Troubled Asset Relief Program: Treasury Needs to Strengthen Its Decision-Making Process on the Term Asset-Backed Securities Loan Facility
Published: 2010-02-05T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Term Asset-Backed Securities Loan Facility (TALF) was created by the Board of Governors of the Federal Reserve System (Federal Reserve) to help meet consumer and small business credit needs by supporting issuance of asset-backed securities (ABS) and commercial mortgage-backed securities (CMBS). This report assesses (1) the risks TALF-eligible assets pose to the Troubled Asset Relief Program (TARP), (2) Department of the Treasury's (Treasury) role in decision making for TALF, and (3) the condition of securitization markets before and after TALF. GAO reviewed program documents, analyzed data from prospectuses and other sources, and interviewed relevant agency officials and TALF participants.
section_title: What GAO Found
paragraphs: TALF contains a number of risk management features that in turn likely reduce the risk of loss to TARP funds, but risks remain. TALF was designed to reopen the securitization markets in an effort to improve access to credit for consumers and businesses. The Federal Reserve Bank of New York (FRBNY), which manages TALF, is authorized to lend up to $200 billion to certain eligible borrowers in return for collateral in the form of securities that are forfeited if the loans are not repaid. To assist in this effort, Treasury has pledged $20 billion of TARP funds in the form of credit protection to the program in the event the loans are not repaid. As of December 2009, FRBNY has made about $61.6 billion in TALF loans, of which $47.5 billion remained outstanding. For most TALF-eligible collateral, FRBNY will stop providing new TALF loans in March 2010, while new-issue CMBSs will be accepted as collateral on new TALF loans through June 2010. Treasury and FRBNY analyses project minimal, if any, use of TARP funds for TALF-related losses, and Treasury currently anticipates a profit. While GAO found that the overall risks TALF poses to TARP funds are likely minimal, GAO analyses showed that CMBSs potentially pose higher risk of loss than ABSs. As shown in figure 1, ongoing uncertainty in the commercial real estate market and TALF exposure to legacy CMBSs warrant ongoing monitoring. Finally, TALF may present risks beyond the potential risks to TARP, such as the risk that FRBNY might fail to identify material noncompliance with program requirements by TALF participants. Because the Federal Reserve views TALF as a monetary policy tool, however, statutory limitations on GAO's authority prohibited GAO from auditing FRBNY's role in administering TALF. Treasury has not fully documented its rationale, as part of its decision-making processes, for reaching final decisions related to the risks of TALF--including decisions involving other agencies. For example, the outcomes of Treasury's internal analysis of the amount of equity that TALF borrowers should hold in TALF ABS collateral, along with other TALF program terms, sometimes differed from FRBNY's. However, there was no clear documentation or explanation of how the discrepancies were resolved or how final decisions were made with FRBNY. Documenting the rationale and basis for these decisions would increase transparency and strengthen internal controls for TALF decision-making processes. Moreover, a sound decision-making process would help ensure that TALF objectives are being met and that it is functioning as intended. Unless Treasury documents the basis for major program decisions that it made with the Federal Reserve, it cannot demonstrate accountability for meeting the goals of TALF and could unnecessarily place TARP funds at risk.

section_title: Letter
paragraphs: The recent financial crisis disrupted the securitization markets—which  have funded an increasing share of consumer credit and small business  loans in recent years—making credit less available to households and  small businesses. This “credit crunch” has been a major factor behind the  weak economy and slow recovery. The Term Asset-Backed Securities  Loan Facility (TALF), which the Board of Governors of the Federal  Reserve System (Federal Reserve) first announced in November 2008, was  created to help restore the securitization markets. The Department of the  Treasury (Treasury) provides credit protection for this program under the  Troubled Asset Relief Program (TARP), as authorized under the  Emergency Economic Stabilization Act of 2008 (EESA). The Federal  Reserve Bank of New York (FRBNY), which manages TALF, is authorized  to lend up to $200 billion in 3- or 5-year nonrecourse loans to investors to  purchase AAA-rated asset-backed securities (ABS) and commercial  mortgage-backed securities (CMBS), which are, in turn, pledged as  collateral for the loans. Nonrecourse loans are provided against collateral,  and if the loans are not repaid, FRBNY’s only recourse is to assume  control of the pledged assets. If borrowers do not repay their TALF loans,  Treasury will fund the purchase of up to $20 billion of the collateral  backing the loans from FRBNY, creating exposure that places TARP funds,  and therefore taxpayers, at risk.
