United States: Term Asset-Backed Securities Loan Facility II

The Federal Reserve Board of Governors authorized the establishment of the TALF on March 22, 2020, as one of several market liquidity programs meant to serve as a funding backstop for troubled term securitization markets. In stabilizing ABS markets, the Fed intended to support a freer flow of credit to households and businesses by facilitating the issuance of ABS at more normal interest rate spreads.

The Fed took extensive measures to enable the flow of credit to the economy through programs such as the Primary and Secondary Market Corporate Credit Facilities, the Commercial Paper Funding Facility (CPFF), the Primary Dealer Credit Facility (PDCF), and the Money Market Mutual Fund Liquidity Facility (MMLF).

The Fed authorized the TALF by invoking its authority under Section 13(3) of the Federal Reserve Act (FRB 2020f). Section 13(3) permits the Fed, in “unusual and exigent circumstances,” to “discount for any participant in any program or facility with broad-based eligibility” (FRB 2017). The invocation of Section 13(3) allowed the Fed to provide liquidity more broadly than its monetary policy and discount window authorities allowed.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 required prior approval of the Treasury for the facility’s establishment. The Treasury also committed a first-loss equity investment to the TALF, using funds appropriated by Section 4027 of the CARES Act (CARES Act 2020, sec. 4027). Although Treasury approval was not required for the GFC-era iteration of the TALF, the Treasury had worked closely with the Fed on that program and provided $20 billion in TARP funds as additional security for that facility (CRS 2020, 19).

The Fed submitted mandated reports to both the Senate Committee on Banking, Housing, and Urban Affairs and the House Committee on Financial Services. Each report included a brief description of the TALF’s operations and any significant updates to its terms and conditions. Provisions specified in Sec. 4026(b)(1)(B) of the CARES Act also required the Fed to publish these reports on its website seven days after submitting them to Congress (116th US Congress 2020).

In addition to scrutiny in House and Senate committee hearings, TALF operations were subject to oversight by the Congressional Oversight Commission and the Special Inspector General for Pandemic Recovery (SIGPR), both of which were established to monitor the government’s CARES Act facilities. The Government Accountability Office also published reports on the Fed’s emergency lending activities.

While the FRBNY acted on behalf of the Fed in managing the TALF, the program utilized several parties to manage the loan transactions and to assess the collateral values and eligibility of borrowers:

• In May 2020, the FRBNY appointed Pacific Investment Management Company LLC (PIMCO) to act as the collateral monitor for the TALF. That same month, the FRBNY designated the Bank of New York Mellon (BNYM) to serve as custodian and administrator of the facility. PIMCO and BNYM were chosen for their experience in the ABS markets and, in the case of the latter, prior involvement with the Global Financial Crisis-era iteration of the TALF (FRBNY 2020a).
• Designated TALF Agents—primary dealers and other investors party to the Master Loan and Security agreement—were responsible for supporting loan issuance on behalf of their customers, the borrowers. Among other duties, they were tasked with the intermediary roles of collecting loan requests, delivering to the custodian any administrative fees, and managing the relationship between the borrowers and delivering counterparties (if applicable) (FRBNY 2020b).

In its initial press release, the Fed committed to “using its full range of tools” to provide credit support for households, businesses, and the general US economy throughout the COVID-19 crisis (FRB 2020g). It reported that the TALF, along with other emergency lending and asset purchase programs, would assist a wide range of markets and institutions while promoting maximum employment and ensuring price stability (FRB 2020g).

The Fed announced on April 23, 2020, that it would publicly disclose on a monthly basis the companies that borrowed under its CARES Act emergency lending programs. The Fed emphasized that this new information would accompany its “already robust financial reporting, including a comprehensive weekly balance sheet and annual audited financial statements” (FRB 2020e, 1). Following up on its announcement in a press release dated May 12, 2020, the Fed began publishing the names of each participant in the TALF, respective amounts borrowed, interest rates charged, and value of pledged collateral (FRB 2020f). These reports also included information on the costs, revenues, and fees associated with the overall facility. On December 30, 2021, the Fed released its TALF-specific Disclosures Regarding the Emergency Lending Response to COVID-19, Pursuant to Section 11(s) of the Federal Reserve Act (FRB 2021).

