Over the weekend, press coverage focused for the first time on assets within ABS against which issuers are taking out large TALF loans. Concern arose on two fronts: the significant risk to the Fed from the motorcycle- paper issue and borrower protections in a credit-card ABS.
After the TALF was announced last November, FedFin advised clients that the Fed and Treasury would face significant political risk if underlying underwriting conditions in TALF ABS did not pass muster. However, TALF of course got off to a very slow start, delaying Congressional interest in it. The slow start also made the Fed far more eager to agree to TALF loans. To date, the Fed’s focus has been exclusively on relations between the issuers and primary dealers to limit its own operational responsibilities in the TALF, with issues such as consumer protection getting little, if any, notice. The Fed has also discounted credit risk because of the AAA requirements for eligible ABS.
In FedFin’s view, public attention will force TALF program changes. That Congress has focused on TALF doesn’t mean that it likes it much. For the Fed to conserve its waning political capital, it will need going forward to look not only at the issuer, but also at the ABS itself. FedFin expects qualifying deals in the future to need to address these concerns in the loan request to the Federal Reserve through the applicant’s primary dealer.
The Fed is already concerned about its reliance on AAAs, although it decided to set this eligibility criterion last November because, in the heat of the moment, it couldn’t think of anything else. Both of these recent deals do, however, pose significant credit risk to the Treasury – which takes first loss before the Fed in TALF. When Treasury gets more staff in place, FedFin expects it to work with the Fed to refine eligibility criteria for TALF ABS to look past the simple AAA from both a credit-risk and consumer-protection point of view. The more deals that get panned, the fewer deals will get done.