EESA, which authorized TARP, also provided GAO with broad oversight  authorities for actions taken under TARP and requires GAO to report at  least every 60 days on TARP activities and performance. To fulfill our  statutorily mandated responsibilities, we have been monitoring and  providing updates on TARP programs, including TALF, in prior 60-day  reports. This report expands on previously reported TALF activities.
The Federal Reserve created TALF under Section 13(3) of the Federal  Reserve Act, which permits the Federal Reserve to authorize a Federal  Reserve Bank to lend to nondepository institutions in “unusual and  exigent circumstances.” The Federal Reserve viewed creation of TALF as  part of its monetary policy activities because, having already reduced the  federal funds target rate to close to zero, it needed additional mechanisms,  like TALF, to provide liquidity directly to borrowers and investors in key  credit markets. GAO is prohibited by statute from auditing deliberations,  decisions, or actions by the Federal Reserve or any Federal Reserve bank  that are related to monetary policy matters. Accordingly, although the  Federal Reserve and FRBNY voluntarily gave us access to TALF-related  documents and staff, our review of TALF was limited and we did not  evaluate the actions of the Federal Reserve with respect to TALF. For  example, we did not assess FRBNY’s system of internal controls or the  role of TALF participants—such as agents, borrowers, or auditors—in  certifying and validating compliance with the program’s terms. We also  conducted only limited verification of factual information provided by  Federal Reserve officials, which we used for background description  purposes and to assess Treasury’s involvement in TALF.
The objectives of this report are to (1) analyze the risks that TALF  presents to TARP funds and therefore to taxpayers, (2) evaluate how  Treasury analyzed the risk of TALF assets and used this information in  making decisions on TALF with the Federal Reserve and FRBNY, and   (3) assess changes in securitization and credit market conditions before  and after TALF’s implementation, based on indicators tracked by Treasury  and FRBNY.
To meet the report objectives, we analyzed data from TALF prospectuses  and data providers to understand securitization volumes, prices, and  spreads. We also reviewed program operation and design documents,  including documentation regarding the selection of eligible asset classes,  the amount of equity a TALF borrower is required to hold in a security,  and requirements for borrowers and collateral. In addition, we analyzed  agreements between the relevant agencies on TALF. We interviewed  officials from the federal agencies responsible for the program, along with  policy analysts, economists, and attorneys. We also interviewed current  and potential TALF program participants, including investors,  underwriters, issuers, and sponsors. For additional information on the  scope and methodology for this engagement, see appendix I.
We conducted this performance audit from May 2009 to January 2010 in  accordance with generally accepted government auditing standards. Those  standards require that we plan and perform the audit to obtain sufficient,  appropriate evidence to provide a reasonable basis for our findings and  conclusions based on our audit objectives. We believe that the evidence  obtained provides a reasonable basis for our findings and conclusions  based on our audit objectives.
subsections: section_title: Background
paragraphs: Securitization is a process by which similar debt instruments—such as  loans, leases, or receivables—are aggregated into pools, and interest- bearing securities backed by such pools are then sold to investors. These  ABSs provide a source of liquidity for consumers and small businesses  because financial institutions can take assets that they would otherwise  hold on their balance sheets, sell them as securities, and use the proceeds  to originate new loans, among other purposes. During the recent financial  crisis, the value of many ABSs dropped precipitously, bringing the  securitization markets to a virtual halt. As a result, households and small  businesses found themselves unable to access the credit that they needed  to, among other things, buy homes and expand inventories.