Additionally, the Fed published annual audited financial statements specific to the SPV, Term Asset-Backed Securities Loan Facility II LLC; two have been published as of this writing (FRBNY 2021b; FRBNY 2022).

The Fed has viewed use of the SPV structure as providing management, accounting, and legal advantages to an intervention—especially when the Fed operates multiple Section 13(3) programs in parallel.^FSee also Bernanke, Geithner, and Paulson 2020, 156–158. Use of an SPV allows the Fed to better tailor a 13(3) program to the goals of the intervention (Baxter 2009, 12–13). Each intervention has its own specific terms, timeline, capital structure, and management team. The management teams may also be in geographically separate reserve banks, depending on which is administering a given intervention.

The SPV structure simplifies the reporting of income and the management of any sales of assets discounted by the facility. As noted in Key Design Decision No. 7, Disclosure, the Fed provided separate annual financial statements for the TALF that were independently audited by an outside accounting firm. These statements provided greater detail and transparency than existed for Fed facilities that did not utilize the SPV structure (Bernanke, Geithner, and Paulson 2020, 157; FRB 2022b). Moreover, the degree of corporate separation from both the Fed and other 13(3) interventions provided by an SPV structure may provide those other entities some protection in the event a 13(3) program is sued.

SPVs are also typically easy and inexpensive to set up. The Fed has viewed its creation of the structures as falling under the “incidental powers as shall be necessary to carry on the business of banking within the limitations” of the Federal Reserve Act (FRB n.d.; Bernanke, Geithner, and Paulson 2020, 156, fn 28).

Peak utilization amounted to $3.7 billion in loans made to eligible borrowers as of October 31, 2020 (FRB 2020m). The majority of transactions were concentrated in securities backed by commercial mortgages and small business loans guaranteed by the Small Business Administration (SBA). Overall issuances of ABS declined substantially year-over-year between January and September 2020 (GAO 2020).

According to the Fed’s disclosures, TALF utilization increased significantly in July 2020, with 106 loans totaling $1.6 billion provided to 36 different borrowers, up from 19 loans totaling $252 million to five different borrowers in June 2020 (COC 2020).

By the end of its operations on December 31, 2020, the TALF had extended 224 loans totaling $4.4 billion to 20 investment funds, more than half of which were foreign-based companies (COC 2021a). Total usage represented 4% of the facility’s initial $100 billion capacity (COC 2021b).

As with the GFC-era version of the TALF, the FRBNY committed to lend to a special purpose vehicle (SPV), TALF II LLC, on a recourse basis.

In addition to granting authorization for the facility, the Treasury Department made a $10 billion equity investment in the SPV using funds appropriated to the Exchange Stabilization Fund (ESF). Treasury was required to use existing ESF funds because the Fed announced the establishment of the TALF prior to the passage of the Coronavirus Aid, Relief, and Economic Security (CARES) Act on March 27, 2020. As of the TALF term sheet dated May 12, 2020, however, Treasury had supplanted the ESF funds with those allocated under section 4027 of the CARES Act (FRB 2020c).

In practice, all TALF borrowers were investment funds. Eligible borrowers included investment funds created or organized in the US and overseen by an investment manager created or organized in the US. These included (1) any type of pooled investment vehicle organized as a business entity or institution, such as a hedge fund, private equity fund, or mutual fund; (2) any type of single-investor vehicle organized as a business entity or institution; (3) any newly formed investment funds, so long as they met other relevant eligibility criteria (FRBNY 2020b).

Eligible participants must have (1) been created or organized in the US or under the laws of the US; (2) had significant operations and a majority of its employees based in the US; and (3) maintained an account relationship with a TALF Agent. Initially, the FRBNY Term Sheet dated May 12, 2020, had described a requirement wherein this account relationship would have to be maintained with a primary dealer. This was updated on July 28, 2020, to include all designated TALF Agents (FRB 2020d).

