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March 3, 2009

The Consumer and Business Lending Initiative
A Note on Efforts to Address Securitization Markets and Increase Lending
The Obama administration along with the Federal Reserve, the FDIC and the Comptroller
of the Currency announced on February 10 a comprehensive package intended to restore
stability to the financial system. An important goal of this program is to strengthen the
economy by getting credit flowing to families and businesses throughout the country.
The recently released Capital Assistance Program and the Homeowner Affordability and
Stability Plan are important components of this package, and should help improve
lending conditions in the economy. Another key component of the President’s package
directed at increasing lending is the Consumer and Business Lending Initiative. The
Term Asset-Backed Securities Loan Facility, a joint program of the Federal Reserve and
the Treasury, is a program that falls under this initiative, and its goal is to improve credit
market conditions by addressing the securitization markets. Taken together, these actions
are a multi-pronged effort to unlock the credit markets in the U.S. economy.
Importance of Securitization Markets
Over the past two decades, the markets for securities backed by loans and other assets
have grown rapidly, and so-called asset-backed securities (ABS) have become an
important means by which financial institutions fund loans to businesses and households.
Strong investor demand for securities structured for different risk appetites allowed banks
and other financial institutions to sell consumer and business loans in the form of assetbacked securities at relatively low yields. This in turn allowed lenders to increase the
availability of credit and lower the rates at which they extended credit to consumers and
businesses throughout the economy.
Consumer Asset-Backed Securitization Process
To create ABS, a lender sells a pool of loans to a bankruptcy-remote special purpose
vehicle (SPV). The SPV funds the purchase of the underlying loans by selling various
classes of securities with different levels of seniority and risk. These securities sold by
the SPV are secured by the pool of loans in the SPV. By creating separate securities with
different levels of risk, the SPV can appeal to different investors and thereby broaden its
investor base, which in turn lowers the cost of funding for the original lender. That
reduced cost of funds results in lower interest rates for the businesses and households that
receive the underlying loans.
According to Federal Reserve data, over the past few years around a quarter of all nonmortgage consumer credit – including loans used to purchase cars or pay for college

tuition - has been funded through this process. In fact, most non-mortgage related ABS is
backed by consumer credit and is rated AAA by the rating agencies. The primary
consumer-ABS markets include ABS backed by auto loans, credit card receivables and
student loans. Similar ABS structures are used to finance small business lending. In
Table A at the back of this document, a list of consumer and business loans that have
historically been financed in the securitization markets is provided. Many of these asset
classes will be included in the TALF in the coming months, subject to a risk analysis.
Consumer Securitization Markets Have Become Extremely Dislocated
With the onset of severe dislocation in the credit markets, new issuance of consumer
ABS declined precipitously in the third quarter of 2008 before coming to a virtual halt in
October. Issuance of consumer ABS has remained near zero since October, which has
significantly reduced the amount of credit extended to consumers throughout the
economy. At the same time, interest rate spreads on AAA-rated tranches of consumer
ABS have increased to levels well outside the range of historical experience, reflecting
unusually high risk premiums.
The problems in these markets reflect three developments. First, many traditional
investors in AAA-rated tranches of ABS have exited the market. The remaining
traditional investors have suffered substantial mark-to-market losses on their ABS
portfolios, are adversely impacted by the loss of liquidity and value on their portfolios,
and have little appetite to increase their ABS holdings until their existing positions trade
at more normalized levels. Second, nontraditional investors such as hedge funds, which
may otherwise be willing to invest in these securities, have been unable to obtain funding
from banks and dealers because of a general reluctance to lend. Third, investors are
increasingly concerned about the prospect of a deep recession and resulting correlated
defaults on loans to households and businesses.
Continued disruption of the ABS markets could result in a reduction in the availability,
and an increase in the cost, of credit for consumers and businesses. Although some
lenders that relied heavily on securitization for funding might be able to fund new credits
on their balance sheets, many are seeking to ration their capital by not acquiring any new
assets or extending new loans. In the current environment, those lenders that fund new
credits on their balance sheet are only willing to do so at markedly higher interest rates.
The reduction in availability and increase in cost of credit is one of the causes of the
deepening recession. While part of the decline in borrowing and lending in these markets
reflects the general reduction in demand for credit that always accompanies a recession, a
portion reflects the historically intense pressures bearing on participants in these markets.
Restoring more normal functioning to these markets and to other segments of the
financial system is an essential step toward establishing a solid recovery of economic
Rationale for Action: TALF Will Promote New Credit Extension