TALF was designed to reopen the securitization markets in an effort to  improve access to credit for consumers and businesses. The program  provides loans to certain institutions and business entities in return for  collateral in the form of securities that are forfeited if the loans are not  repaid. To assist in this effort, Treasury provides credit protection for the  program as part of TARP’s Financial Stability Plan under the Consumer  and Business Lending Initiative (CBLI). Treasury has pledged $20 billion  for TALF LLC—a special purpose vehicle created by FRBNY—to purchase  the underlying collateral associated with TALF loans in the event the loans  are not repaid. Because of Treasury’s role in protecting these taxpayer  funds committed through TARP, Treasury has consulted with the Federal  Reserve on TALF’s design. Under TALF, FRBNY is currently authorized to  extend up to $200 billion in nonrecourse loans to eligible borrowers  pledging eligible collateral. TALF is authorized to extend new loans  against nonmortgage-backed ABSs and legacy CMBS collateral until March  31, 2010, and against newly issued CMBS collateral until June 30, 2010. As  of December 2009, FRBNY has made about $61.6 billion in loans under  TALF. Of that amount, $47.5 billion in TALF loans remained outstanding as  of the end of December 2009. The amount of loans outstanding may be less  than the amount of loans extended due to loan prepayments by the TALF  borrower or paydown of principal.
TALF accounts for a small proportion of TARP funds (see fig. 1). As of  December 31, 2009—of the $20 billion committed—Treasury had loaned  TALF LLC $100 million: $16 million for administrative expenses and $84  million for potential asset purchases. This amount is less than 1 percent of  the $25.3 billion apportioned to the CBLI program, which itself represents  5 percent of apportioned TARP funds. TALF will receive TARP funds  beyond the $100 million already loaned if additional funding is required by  TALF LLC to purchase surrendered or seized collateral resulting from  unpaid TALF loans.
FRBNY created TALF LLC, a special purpose vehicle, to purchase and  manage any assets that TALF borrowers surrender or the FRBNY seizes.   TALF LLC also holds any excess accumulated interest from TALF loans  and the $100 million funded portion of the Treasury loan for administrative  expenses and collateral purchases, plus interest earned from permitted  investments.
A portion of the interest earned by FRBNY on all TALF loans—called the  “excess interest”—is paid to TALF LLC as a fee for TALF LLC’s  commitment to purchase the assets received by FRBNY in conjunction  with a TALF loan. As of December 31, 2009, TALF LLC had accumulated  approximately $198 million in excess interest, with roughly $30 million  added each month (according to FRBNY officials), based on the current  loan portfolio.
If accumulated fees and interest earned on TALF LLC’s investments are  insufficient to cover any asset purchases, Treasury will provide additional  TARP funds to TALF LLC to finance up to $20 billion of asset purchases.  Subsequently, TALF LLC will finance any additional purchases by  borrowing funds from FRBNY. The TARP loan is subordinate to the  FRBNY loan, thus the TARP funds provide credit protection to FRBNY.
subsections: section_title: Asset Classes Eligible for Use as TALF Collateral
paragraphs: When TALF was first announced, the Federal Reserve made a number of  asset classes eligible for use as collateral in consultation with Treasury,  adding more as the program evolved (see table 1). Initially, securities  backed by automobile, credit card, and student loans, as well as loans  guaranteed by the Small Business Administration (SBA), were deemed  eligible because of the need to make credit in these sectors more widely  available. For most TALF-eligible collateral, FRBNY will stop providing  new TALF loans in March 31, 2010, while new-issue CMBSs will be  accepted as collateral on new TALF loans through June 30, 2010.
All TALF-eligible ABSs must be denominated in U.S. dollars, must be rated  AAA by at least two TALF-eligible nationally recognized statistical rating  organizations (NRSRO), must not have a credit rating below the highest  investment-grade rating category from a TALF-eligible NRSRO, and must  not be on review for a potential rating downgrade. In general, borrowers  must be U.S.-based businesses, investment funds, or U.S.-insured  depository institutions, although foreign banks with U.S. branches that  maintain reserves with a Federal Reserve bank are also eligible. However,  all or substantially all of the eligible collateral’s underlying credit  exposures must be  for newly issued ABSs—originated by U.S.-organized entities or  institutions, or U.S. branches or agencies of foreign banks—and for all ABSs—made to U.S.-domiciled obligors or located in the U.S. or one  of its territories, in the case of real property.
Interest rates for TALF loans are either fixed or floating and vary  according to the collateral securing the loan, as has been determined by  FRBNY.