A business that named a foreign government as a Material Investor (defined by FRBNY as owning “directly or indirectly, 10% or more of any outstanding class of securities of an entity”) was not eligible to borrow (FRBNY 2020b, 2). The TALF terms considered sovereign wealth funds to be equivalent to foreign governments for the purposes of these restrictions. It similarly deemed ineligible any pension plan in which foreign governments owned, directly or indirectly, 10% or more of any outstanding class of securities.

In a departure from GFC-era TALF terms, the FRBNY required COVID-era TALF borrowers to submit to their respective TALF Agents proof of eligibility throughout the duration of the outstanding loan term. The Fed added these requirements to the 2020 TALF conditions following Congress’s post-GFC amendments to Section 13(3) and the Fed’s subsequent amendments to Regulation A, the authority’s implementing rule. Congress amended Section 13(3) to mandate that recipients of such assistance could not be insolvent. While Section 13(3) had already required that the Fed “obtain evidence that such participant . . . is unable to secure adequate credit accommodations from other banking institutions,” the Fed amended Regulation A to specifically mention a certification of such from the borrower as “relevant evidence” (FRB 2015, 78963).  

Regulation A allowed borrowers to cite one or more of the following when proving eligibility for the TALF: (1) unusual economic conditions in a sector of the ABS market(s) intended to be addressed by the TALF, such as elevated spreads in the primary and secondary ABS markets in sectors for which the borrower sought to use as collateral for the loan; or (2) increased rates or haircuts in the financing market (e.g., the repurchase agreement, “repo,” market) relevant for the collateral that the borrower sought to use for a TALF loan (FRBNY 2020b).

This design feature was a holdover from the first iteration of the TALF. Each month, borrowers were able to request loans on each of the two preannounced subscription dates. The TALF then disbursed loans to the borrower, pending receipt by the custodian of eligible collateral, administrative fee, and applicable margin to cover the haircut. To support market functioning, the TALF made loans at a premium above the market rate that would prevail under otherwise normal conditions (Caviness and Sarkar 2020).

Because the loans were non-recourse to the borrower, the SPV was able to “enforce its rights in the collateral” if the loan were not repaid (FRBNY 2020b, 1). FRBNY staff members Elizabeth Caviness and Asani Sarkar considered this to be an unconventional feature of market financing in non-crisis times (Caviness and Sarkar 2020).

One of the designers of the GFC-era TALF emphasized that the non-recourse feature was key to the program design. If the market price of the ABS declined, whether because of risk-aversion in the market or because of mounting credit losses, the borrowers’ capital loss would be limited by the collateral haircut. They could then exit the loan agreement, leaving the collateral ABS with the Federal Reserve. This aspect of the program highlights that the purpose of the TALF was to heal the securitization markets and motivate investors to be involved in that process (Rhee 2020).

A borrower could pledge only a single type of eligible collateral per TALF loan. Eligible collateral for a particular borrower could not be backed by loans originated or securitized by the borrower or by an affiliate of the borrower. There were two exceptions, however: (1) A borrower was able to use Small Business Administration (SBA) ABS as collateral for its TALF loan if the loans underlying were originated by the borrower or its affiliates, so long as the borrower had no prior knowledge thereof; and (2) a borrower was also able to use syndicated CLOs as collateral for its TALF loan even if the underlying loans were originated by the borrower or affiliates as part of its syndicate.

Eligible collateral included US dollar-denominated cash (i.e., not synthetic) ABS that had received AAA credit ratings from two qualified, nationally recognized statistical rating organizations (NRSROs) and possessed no lower rating from any NRSRO. Although outstanding TALF loans backed by downgraded ABS were not affected by rating changes, downgraded ABS could not be used as collateral for any new TALF loans until it regained its status as eligible collateral.

For ABS to be eligible as collateral, the FRBNY required that it consist of one of the following underlying credit exposures:

• Auto loans and leases
• Student loans
• Credit card receivables (both consumer and corporate)
• Equipment loans and leases
• Floorplan loans
• Premium finance loans for property and casualty insurance
• Certain small business loans guaranteed by the SBA
• Leveraged loans, or
• Commercial mortgages.

