Tortuous TALF 2.0

News Analysis

Tortuous TALF 2.0

Markets question TALF usage

The Federal Reserve this Tuesday (May 12) published more details about the terms of its $100bn new emergency lending facility generally referred to as TALF 2, and while these details were welcomed there are a still a lot of questions in the market about how useful this programme will be.

The first of those questions revolves around relative value. The cost of a TALF loan is benchmarks plus 125bp (150bp in the case of CLOs), which is 25bp more than the original TALF programme over a decade ago. This elevated cost of funding makes relative value often difficult to realise, particularly in the light of recent spread compression.

“TALF 1.0 provided below market rates for financing and that was what made it so attractive. Is plus 125bp or plus 150bp a rate at which anyone will utilise TALF with the restrictions that it imposes? The problem we’re seeing is that the price is high enough to have a chilling effect on the market,” says Gregg Jubin, a managing partner in the securitization practice at Cadwalader, Wickersham & Taft in Washington, DC.

For example, this week Volkswagen priced a $4bn four tranche ABS deal, of which the longest dated tranche, the A4s, paid Libor plus 100bp. The other three tranches were considerably tighter (the A1s came in at Libor minor 8bp). It makes no sense to buy notes and borrow under TALF at levels such as these.

“I’m a lawyer not a banker, but even I can see that if you’re borrowing at plus 125bp and investing at plus 100bp, you’re probably not going to make any money,” says Stuart Litwin, co-head of the securitization practice at Mayer Brown in Chicago.

As CLO buyers have to borrow under TALF at an even wider spread of plus 150bp, it is of little use to this area of the securitization market, as numerous prominent market commentators have noted.

There are other logistic caveats to TALF as well. It is limited at $100bn, and, as sources say, if the programme is needed then that relatively slim sum of money will be exhausted quickly.

Secondly, it is scheduled to expire on September 30, and, with Memorial Day looming in the USA, it is unlikely that programme documents will be released by the Fed until early June. As deals cannot be packaged and potential buyers lined up overnight, the first TALF deals would not probably hit the tape until July. This makes TALF’s borrowing window particularly narrow.

There are a couple more impediments to usage. Under TALF’s terms, investors must be publicly disclosed; this could be a sticking point for some wealth management platforms.

There is also an attestation provision, termed by one source “an odd requirement”. It means that a potential TALF borrower has to show that alternative forms of financing are not available. Many would be investors will find this requirement difficult to meet.

Certain classes of ABS are boxed into an even tighter corner. Commercial real estate CLOs, SASBs and, most strikingly, legacy CMBS deals are not eligible under TALF. With regard to the latter, only recently issued fixed-rate senior conduit CMBS rated triple-A by two rating agencies (from Fitch, Standard and Poor’s or Moody’s) and not on downgrade watch are eligible.

This is different to TALF 1.0. “The intention of the other parts of TALF is to see new issuance. Clearly this is not the case for CMBS. For whatever reason, making sure there is additional liquidity in the commercial real estate lending market wasn't a priority," says Stuart Goldstein, a partner and co-chair of the CMBS group at Cadwalader.

Moreover, TALF loans are for only three years, and the great majority of CMBS deals are of much longer duration so investors have to work out what to do with the investment when TALF expires. This makes the question of relative value even more germane to the CMBS sector.

“How much use will TALF be to the CMBS market?  Not very.  It could limit spread widening in the (super) duper but that is about it. I am not sure what the take up will be,” says Lea Overby, a CMBS strategist at Wells Fargo in New York.

Five year new issue triple-A conduit CMBS paper is dealing at plus 160bp, more than 100bp outside the 52-week lows but also almost 200bp narrower than the recent wide prints.

The Federal Reserve in Washington was unavailable for comment on the reasons for these various restrictions and exclusions in TALF 2.0.

However, there are several caveats to be made. There are good reasons why the Federal Reserve has drawn the net of eligibility so tightly. It has a responsibility to husband the nation’s resources carefully, and some classes of ABS deal represent a degree of credit risk that it perhaps feels it should not countenance. A SASB deal, for example, means exposure to a single hotel.

For broadly the same reasons, the Fed has set the borrowing rate deliberately high, surmise dealers. TALF only becomes remunerative for investors if spreads have backed up sufficiently widely, and at this point it forms a backstop to prevent further widening. Public funds are supposed to be last resort financing, and, in the case of TALF 2.0, it seems the Fed has taken its responsibilities very seriously.

“If the test of TALF is to function as a safety net, then it has already done a good job of making an impact,” says Stuart Litwin.

Moreover, despite the many misgivings those in the US securitization markets express, there are plenty of potential investors, say sources. Both US and offshore funds are circling TALF assets. For the latter, the attraction of safe haven US assets at a time of considerable crisis remains undimmed despite the strictures TALF imposes, it seems.

Consortiums of fund investors and ultra-high net worth individuals particularly from Europe and Latin America are showing interest, while among the potential domestic buyers, traditional wealth managers and pension funds are lining up, as they did in TALF 1.0, says Dorothy Mehta, a partner at Cadwalader.  

These investors have not yet, of course, committed  capital, but neither are they dismissing TALF out of hand. “We’re taking calls from funds every day,” says Mehta.

Simon Boughey

15/05/2020 23:59:05

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