pdf

Term Asset-Backed Securities Loan Facility Expanded to Include Commercial Mortgage-Backed Securities and Securities Backed by Insurance Premium Finance Loans

January 1, 0001

 

The Federal Reserve Board of Governors (“Federal Reserve”) announced on Friday the anticipated expansion of the Term Asset-Backed Securities Loan Facility (“TALF”) to include commercial mortgage-backed securities (“CMBS”) and asset backed securities (“ABS”) backed by insurance premium finance loans (“IPFL”) as eligible collateral, beginning with June TALF subscriptions. The Federal Reserve also announced that, for TALF loans secured by CMBS, as well as for student loans and Small Business Administration-guaranteed loans (for which there have been no requests for TALF funding to date), TALF borrowers would be permitted to elect loan maturities of five years (increased from three years for existing TALF loans).

As part of the multi-pronged Financial Stability Plan, the Federal Reserve announced in November 2008 the creation of TALF, a consumer and business lending initiative administered by the Federal Reserve Bank of New York (“FRBNY”) that would leverage $100 billion of funding from the U.S. Department of the Treasury (“Treasury”) and up to $1 trillion in Federal Reserve lending to provide non-recourse loans to purchasers of new consumer loan, small business loan and commercial mortgage ABS. TALF-eligible collateral was initially limited to newly issued, AAA-rated ABS backed by credit card receivables, student loans and Small Business Administration-guaranteed loans, and was expanded in recent TALF subscriptions to include newly issued, AAA-rated ABS backed by floorplan loans, vehicle fleet leases, loans and leases for business equipment and mortgage servicing advances. Tomorrow is the next subscription date for TALF loans backed by such eligible collateral. Click to view an overview of the TALF program.

In February 2009, the Federal Reserve announced its intention to undertake a substantial expansion of TALF to encompass CMBS, as well as private-label residential mortgage-backed securities (“RMBS”) and other ABS. In its announcement, the Federal Reserve indicated that the inclusion of CMBS as eligible collateral for TALF is intended to unlock the presently-seized CMBS market in order to prevent defaults on otherwise economically viable commercial properties, permit refinancing of maturing loans, and facilitate the sale of distressed properties. Adding securities backed by IPFL to the TALF program is intended to increase the availability, and reduce the cost, of property and casualty insurance coverage for small businesses.

While the Federal Reserve has provided broad outlines of the expanded TALF program, there remain, as discussed below, a number of issues that will require further elaboration by the Federal Reserve. In addition, it is important to note that these newly eligible forms of TALF-eligible ABS must be newly issued; thus far, TALF has not been expanded to include, as eligible collateral, legacy (i.e., not recently issued) RMBS or CMBS, the market for which has become highly illiquid. In its March 23, 2009 announcement of the Public-Private Investment Program, Treasury indicated that TALF was expected to be expanded to include legacy RMBS that were originally rated AAA and CMBS and ABS that are rated AAA.

Click to view previous client alerts concerning the Public-Private Investment Program distributed on March 24, 2009 and April 7, 2009.

Below is an outline of key aspects of the expanded TALF program:

Expansion of TALF-Eligible Collateral

CMBS

Eligible CMBS includes U.S. dollar-denominated, cash (i.e., non-synthetic) CMBS issued on or after January 1, 2009 that are generally diversified (with respect to loan size, geography, property type, and other characteristics), and that otherwise meet the following requirements:

  • Qualifying assets: Eligible CMBS must securitize fully-funded, first-priority, fixed-rate, non interest-only mortgage loans originated on or after July 1, 2008, which are current in payment at the time of securitization, and which, upon default, provide the lender with a pari passu or senior right of repayment of principal and interest. The properties underlying the eligible CMBS must be a fee or leasehold interest in income-generating commercial properties located in the United States or its territories.

  • Underwriting: All mortgage loans must have been underwritten or re-underwritten recently prior to the CMBS issuance, generally on the basis of then-current in-place, stabilized and recurring net operating income and then-current property appraisals.

  • Issuer: Eligible CMBS may not be issued by an agency or instrumentality of the United States (including government-sponsored enterprises).

  • Credit rating: Eligible CMBS must have a credit rating in the highest long-term investment-grade rating category from a required number (yet to be specified) of CMBS-eligible rating agencies (with no CMBS-eligible rating agency rating the CMBS below such level). CMBS that uses third-party guarantees as a credit enhancement to obtain such a rating, or which has a rating on review for possible downgrade, is ineligible.