The March 23, 2020, term sheet included eligible servicing advance receivables in its list of acceptable collateral. However, the Fed excluded them from its April 9, 2020, term sheet, instead adding leveraged loans and commercial mortgages.

Eligible ABS must also have been issued on or after March 23, 2020, with the exception of CMBS and SBA Pool Certificates (7[a] loans) or Development Company Participation Certificates (504 loans). Collateral falling into the latter two categories must have been issued on or after January 1, 2019.

In a significant departure from the design of the GFC-era TALF, the Fed announced on April 9, 2020, that it would permit certain types of CMBS and static collateralized loan obligations (CLOs) to be used as collateral. This expansion followed the observation that interest rate spreads on these asset classes had tightened following the initial announcement of the TALF (Caviness and Sarkar 2020).

All, or substantially all, of the credit exposures underlying the eligible ABS must (1) for newly issued ABS, except for CLOs, have been originated by US-organized entities (including US branches or agencies of foreign banks); (2) for CLOs, have had a lead or a co-lead arranger that is a US-organized entity (including a US branch or agency of a foreign bank); and (3) for all ABS (including CLOs and CMBS), have been US-domiciled obligors or with respect to real property located in the United States or one of its territories.

ABS that bore interest payments that stepped up or down to predetermined levels on specific dates were ineligible. Additionally, underlying credit exposures of eligible collateral could not include exposures that were themselves cash ABS or synthetic ABS. Single-asset single-borrower CMBS, non-static CLOs, and commercial real estate CLOs were also ineligible.

The FRBNY also required eligible collateral to undergo clearance procedures through the Depository Trust Company. As was the case during the GFC, “this review provided a layer of due diligence beyond that of the credit rating agencies and investors, putting the public sector in a better position to manage adverse selection” (Rhee 2020, 295).

There were no penalties for investors who failed to provide a security on the settlement date; however, a delay would result in the cancellation of that portion of the loan and the withholding of the administrative fee.

Although the FRBNY required borrowers to request a minimum of $5 million per loan application, there were no maximum amounts imposed. The FRBNY determined the value of the loans collateralized by both CMBS and ABS by the base value minus the base dollar haircut, defined by the following FRBNY guidelines:

CMBS:

• The base value was equal to the least of (1) the dollar purchase price on the applicable trade date, (2) the market value as of the subscription date, and (3) a value based on the New York Fed’s collateral review, provided, however, that the base value was not to be greater than par.
• The base dollar haircut was equal to: (1) for CMBS with an average life under five years, 15% or (2) for CMBS with an average life beyond five years, 15% plus one percentage point for each additional year of average life beyond the five-year date. No CMBS could have an average life of 10 years or longer.
• If the base value was less than the base haircut, the CMBS was ineligible.

ABS:

• The base value for seasoned collateral was equal to the least of: (1) the dollar purchase price on the applicable trade date, (2) the market value as of the subscription date, and (3) a value based on the New York Fed’s review, provided, however, that, other than SBA ABS, the base value was not greater than par.
• For SBA ABS with a market value greater than par, the Fed lent an amount equal to market value, subject to a cap of 105% of par value, minus a haircut.
• The base value for newly issued collateral was equivalent to the dollar purchase price on the applicable trade date.
• The base dollar haircut varied with the asset class and average life of the ABS.
• If the base value was less than the base haircut, the ABS was ineligible (FRBNY 2020b).

The weighted average life of a CMBS asset was calculated on the basis of (1) “the current composition of the mortgage pool, as reflected in recent servicer and trustee reports, (2) the entitlement of the legacy CMBS to make distributions, (3) the assumption that “anticipated repayment dates” are maturity dates, and (4) a 0% conditional payment rate and the absence of future defaults” (FRBNY 2020b, 13–14). Loans in default or special servicing were considered as if they had not defaulted, and previously modified loans were considered according to their modified terms.

FRBNY required CMBS to bear interest at a pass-through rate that was fixed or based on a weighted average of underlying fixed mortgage rates.

The haircut schedule (see Figure 1) was mostly consistent with that of the GFC-era iteration of the TALF, with a few notable exceptions: The 2008 predecessor never bought leveraged loans but did include newly issued CMBS (FRB 2020d, 3; Rhee 2020, 290).