In order to constitute eligible collateral for a TALF loan, both the issuers  and sponsors of the proposed collateral must provide certification  documents stating that, among other things,  they have reviewed TALF’s terms and conditions; the collateral is TALF-eligible;   an independent accounting firm was provided consent, in certain cases, to  contact the TALF compliance fraud hotline if it suspects fraud or illegal  acts; and   purchasers of the securities that are affiliated with the originators, issuers,  or sponsors cannot use these securities as TALF collateral.
In addition, external auditors review certain representations made by  issuers and sponsors about the TALF eligibility of the collateral. If any of  these representations change, the issuer and sponsor must provide public  notice. If any of the certifications are found to be incorrect, TALF LLC and  FRBNY can recover damages and the issuer and sponsor will be subject to  review by Treasury, the Special Inspector General for TARP (SIGTARP),  and GAO.
section_title: How TALF Works
paragraphs: A number of entities help administer the TALF program.
TALF agents, which are primary dealers or designated broker-dealers that  operate under FRBNY’s Master Loan and Security Agreement. The agents’  responsibilities include conducting due diligence on TALF borrowers and  making representations to FRBNY regarding eligibility of TALF borrowers  and their collateral, submitting TALF loan requests and supporting  documentation to FRBNY and the TALF custodian on behalf of borrowers,  delivering administrative fees and collateral from TALF borrowers to  FRBNY, and distributing the TALF borrower’s share of principal and  interest payments paid on the collateral backing the TALF loan.
The Bank of New York Mellon, which serves as custodian of the program  and is responsible for administering TALF loans, holding and reviewing  collateral, collecting payments and administrative fees, disbursing cash  flows, maintaining the program’s books and records, and assisting other  TALF entities with the pricing of collateral.
Collateral monitors—Trepp LLC and Pacific Investment Management  Company LLC (PIMCO)—which check the pricing and ratings of  securities; provide valuation, modeling, reporting, and analytical support;  and advise on related matters.
CW Capital, which provides underwriting advisory services related to  certain commercial mortgage loans backing newly issued CMBSs.
FRBNY announces monthly subscription periods, during which potential  borrowers apply for loans and funds are disbursed. FRBNY has a  precertification process to streamline the process for certain eligible  borrowers. TALF precertification documents indicate that borrowers must  be deemed to be top-tier financial entities—that is, they must be seen as  industry leaders and be ranked among the largest entities in the industry  or have some of the largest operations. During our audit, FRBNY officials  told us that they review loan requests from all borrowers that meet general  eligibility criteria, and that not all borrowers need to be precertified;  indeed, most are not precertified. Applicants must work through a TALF  agent throughout the application process. Because the agents must  demonstrate that they know a potential borrower and must vouch for its  reputation, they put applicants through a “Know Your Customer” program  based on provisions in the Patriot Act. Once this process is completed,  TALF agents submit a loan request package to FRBNY that includes:    borrower identification information, such as name, address, and tax  loan information, such as the requested loan amount ($10 million  minimum), the term of the loan, the loan rate, and the type of interest rate  (fixed or floating) that corresponds to the type of collateral offered;   collateral information, such as the CUSIPs of the securities, asset class  and subclass, price and face value of the collateral, the weighted average  life of the collateral, and the haircut amount—a percentage assigned to  the loan based on the asset class, or subsector where appropriate, of the  collateral and its weighted average life;   any appropriate filing documents, including a prospectus and offering  documents of the securities expected to be pledged; and   proof of purchase for the ABSs and CMBSs that are being offered as  collateral.
Next, the Bank of New York Mellon and FRBNY verify the data that the  TALF agents provide and, among other things, ensure that the ratings  submitted for the securities are the most recent. For legacy CMBS  collateral, FRBNY evaluates whether the price the TALF borrower paid  was reasonable based on pricing information FRBNY receives from the  collateral monitors and Bank of New York Mellon. The collateral  monitors, Trepp LLC and PIMCO, also conduct stress tests on pledged  legacy CMBS collateral to help ensure that the loan amounts will not  exceed the stressed value of the pledged securities. Three weeks prior to  each ABS subscription, a newly issued ABS undergoes a risk assessment  by FRBNY (with PIMCO’s support) to determine if it is likely to be  accepted as TALF collateral. The issuer must provide FRBNY any  information it provided the NRSROs so FRBNY can conduct its own credit  risk assessment. The issuer must also consent to permitting NRSROs to  discuss all aspects of the rating with FRBNY, including credit quality of the  ABS, modeling, and methodology, among other things.