    FRBNY is currently assessing rating methodologies to be employed in rating TALF-financed CMBS, as well as identifying rating agencies for such eligible collateral, and will provide further guidance in advance of the planned June subscription for TALF-financed CMBS.

  • Payment terms: Eligible CMBS must entitle its holders to both principal and interest payments, bear interest at a pass-through rate tied to the weighted average underlying fixed mortgage rates, and not be junior to other securities secured by the same collateral.

  • Pooling and Servicing: The pooling and servicing agreements governing the issuance of the CMBS and the servicing of its assets must include the following requirements:

    • If the class of the CMBS is one of several time-tranched classes of the same distribution priority, then distributions of principal must be made on a pro rata basis to all such classes once the credit support is reduced to zero as a result of both actual realized losses and “appraisal reduction amounts.”

    • Once actual realized losses and “appraisal reduction amounts” reduce the principal balance of a subordinate class of CMBS to less than 25% of its initial balance, investors in such a subordinate class must not control the servicing of the assets, whether through approval, consultation, or servicer appointment rights.

    • A post-securitization property appraisal may not be recognized for any purpose under pooling and servicing agreements if the appraisal was obtained at the demand or request of any person other than the servicer for the related mortgage loan or the trustee.

    • The mortgage loan seller must represent that, upon the origination of each mortgage loan, the improvements at each related property were in material compliance with applicable law.

  • TALF Loan Maturity: TALF loans supported by CMBS may have a three- or five-year maturity, at the borrower’s election, with loans bearing interest at a fixed annual rate of 100 basis points (“bps”) over either the 3-year Libor swap rate (for loans with three-year maturities) or the 5-year Libor swap rate (for loans with five-year maturities).

  • Collateral haircut: CMBS with an average life of five years or less will have a 15% collateral haircut, currently the steepest haircut for TALF-eligible collateral. The haircut for CMBS increases by one percentage point for each year over five years for CMBS with longer average life. In no case, however, may the CMBS have an average life that exceeds 10 years, as calculated based on the remainder of the original weighted average life as set by its issuer, using industry-standard assumptions.

  • Principal payment: Principal payments on the CMBS must be applied to the principal of the TALF loan in proportion to the TALF advance rate, with interest payments to the TALF-borrower limited to 25% of the collateral haircut amount in years one through three of the CMBS, and limited to 10% and 5% of the collateral haircut amount in years four and five, respectively. Interest distributions on the CMBS in excess of such thresholds will be used to reduce the outstanding principal amount of the TALF loan.

  • Collateral Matters: FRBNY expects to engage a collateral monitor and will have the right, until the issuance of a CMBS, to exclude specific loans from the proposed CMBS pool. FRBNY will also have the right to reject any CMBS based on its risk assessment.

  • FRBNY Information and Consent Rights: The terms and conditions of each CMBS must be such that FRBNY can monitor and evaluate its position as secured lender. The TALF borrower must agree not to exercise or refrain from exercising its voting, consent and waiver rights without FRBNY’s consent.

  • Subscription and Settlement: Whereas the cycle for non-CMBS ABS TALF subscriptions will remain at the beginning of each month while the TALF program is in effect, the subscription and settlement cycle for CMBS will occur in the latter part of the month. Each CMBS must be cleared through the Depository Trust Company.

There are a number of open issues relating to the implementation of CMBS TALF, with respect to which FRBNY has indicated that further guidance is forthcoming:

  • Credit Rating: FRBNY is currently assessing rating methodologies to be employed in rating TALF-financed CMBS, as well as identifying rating agencies for such eligible collateral, and will provide further guidance in advance of the planned June subscription for TALF-financed CMBS.

  • Certifications: FRBNY is still developing the framework for the issuer/sponsor certification and auditor certification that will be required to confirm that the CMBS is TALF eligible.

  • Deferred Funding: FRBNY is considering a process whereby CMBS issuers would reserve TALF funding capacity for to-be-issued CMBS, subject to the TALF availability period and compliance with other TALF requirements. FRBNY indicated that the reservation process would likely include a monthly reservation fee based on the TALF funding amount reserved.

