Many hopes and dreams reside with what so far has been the best accepted (at least by Wall Street's conventional wisdom) government program - the Term Asset-Backed Securities Loan Facility, aka
TALF, aka Prime Broker Of The People, By The People, For The People. But as we have seen before (TARP 1, TARP 2, Tim
Geithner) it is usually only a matter of time before those who read (instead of just repeating the talking heads) scratch the surface and sniff between the lines.
An implicit role for the
TALF is to provide the role that
securitizations used to provide in the
good old days (and which also were one of the main factors that lead the global economy to be where it is now), as
securitizations facilitate the reselling of leverage by allowing risk
tranching (of which Iceland always somehow ended up buying the riskiest class) and further leveraging when it is finally offloaded to the end investor. The
TALF launched yesterday in its non expanded version covers $200 billion of loans ($20 billion of TARP funds leveraged 10 times) supporting autos, credit cards, student loans and small business lending. Once the
TALF is expanded into its fully
unaccordioned state it will have access of up to $1 trillion and will support
CMBS,
RMBS and ABS corporate loans (through the soon the be downgraded
CLOs). The three main benefits to a
TALF investor are the following: the program will be non recourse (no risk aside from an initial haircut defined for any specific asset class it is used for), there will be no mark to market, and participants will not be subject to executive compensation limits.
TALF has some significant limitations on the surface (and below it, as we will investigate further): the
TALF only lets investors back into the AAA market (
TALF is not geared at any asset classes below AAA), it does not benefit auto and credit card issuers that have become bank holding companies (due to the direct-from-Fed lower funding costs of on-balance sheet
financings), and lastly, the cost of all these incremental loans will have to be funded by the Fed which is already seeking enhanced authority to issue debt and finding ways to create other monetary base expansion mechanisms.
How does the
TALF work?
In summary,
TALF leverages TARP funds, turning $20 billion of funds into $200 billion purchasing power (or $100 billion leveraged to $1 billion per the revised
TALF definition), which as mentioned, is non-recourse and has no-
remargining. This means the only risk for investors is the initial haircut, and even that should not be classified as a risk per
se (more on this shortly).
The initial problem with the
TALF appears its expanded size, which may have been just some more of the Fed's psychology of "picking a really big number." As Bank Of America says, the $1 trillion target size "appears
outsized relative to the underlying issuance capacity of the targeted markets suggesting less impact from this program than advertised." Granted, when the
TALF was first announced on December 19, it caused a dramatic tightening of AAA spreads in the auto loan, credit card and student loan space, and per the recent update, will also likely benefit the
CMBS and CLO AAA spreads. One could argue, and the market would justify, that all benefits from the
TALF have already been priced into AAA tranches.
The Treasury's justification for such a focus was the "$1.2 trillion decline in
securitized lending" between 2006 and 2008. The figure below demonstrates the changes in level and composition of
securitized lending that were being referred to:
Unfortunately for
Geithner, who apparently did not read too deeply into the data, the bulk of the $1 trillion decline in
securitizations came from home equity lending and non agency
RMBS, which reflect the "non-conforming" mortgage market, i.e. the
subprime, alt-A and jumbo origination, loans which are the cause for the credit crisis, and which are rated far below the relevant AAA level. The truly unmet market, which the Treasury is
addressing is at best 20% of the revised total amount.
Thus, the focus of the TALF appears misplaced. While the original size of $200 billion is applicable to current market needs, pushing for a 5x higher total notional of securitization replacement, even after utter pandering to private participants, is nonsensical, and likely the administration had the unfortunate intent of merely shocking the market into believing that as the program now has a trillion handle, all securitization problems could be resolved. That is patently wrong. What is in it for the investor?
The
TALF will not be demand limited, as it will generate up to 20% virtually risk-free returns to investors, due to low funding levels (roughly 100 bps over
LIBOR) and marginal haircuts. The
simplest return calculation is taking the net spread on the assets times the leverage, the traditional formula used by all leveraged lenders. Using a prime credit card 3 year loan, this works out to 200 bps over
LIBOR less funding costs (i.e. 100 bps) all times 20 (1/ asset specific haircut of 5% as seen in matrix below), resulting in the mentioned 20% return.
Based on that formula the returns would vary between roughly 7% and 20% with essentially no downside risk due to the non-recourse and non-margin nature of the
TALF.
Summary
As noted above, there seems to be a gross
misperception of the nature of the
TALF as a product that
has been created to
address a "demand for credit" problem. This is wrong, as seen in the returns analysis above from a
TALF investor's standpoint: the very attractive returns guarantee there will be no lack of desiring participants to use taxpayers' capital and backstopping to generate up to 20% returns. The problem is that in an overall environment of consumer and commercial
deleveraging, using the 2006 peak market conditions as a guide to the program's success ignores that based on the inevitable decline in demand by potential
securitizers, overall use of the program relative to peak
securitization levels will decline. Therefore the $1 trillion maximum utilization target on the
TALF is a pipe dream and merely one more round in the government's arsenal of shocking the market with soundbites and large numbers: its old incarnation of $200 billion would have been perfectly satisfactory, even more so as $80 billion less taxpayer capital (via TARP) would have been put at risk. The success of the program will hinge on merely avoiding more defaults and economic damage that would have been inevitable if credit availability had not been there. And lastly, the stupid shift in the administration's push to encourage demand, which will be there regardless, by
removing compensation limits is, of course, another blatant demonstration of the government's misunderstanding of its own programs and the supply/demand market mechanics they create.
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