On each TALF loan’s settlement date, the borrower must deliver the loan  collateral and administrative fees to FRBNY’s custodian, the Bank of New  York Mellon, which holds the collateral for the life of the loan. The  administrative fees vary by asset class and cover FRBNY’s administrative  costs for the facility.
subsections: section_title: Determining the Loan Amount
paragraphs: If FRBNY deems the collateral eligible, it will lend an amount calculated  by subtracting a designated haircut percentage from the lesser of either  par or market value of the pledged collateral (or, in the case of legacy  CMBSs, a value based on an internal risk assessment). This percentage, or  “haircut,” in effect sets the amount of equity the TALF borrower holds in  the collateral. Haircuts vary by FRBNY’s assessment of market risks for  each sector and subsector. The haircut represents the difference between  the value of the proposed collateral and the value of the loan (table 2).
As discussed earlier, the Bank of New York Mellon holds the collateral  throughout the life of the loan. As the collateral securities generate cash  flows, the Bank of New York Mellon makes all principal and interest  payments to FRBNY on behalf of the TALF borrower. The borrower may  earn returns from the collateral after all loan obligations have been  satisfied. As shown in figure 2, any returns that the collateral assets earn  beyond the required principal and interest payments is delivered to the  borrower via the TALF agent after all monthly loan payment obligations  are met. FRBNY retains a portion of the interest that is calculated using  Overnight Indexed Swap (OIS) rates plus 25 basis points (approximately  the FRBNY’s cost of funds). The remaining part of the TALF loan interest  payment is transferred to TALF LLC, which would use the funds to  purchase surrendered collateral before accessing funds from Treasury.  This accumulated interest from TALF loans is held in an account called  the cash collateral account, and the Bank of New York Mellon is  authorized to invest these funds on behalf of TALF LLC to earn interest  income.
TALF offers nonrecourse loans, which allow borrowers to walk away—or  stop paying a loan—with no personal exposure for the unpaid portion of  the debt. In this case, borrowers would surrender their collateral through  a TALF agent, which would submit a collateral surrender form to FRBNY.  Within 10 days of receiving the surrender notice, the Bank of New York  Mellon cancels the outstanding balance of the loan and transfers the  related collateral to FRBNY. FRBNY has the option to sell the collateral to  TALF LLC (see fig. 3) at a price equal to the then outstanding principal  amount of the TALF loan plus accrued but unpaid interest. This process  has several steps:    FRBNY sends a purchase notice to TALF LLC. To purchase surrendered  assets, TALF LLC first uses funds that have been accumulating in the cash  collateral account (as of December 31, 2009, the account contained  approximately $198 million).
When these funds are exhausted, TALF LLC borrows money to purchase  any surrendered assets. Its first source of borrowed funds is Treasury,  which has committed up to $20 billion in TARP funds to the TALF program  for this purpose. To obtain these funds, TALF LLC must submit a request  to Treasury (as the subordinate lender) one business day prior to the  desired funding date. Treasury’s loan rate is equal to the 1-month London  Interbank Offered Rate (LIBOR) rate plus 300 basis points.
If the $20 billion TARP loan commitment is fully exhausted, TALF LLC  must ask FRBNY for a loan to purchase any additional surrendered assets.  FRBNY has committed to provide up to $180 billion to TALF LLC for this  purpose. TALF LLC must submit a borrowing request to FRBNY (as senior  lender) one business day prior to the desired funding date. The FRBNY’s   loan rate is equal to the 1-month LIBOR rate plus 100 basis points. The  principal on FRBNY’s loan would be repaid before the principal of the $20  billion TARP loan.
Alternatively, if a TALF borrower stops payment on a loan and does not  submit a collateral surrender form, under certain circumstances FRBNY  has rights to seize the collateral.