Insurance Premium Finance Loans

Eligible IPFL includes loans used to finance property and casualty insurance premiums, but excludes deferred payment obligations acquired from insurance companies. An issuer of ABS backed by IPFL must acquire ownership in each IPFL in its entirety, and not merely a participation or beneficial interest. ABS backed by IPFL may not have an average life that exceeds five years. To be eligible, ABS issued by a revolving (or master) trust must be issued to refinance existing IPFL that is maturing in 2009 and must be issued in amounts no greater than the amount of the maturing ABS. Eligible IPFL ABS may also be issued out of an existing or newly established master trust in which all or substantially all of the underlying exposures were originated on or after January 1, 2009.

Haircuts for IPFL ABS are as follows:

 

 

ABS Average Life (years)

Sector

Subsector

0-1

>1-2

>2-3

>3-4

>4-5

Premium Finance

Property and casualty

5%

6%

7%

8%

9%

FRBNY expects to provide additional updates regarding TALF-eligible IPFL in advance of the June subscription date.

Extended Maturity of Certain TALF Loans

The Federal Reserve also announced on Friday that it would permit five-year maturities on TALF loans used to finance the acquisition of CMBS, as well as student loan and Small Business Administration-guaranteed ABS, up to an aggregate of $100 billion in such five-year loans. The Federal Reserve indicated that the $100 billion limit would be evaluated in the future. TALF loans with five-year maturities would also be permitted to divert certain interest amounts toward accelerated loan repayment primarily in years four and five.

FRBNY also clarified that it will determine the adjusted average life (“AAL”) of ABS (excluding ABS with Small Business Administration guarantees) using the following formulae (where “OAL” equals the original average life of the ABS as reported in its prospectus):

AAL of bullet maturities:

OAL - [1 x ((upcoming TALF loan closing date - original ABS closing date) / 360)]

AAL of amortizing assets:

OAL - [1/2 x ((upcoming TALF loan closing date - original ABS closing date) / 360)]

Revised TALF Master Loan and Security Agreement

Finally, FRBNY released today a revised Master Loan and Security Agreement (the standard agreement which sets forth the terms that will apply to borrowings under TALF), which clarifies how principal payments on underlying ABS with respect to which the issuer has a redemption option must be applied to repay the TALF loan secured thereby. In cases where the issuer of collateral backing a TALF loan is entitled to redeem the outstanding principal amount thereof at a price less than the par value thereof, 100% of the principal payments resulting from the issuer’s exercise of the redemption option must be applied to repay the principal amount of the TALF loan and any accrued monthly interest deficiency amount. In the case of above-par collateral, the applicable trigger is redemption by the issuer of TALF-financed collateral at a price less than the par value thereof plus the sum of all monthly amortization payments required to be made with respect to the applicable TALF loan for the remaining weighted average life of such collateral, calculated using the relevant TALF prepayment assumption.

FRBNY also made clear that only in rare cases will it consider accepting ABS where the issuer of the collateral has a redemption option, and in any event only in circumstances where FRBNY determines that the issuer’s redemption option does not increase FRBNY’s risk exposure and the collateral otherwise meets TALF eligibility requirements. In addition, TALF borrowers may not pledge ABS with a redemption option (other than pursuant to the servicer’s clean-up call) in connection with a TALF subscription without prior consultation with, and the consent of, FRBNY. FRBNY indicated that further guidance on these issues would be forthcoming.

 

Additional information regarding the Federal Reserve’s updates to the TALF program:

Press Release:
http://www.federalreserve.gov/newsevents/press/monetary/20090501a.htm

TALF CMBS Terms and Conditions:
http://www.newyorkfed.org/markets/talf_cmbs_terms.html

TALF CMBS FAQs:
http://www.newyorkfed.org/markets/talf_cmbs_faq.html

TALF FAQs:
http://www.newyorkfed.org/markets/talf_faq.html

TALF Overview:
http://www.newyorkfed.org/markets/talf.html

Revised Master Loan and Security Agreement:
http://www.newyorkfed.org/markets/mlsa_050409.html


This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Maritza Okata, an O’Melveny partner licensed to practice law in Washington D.C. and New York, Kenneth Yellen, an O’Melveny partner licensed to practice law in Washington D.C. and New York, John Stevens, an O’Melveny associate licensed to practice law in Washington D.C. and Maryland, Sam Brown, an O’Melveny associate licensed to practice law in New York, and Michael Thakur, an O’Melveny associate licensed to practice law in Pennsylvania, contributed to the content of this Client Alert. The views expressed in this Client Alert are the views of the authors except as otherwise noted.