TALF Investments: Progress and Political Risk
The Term Asset-Backed Securities Liquidity Facility (“TALF”) was announced in February 2009 and first implemented in the following month. As an emergency lending facility established by the Federal Reserve Bank of New York (the “New York Fed”) pursuant to Section 13(3) of the Federal Reserve Act, TALF provides non-recourse term financing for the purchase of highly rated asset-backed and mortgage-backed securities at attractive rates. Although it is backed by a $200 billion credit facility from the Treasury, it is not considered a TARP program subject to the Emergency Economic Stimulus Act of 2009 (“EESA”). However, because of the involvement of the New York Fed in the program as well as its close association with TARP, prospective borrowers have had to weigh the political risks of their involvement and the extent to which governmental authorities could access information about their activities and their investors.
In the first three subscriptions that occurred in March, April and May 2009, TALF borrowings financed approximately $16 billion in newly issued asset-backed securities, facilitating over $24 billion in issuance of asset-backed securities. After a slow start, and considerable hesitation by investors over participating in the April subscription owing to political and other risks, the TALF program appears to have come into its own in the May subscription, with approximately $10.5 billion of TALF subscriptions facilitating the issuance of approximately $13.5 billion of TALF eligible securities. Subscriptions for the June funding appear to be on track to increase substantially from the May subscription level.
The acceleration of TALF subscriptions reflects several factors. These include
- expansion of the scope of asset classes eligible for TALF funding;
- clarification by the New York Fed and the Treasury that private TALF participants are not (without more) subject to the executive compensation restrictions of the EESA;
- increased experience with the TALF subscription process and the streamlining of TALF borrowing logistics, which increased the comfort level of investors and others with the program; and
- the sense that TALF was a constructive force in the markets for asset-backed securities and consumer credit.
These considerations acted to counter prospective participants’ concerns about political risk, which appeared to have come to a peak following the disclosure in March 2009 that employees of AIG Financial Products had been paid $165 million in retention bonuses after the company had received TARP funds. However, recent political and legislative developments may make it more likely that Congress will obtain information about TALF investment funds and their investors through audits of the New York Fed or of TALF borrowers by the Government Accountability Office (“GAO”). This concern may dampen the willingness of funds to borrow under TALF to the extent that spreads on TALF-eligible ABS continue to compress to a point where perceived risks outweigh rewards.
The contractual path of transparency is familiar to participants in the TALF borrowing process. Section 11.1 of the TALF Master Loan and Security Agreement (the “MLSA”) authorizes the Federal Reserve Board (the “Board”) to obtain reports or statements that it reasonably requests with respect to the borrowing and the collateral. Section 11.3 of the MLSA also authorizes the New York Fed to obtain “know-your-customer” (“KYC”) information submitted by a borrower to the primary dealer acting as its agent for TALF borrowings.
Primary dealers have recently been expanding the scope of KYC diligence required for TALF investment funds to “look through” the fund to get information about investors who own (directly or indirectly) 10% or more of a class of securities in the fund. The extent of the look-through varies among dealers, with different formulations covering direct, intermediate and/or ultimate owners of the borrower. KYC information is typically given to dealers under confidentiality restrictions, and the MLSA obligates the New York Fed to comply with any confidentiality restrictions. However, the New York Fed is permitted to disclose any information it receives to oversight bodies (including Congress) to the extent required by applicable law or regulations or by subpoena. Once so disclosed, information given in confidence may become publicly available. Therefore, the scope of KYC disclosure that TALF investment funds make to their primary dealers could be a crucial issue for direct and indirect investors in those funds.
The increasing level of KYC diligence has coincided with expressions of concern by the Office of the Special Inspector General for the Troubled Asset Relief Program, in its April report to Congress, that a look-through is appropriate to ensure that TALF not be used to leverage proceeds of crime. Even though TALF is not a TARP program, policymakers and enforcement agencies have been concerned about moral hazard implications of non-recourse TALF borrowings (at a 6-1 leverage ratio) by public-private investment funds established under the Treasury’s Public-Private Investment Program (“PPIP”). This moral hazard arises from the potential of such leverage to dilute the risk of loss of private equity investors in PPIP funds even beyond the dilution implicit in the Treasury’s co-investments in the equity of those vehicles. To the extent that private parties have limited “skin in the game,” they may have disincentives to conduct appropriate due diligence on financed assets or establish a fair price, which could harm a fundamental taxpayer protection in the design of TALF and PPIP by potentially exposing the public purse, as represented by the New York Fed and the Treasury, to a heightened risk of loss.
Recent legislative developments may also be providing a separate avenue to disclosure of information about investors in TALF funds. Section 8.01(d) of the enrolled version of Senate bill S.896 (Helping Families Save Their Homes Act of 2009) permits the GAO to conduct audits, including onsite examinations, of any action taken by the Board under the authorizing legislation for TALF “with respect to a single and specific partnership or corporation.” Section 8.01(c) of that bill provides that it may obtain access to any entity receiving TALF funding in connection with such audits. A separate bill introduced in the House of Representatives, H.R.1207 (Federal Reserve Transparency Act of 2009), provides for a report to Congress with respect to GAO audits of the Board. It appears that sponsors of this legislation conceive of it as a basis for Congress to obtain information with respect to TALF borrowers and their investors.
