a newly or recently originated exposure.[4]

Notably, eligible collateral for a particular borrower must not be backed by loans originated by the borrower or by an affiliate of the borrower.

(5) Executive Compensation

Originators of the credit exposures underlying any Eligible Securities (or, in the case of SBA guaranteed loans, the ABS sponsor) must agree to comply with, or already be subject to, the executive compensation requirements consistent with TARP guidelines applicable to the Capital Purchase Program (“CPP”). By way of background, the executive compensation requirements under the CPP are applicable to an originator’s five “senior executive officers”.[5] The requirements provide that the originator and its senior executive officers must modify or terminate all benefit plans, arrangements and agreements (including golden parachute agreements) to the extent necessary to be in compliance with the executive compensation and corporate governance requirements of Section 111 of the EESA and any guidance or regulations issued by the Secretary of the Treasury.[6]

Conclusion

We continue to monitor the implementation of TALF by the Treasury and FRBNY, and we will issue additional memoranda as the situation requires, including if Treasury or FRBNY issues additional interpretive guidance on the definition of an eligible borrower and an Eligible Security.