To address these problems, Treasury and the Federal Reserve launched the Term AssetBacked Securities Loan Facility (TALF). Under the first phase of the TALF, the Federal
Reserve Bank of New York will lend up to $200 billion on a collateralized, non-recourse
basis to holders of eligible ABS. The objective of the program is to stimulate investor
demand for these securities, and thereby to reduce the funding costs of the issuers of the
loans in the eligible classes. Ultimately, the program should bring down the cost and
increase the availability of new credit to consumers and businesses.
Eligible ABS includes newly issued AAA-rated tranches of securitizations backed by
auto loans, credit card loans, private and government-guaranteed student loans, and loans
guaranteed by the Small Business Administration. The allocation of lending between
these asset classes will be determined by investor demand. TALF loans will have a threeyear term, and will be open to a large number of investors who have not traditionally had
access to Federal Reserve liquidity.
The mechanics of the TALF program are as follows. Once a month investors can request
Federal Reserve funding for loans against eligible consumer or small business ABS.
Assuming that the borrower and the ABS it plans to pledge as collateral meet Treasury
and Federal Reserve requirements, the investor will receive funding to purchase the ABS.
Given that the loan is non-recourse, if the borrower does not repay the loan, the Federal
Reserve Bank of New York will enforce its rights in the collateral and sell the collateral
to a SPV established specifically for the purpose of managing such assets. The SPV is
funded, in part, by a $20 billion investment by Treasury under the Troubled Assets Relief
U.S. Government Credit Protection
The Treasury and Federal Reserve have structured the TALF to minimize credit risk for
the U.S. government to the greatest extent possible, consistent with achieving the
program’s purpose of encouraging lending to consumers and small businesses. Several
structural features of the program protect taxpayer dollars.
First, with the exception of ABS that are fully guaranteed by the SBA, TALF eligible
ABS must satisfy several credit rating requirements. Eligible securities must have
received two AAA ratings from the major rating agencies, and none of the major rating
agencies can have rated the security below AAA or placed the security on watch for
downgrade. Moreover, each ABS issuer must hire an external auditor to offer an opinion
that supports management’s assertion that the ABS is TALF eligible.
Another source of credit protection is the requirement that private investors unrelated to
the ABS issuer must supply risk capital in the form of “haircuts.” For example, the
haircut on a two- to three-year private student loan is 10 percent, meaning that in order to
receive a $90 loan, the investor must give the Federal Reserve $100 in collateral. The
haircuts vary across asset types, depending on Treasury and the Federal Reserve’s
assessment of the riskiness of the ABS. Haircuts will be higher for riskier assets, thereby


limiting the risk that the asset will decline in value over the life of the loan by enough to
induce the purchaser to not repay the loan and leave the ABS with the Federal Reserve.
Further protection is provided by the risk premium included in the TALF loan rates. The
interest rate spread will accumulate as a first loss position for the SPV established to hold
ABS surrendered to the facility in lieu of repayment.
Extension of TALF Eligible Collateral Underway
As announced on February 10, work is underway on the expansion of TALF. The
Treasury and the Federal Reserve are analyzing the appropriate terms and conditions for
accepting commercial mortgage-backed securities and are evaluating a number of other
types of AAA-rated newly issued ABS for acceptance under the expanded program,
which could lend up to $1 trillion against eligible ABS. Focus remains on including
securities that will have the greatest macroeconomic impact and that could most
efficiently be added to the TALF at a low and manageable risk to the government. The
Federal Reserve and Treasury currently anticipate that ABS backed by rental,
commercial, and government vehicle fleet leases, and ABS backed by small ticket
equipment, heavy equipment, and agricultural equipment loans and leases will be eligible
for the April funding of the TALF. Other types of securities under consideration include
private-label residential mortgage-backed securities, collateralized loan and debt
obligations, and other ABS not included in the initial rollout. Treasury and the Federal
Reserve expect to announce which additional classes of ABS will be eligible under the
expanded program as soon as the analysis is completed.


Table A – Asset Classes That Have Historically Been Funded in Securitization Markets

Lending Examples

Assets Funded Through
Automobiles, light trucks,
motorcycles and recreational
vehicles (RVs)

Auto Lending

Consumer loans and leases.
Dealership funding programs

Student Loans

Federally guaranteed student
loans (including consolidation
loans) and private student loans

Students and education providers

Small Business Administration

Loans, debentures, or pools
originated under the SBA’s 7(a)
and 504 programs

Small businesses

Credit Cards

Consumer and corporate credit

Vehicle Leases

Rental, commercial and
government fleet leases

Equipment Loans and Leases

Small ticket equipment loans and

Automobiles and other fleets
including forklifts, taxis, and
long-haul trucks
Phone systems, computers and
copiers to small businesses

Heavy equipment loans and

Cranes, excavators, and a range
of other construction equipment

Agricultural equipment loans and

Harvesters, specialty grape
harvesters, and a variety of other
agricultural equipment

Other Floorplan Securtizations

Floorplan loans and dealer
inventory programs

Small equipment showrooms,
heavy equipment showrooms,
certain lots of used car dealers

Residential Property (RMBS)

Non-agency residential
mortgages and loans

Residential property

Commercial Property (CMBS)

Commercial mortgages,
commercial loans

Industrial, office, retail and multifamily residential property