Figure 1: Initial Haircut Schedule for TALF II LLCSource: FRB 2020d, 3.

The FRBNY determined interest rates on TALF loans based on the type of collateral securing the loan, setting them one day prior to the subscription date. A borrower then had a 30-day grace period during which to pay interest if the net interest pledged on the ABS was not sufficient to cover the interest payment associated with the TALF loan.

Pricing was determined as follows: 

• For collateralized loan obligations (CLOs), the interest rate was 150 bps over the 30-day average secured overnight financing rate (SOFR).
• For SBA Pool Certificates (7[a] loans) the interest rate was the top of the federal funds target range plus 75 bps.
• For SBA Development Company Participation Certificates (504 loans), the interest rate was 75 bps over the three-year federal funds overnight index swap (OIS) rate.
• For all other eligible ABS, the interest rate was 125 bps over the two-year OIS rate for securities with a weighted average life less than two years, or 125 bps over the three-year OIS rate for securities with a weighted average life of two years or greater (FRB 2020d).^FRates per the March 23, 2020, term sheet were based on LIBOR rather than SOFR (for CLOs) or OIS (all other asset classes). The FRBNY began using the latter benchmarks beginning with the publication of the term sheet dated April 9, 2020 (FRB 2020a, 2; FRB 2020b, 2).

Similar to its GFC-era predecessor, the interest rates on TALF loans were generally high relative to the historical coupon rate on ABS and CMBS (Caviness and Sarkar 2020). 

Upon settlement of collateral, the FRBNY required borrowers to pay to the TALF II LLC an administrative fee equaling 10 basis points of the loan amount.

Loans offered under the GFC iteration of the TALF initially carried terms of three years. However, the FRBNY later extended these terms because of a mismatch between the maximum three-year range of the loans and the maximum five-year range of their underlying assets (Rhee 2020).

Despite the extension of the previous version of the program, the TALF II terms specified a three-year maturity for each loan. As noted in Figure 1, the maximum maturity for the underlying collateral remained much longer than three, or even five, years.

Upon receipt of a Prepayment Notice, the FRBNY allowed borrowers to prepay a TALF loan, in full or in part and without penalty. The borrower then received collateral securing the relevant TALF loan on a pro-rata basis. Despite this prepayment provision, borrowers were not permitted to substitute collateral during the term of the loan.

Furthermore, there were no additional regulatory capital requirements for securities financed by a TALF loan. Borrowers were, however, subject to the conflicts of interest requirements outlined in section 4019 of the CARES Act. 

As with the first iteration of TALF, the principle underlying executive compensation restrictions needed not apply to TALF borrowers because they were not the ultimate recipients of emergency credit (FRBNY 2020b).

Sources consulted do not indicate the existence of regulatory concessions.

Sources consulted do not indicate that the Fed consulted with international parties.

Due to prevailing pandemic-related market volatility and slow national economic recovery, the Fed announced a three-month extension on July 28, 2020 (FRB 2020h). 

On November 19, 2020, Treasury Secretary Steven T. Mnuchin formally requested that the Fed return unused funding for CARES Act facilities (including the TALF, among others) to the Treasury (Mnuchin 2020). Although the Fed initially expressed reservations about the early closure, Chair Powell later indicated that he would defer to Treasury (Powell 2020). Following Secretary Mnuchin’s request, Congress passed an amendment to the Consolidated Appropriations Act (CAA) of 2021 that would explicitly prevent the Fed from reinstating any of the CARES Act facilities, with the notable exception of the TALF (House of Representatives 2021, 966). According to a CRS report, the CAA may have excluded the TALF because it was the only program backed by CARES Act funding initially established during the GFC (Labonte 2021).

On January 7, 2021, the FRBNY and Treasury amended the TALF II Limited Liability Company Agreement to provide for “an interim distribution to Treasury of a portion of its previously contributed capital” (FRBNY 2021a, 1). This return of equity amounted to approximately $10 billion, less the amount of outstanding loans (FRBNY 2021a).