The Federal Reserve gave more specifics on Tuesday about its $100 billion emergency lending facility to keep credit flowing to consumers and businesses during the pandemic, a step that could get the program up and running in mid-June, according to a Fed official.
The crisis-era program, called the Term Asset-Backed Securities Loan Facility, or TALF, was originally created more than a decade ago from the ashes of the U.S. subprime mortgage crisis, initially to keep the credit spigots open at the consumer-lending arms of companies like Ford Motor Co. F, -2.73% and American Express Co. AXP, -2.56%.
Like last time, the Fed isn’t making loans directly to consumers or businesses. But it does expect to finance investors who create funds to sop up their debt — specifically, credit card, auto and student debt, as well as corporate and commercial mortgage debt packed into bond deals, or securitizations, as they’re known on Wall Street.
As of last week, securitizations of consumer debt were down 33% year over year, with the credit-card sector seeing the sharpest decline at 76% for the period, according to BofA Global Research.
“The TALF program is expected to lift new issue volume for ABS, but we expect the market will continue to see new-issue volume that is lower than last year’s levels,” wrote a team of BofA’s analysts led by Chris Flanagan, who noted that bond issuers are seeing improved financing terms since the mid-March selloff, but also that they are grappling with deferring loan payments and other relief efforts for borrowers hit by the pandemic.
To entice investors to buy securitizations, the Fed is offering short-term, non-recourse loans to qualified firms at rates that range from 75 basis points to 150 basis points over risk-free benchmarks, for collateral in nine different segments of the market.
Of note, the new Fed facility will be open to the embattled collateralized loan obligation market, or CLOs, a key driver of the past decade’s lending boom to debt-laden businesses.
Read: Here are the risks to watch in the CLO market, says industry group made famous by ‘The Big Short’
Fitch Ratings warned on Tuesday that North America is set to lead a record amount of global downgrades to corporations and financial institutions this year “owing to the economic crisis caused by the coronavirus pandemic.”
A Fed official said the point of Tuesday’s update on TALF was to give dealers more clarity on what kind of collateral will be allowed into the program, so they can start putting together bond deals, potentially as soon as three to four weeks.
The official also stressed that TALF isn’t focused on producing windfalls for investors who create funds for the program, but rather to provide confidence in U.S. credit markets, namely by keeping credit spreads (and therefore borrowing rates) in check.
See: Distress signals are flashing in U.S. commercial real estate. But will it need a TALF rescue?
To that end, the Fed is allowing only top, AAA-rated slices of bond deals as collateral for the facility, an effort to minimize taxpayer risks.
And for CLOs, it also set out stricter parameters for eligibility, including that qualifying funds must be “static,” or confined to a set pool of loans, rather than the traditional format where managers trade in and out of collateral to maximize returns, or minimize losses.
Investors must maintain an account with a primary dealer to qualify for TALF funding and be organized and operate under U.S. law, among other criteria.
The TALF update comes as the Fed begins to unleash other credit facilities unveiled in March, including a $750 billion program that on Tuesday started buying corporate debt exchange-traded funds for the first time ever.
The move helped boost corporate bond ETFs Tuesday, including the mammoth iShares iBoxx $ Investment Grade Corporate Bond ETF LQD, +0.96%, even as the blue-chip Dow Jones Industrial Average DJIA, -1.88% stock benchmark tumbled to its worst one-day drop since May 1, as investors weighed efforts toward reopening the U.S. economy.
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