Talf takes plaudits but much to be done

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Securities backed by credit cards and auto loans have rallied sharply in recent months and values are now close to levels not seen since before the sector’s breakdown last September.

Following the panic that seized financial markets across the globe after the bankruptcy of Lehman Brothers, the value of even relatively low-risk securities backed by loans plunged as selling hit all credit markets. The turmoil made it impossible for new financing to be raised through the sale of asset-backed bonds, for years one of the biggest sources of financing for the credit market.

But, like most other parts of the financial markets, consumer asset-backed securities are now in better shape, largely thanks to government intervention. Much of the credit for the improved sentiment and renewed functioning of this part of the asset-backed securities market has been given to the Federal Reserve and its loan financing plan, the term asset-backed securities lending facility (Talf).

The original $200bn portion of that plan – later expanded to provide financing of up to $1,000bn with the planned inclusion of mortgage loans – has restored confidence among investors that there is a buyer of last resort, and the existence of such a “backstop” has helped normalise the market and encouraged investors to return.

Talf works like this: the Fed lends money to investors, on favourable terms, which they can use to buy certain types of triple A-rated securities.

“The fact that we have seen secondary [market] spreads come in nicely is a good sign,” said Katie Reeves, director of asset-backed research at Deutsche Bank, at a recent conference. She said the most important part of the Talf was that it showed the government was serious about fixing the securitisation markets. In addition, the Fed’s willingness to revise terms until they worked “was critically important to confidence of the securitisation market”, she said.

Next week, the fourth leg of the Talf will begin. Already, close to $6bn of deals have been announced, and the final amount of money borrowed could be at least double that.

In spite of the success, however, the programme has not played out precisely as expected.

Even as the consumer loans part of the market has rallied, the much larger mortgage-backed securities sectors have not done as well.

On the residential mortgage-securities side, for example, confusion remains about how various government programmes to modify mortgages and reduce foreclosures will affect investors owning securities backed by these mortgages.

On the commercial mortgage-backed securities front, renewed uncertainty about whether many of the triple A-rated securities will retain those ratings has pushed spreads wider again.

Indeed, tackling these more troubled parts of the asset-backed markets presents a much bigger challenge to the Fed.

Although the Fed is widely expected to try to readjust its programme following the potential for downgrades by Standard & Poor’s of triple A-rated commercial mortgage-backed securities, such rating uncertainty at the very least delays any stabilisation of this sector.

The political spotlight will be especially fixed on these riskier securities, on which taxpayers stand to make losses, and balancing the needs of investors and taxpayers could be a far bigger challenge than the ones tackled so far.

More broadly, the concerns about the Talf fall into two areas.

First, the economic slowdown means there is likely to be less of a need for financing than anticipated. The loans used to back the securities are new loans and the financing method allows banks and financial institutions to take them off their balance sheets and make room for fresh loans. But credit is slowing, and not just because of the state of the credit markets.

Chris Flanagan, analyst at JPMorgan, says he expects the consumer loans part of the Talf – such as credit cards and auto loans – to contribute to volumes of $100bn this year, not the original $200bn anticipated by the Fed.

Second, the original idea was to bring in a wave of new investors, to take the place of the special investment vehicles that were big buyers of structured and securitised debt. Hedge funds, not usually buyers of triple A-rated securities, were particularly targeted by the Fed, as these investors often borrow money to pump up the returns on investments.

However, the political tensions that have surrounded this and other government plans that involve taxpayers subsidies to allow large returns for private investors, have kept hedge funds and others on the sidelines.

Ish McLaughlin, managing director for investment grade syndicates at Citigroup, said hedge funds were among those most nervous about political fallout.

“It still is a market that is resting on too narrow a base of investor support,” Mr McLaughlin said at a recent conference. “We have not seen the dozens and dozens of investors who asked all these questions show up yet.”

He said many of the new deals were still being supported by half a dozen big investors.

Hayley Boesky, director of market analysis at the Federal Reserve Bank of New York, which is responsible for handling the Talf, says that although the political temperature has dropped, concerns about executive compensation restrictions, whether or not profits would be clawed back and other issues such as visa restrictions that come with some government plans remained factors for some investors.

“The temperature seems to have been lowered but these concerns continue as they are extraordinarily sensitive issues among the investor community,” she said at a securitisaton conference.

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