Fed decision to extend TALF scheme boosts recovery hopes for US securitisation market

By prolonging the lending facility until March 2010 for ABS and June 2010 for CMBS, central bank aims to increase issuance and restore investor confidence in the asset class.

The US securitisation market has seen a dramatic revival from its fragile state at the start of the year. Spreads have come in since their March wides and, in some areas at least, issuance looks to be picking up.

The catalyst for much of the revival has been the Term Asset-Backed Securities Lending Facility (TALF), instigated by the US Federal Reserve in March, which provides cheap government financing for investors to purchase securitised assets.

Market participants do not normally like governments to be involved in their business, but in this case nearly everyone has praised the Fed’s role in supporting the market.

“The TALF established a backstop for the market,” says Chris Flanagan, head of asset-backed research at JP Morgan in New York. “Even late last year people thought the market was cheap but spreads kept widening as banks and others were forced to sell to maintain liquidity. The TALF increased confidence and has helped the market turn the corner.”

Last month the Fed decided to further help the market by announcing it was going to extend the TALF programme until March 2010 for ABS deals and June 2010 for CMBS, from the original year-end deadline.

The move has been roundly welcomed by participants. “The TALF facility is working,” says Amanda Magliaro, director in US syndicate at Citi in New York. “So far, it has undoubtedly unglued the ABS market which is now functioning better than it has in two years. If the facility is working by giving issuers depth of access for on-the-run assets and an access period to off-the-run assets or issuers, with little risk or cost to the Fed, then why not extend it?”

Indeed, the fact that nearly all of the ABS supply over the last three months has been TALF eligible shows just how keen participants are to maintain this vital prop for the time being.

Consumer ABS
The biggest improvement so far has been in consumer ABS which, tellingly, was the first segment of the securitisation business to receive support in March. There was over $100bn of US consumer ABS issuance to the beginning of September 2009 which puts the market ahead of the curve for 2008 and close to the levels of 2007. Performance-wise the TALF’s influence is also notable, with spreads in auto loans, credit cards and student loans seeing a huge compression in the last six months.

Bank of America Merrill Lynch issued a research note in September comparing the spread and yield performance of the UK and US credit card ABS to illustrate the TALF’s impact. Since the launch of the TALF, spreads on US credit card ABS deals have tightened from 175bp in March 2009 to about 125bp in September 2009, with a commensurate decline in levered yield from 14.1% to 5.5% for triple-A rated ABS.

In comparison, UK credit card triple-A rated ABS deals currently trade at generic spreads in excess of 500bp, and have experienced very little spread compression from the wides of nearly 600bp of earlier in the year. Some believe that this may be an argument for a TALF-style intervention in the UK.

So how close is the ABS market to standing on its own two feet? There are certainly signs of progress. While most consumer ABS deals are being done with TALF eligibility, the actual number of TALF-purchased deals in this sector looks to be declining.

“In the first week of September we had $16bn of ABS issuance picked up by the market but around $5.7bn of this was TALF loan funded,” says Flanagan. “This shows that the TALF component is diminishing. Deals were all sold and spreads have been moving consistently tighter. So the consumer ABS market is definitely open right now.”

In contrast to consumer ABS, residential mortgage-backed securities – which have not had the benefit of TALF support – still look to be languishing. US government agency-backed RMBS issuance has picked up dramatically during the course of the year, but most of this has been purchased by the Federal Reserve itself.

Issuance of non-agency US RMBS, on the other hand, has been slim to non-existent so far this year.
While prices have rallied by between 40% to 50% for originally triple-A rated non-agency RMBS securities from their March lows of around 76 cents on the dollar – mostly driven by repackaging of existing deals and an improvement in general market conditions – the prospects for this market continue to look weak. This is unsurprising given the dire performance of the collateral underlying much of this asset class and the uncertain outlook for the housing market.

“The performance expectations on MBS collateral was 10 times higher than realised,” says Flanagan. “The response from the rating agencies has been to increase the equity tranche so it is more expensive to do that type of securitisation. Spreads are so wide that it is hard to make the economics work on non-agency securitisation. You currently get 93 cents on the dollar on every loan originated if you securitise it, which is non-economic.”

The CMBS market has also seen virtually no issuance this year. To date there have only been three or four new deals in the US, totalling some $1bn, a drop in the ocean against the roughly $200bn figure two years ago. Still, there are mitigating circumstances. The first TALF subscription for new issue CMBS only came in in July, hence the impact of the programme will take longer to surface. Participants expect the first batch of TALF-eligible new CMBS issues to hit the market in October, and these should spur the market into further activity in the fourth quarter.

Despite the dearth of new issuance, spreads on back-end super-senior deals have come in substantially, from around 1200bp over Treasuries last year to inside 600bp currently, and hopes remain that the programme will have a stabilising impact on the business.

Jeffrey DeBoer, president and chief executive of The Real Estate Roundtable, a US commercial real estate association, believes that the extension to the TALF date should enable the CMBS markets to start moving.

“Due to the long lead-time necessary to assemble TALF-eligible CMBS transactions, it was important to extend the programme’s remaining term to address the massive credit shortfall to the sector,” says DeBoer. “With this extension, we are optimistic that an increased number of CMBS securitisations will take place under TALF, and the programme will facilitate the return of an active securitisation market.”

Normal service not yet resumed
Despite all the optimism engendered by the TALF, the securitisation market has not returned to what participants would consider a state of normality, and may not for a long time yet, according to some observers.

Andy Nybo, head of derivatives at financial markets research and strategic advisory firm Tabb Group, says that confidence is likely to take a long time to recover: “The issue in the securitisation market is one of confidence in the assets underlying the pools,” he says. “Given the shoddy and loose credit practices that contributed to the financial crisis last year, the confidence of investors was badly shaken and possibly destroyed for ever.”

Indeed some propose that the TALF should be extended beyond the already agreed extension date next year.

“I think the TALF should be in place for as long as it takes and this may not be the only extension,” says Alexander Batchvarov, head of international structured product research at Bank of America Merrill Lynch in London. Clearly the securitisation market is not able to stand on its own two feet just yet.