Management of TALF LLC  With the Federal Reserve’s and Treasury’s agreement, TALF LLC may  dispose of assets it has acquired. Agency officials told us that there were  no formal guidelines on when to sell any acquired assets and that the  decision to sell would be made on a case-by-case basis as is necessary  given the differences in types of assets that could be acquired by TALF  LLC. However, they added that factors such as market rates and the nature  of the underlying collateral would likely play a role in any decision to hold  or sell assets purchased by TALF LLC. According to Treasury officials,  because the Federal Reserve’s monetary policy considerations may not  align with Treasury’s investment interests in the TALF program, Treasury  plans to obtain independent advice on the disposition of investments.
TALF LLC has certain sources of cash inflows, such as the excess interest  from TALF loans, interest paid from permitted investments, principal and  interest paid on ABS holdings, and proceeds from possible asset sales of  ABS holdings. These inflows are distributed according to the order defined  in an agreement among Treasury, FRBNY, the Bank of New York Mellon,  and TALF LLC. The payment order is as follows:    Pay TALF LLC expenses.
Fund expense reimbursement account up to $15 million.
Repay outstanding principal on any FRBNY senior loans to TALF LLC.
Fund the cash collateral account up to the senior loan commitment  (currently $180 billion).
Repay outstanding principal on any Treasury loans.
Repay FRBNY loan interest.
Repay Treasury loan interest.
Repay any other secured obligations that may arise that have not been  specified yet by the agencies.
Pay Treasury and FRBNY (90 percent and 10 percent, respectively) any  residual amounts but only after the above requirements are satisfied.
As of December 2009, cash inflows have been used to pay TALF LLC  expenses and fund the expense reimbursement and cash collateral  accounts.
section_title: TALF Includes Features That Mitigate Potential Losses, but CMBSs Could Pose Greater Risks Than Other Asset Classes
paragraphs: Under some scenarios, TALF borrowers may have economic incentives to  stop payment on their loans and surrender collateral. Treasury and FRBNY  assessments, along with our analyses, however, suggest that a number of  factors reduce the likelihood of this occurring. First, certain TALF features  are designed to protect TARP funds and also limit taxpayer exposure.  Specifically, FRBNY officials told us that risks in TALF are managed based  on four pillars: credit protection, credit ratings, FRBNY due diligence, and  market discipline. FRBNY also sought market perspectives on the level of  returns from TALF-eligible securities that would be required to encourage  market participation while also ensuring proper due diligence by TALF  participants, which in turn reduces the risks to taxpayers. Second, most  ABSs issued since the credit crisis began contain features such as  increased levels of subordination and overcollateralization that reduce the  likelihood that TALF borrowers will stop payment on their loans. Third,  Treasury and FRBNY analyses project minimal, if any, likelihood that  TARP funds will be used for TALF-related purchases, and Treasury  currently projects a profit from TALF. While TALF poses minimal risks to  TARP even in adverse market conditions, our analyses showed that  CMBSs held as collateral as of September 2009 potentially pose higher  risks than ABSs and under adverse conditions losses could exceed $500  million. TALF presents a range of other taxpayer risks beyond those  presented to TARP funds. Such risks include the risk that FRBNY might  not identify instances of material noncompliance with program  requirements by TALF participants. However, because of statutory audit  limitations on GAO, this review has been limited to presenting only  descriptive information about FRBNY’s role in TALF and we cannot  evaluate FRBNY’s TALF operations.
subsections: section_title: Some Scenarios Could Provide TALF Borrowers with Economic Incentives to Stop Payment on Their Loans
paragraphs: As of January 8, 2010, there have been no collateral surrenders by any  TALF borrowers, but in some instances, a TALF borrower could have an  economic incentive to stop payment on a loan and surrender the  underlying collateral. A number of scenarios could result in a borrower  walking away from a loan. For example, the collateral could lose value so  that the loan amount exceeded the value of the collateral. Or, the expected  returns from the collateral could be less than the cost of financing the  loan. Also, interest rates could rise across the board, decreasing the  market value of the collateral or making refinancing more difficult.
A borrower can lose equity in the collateral if the collateral’s value falls  below the outstanding loan balance. As discussed earlier, TALF’s  established haircuts determine the amount of equity borrowers have in  their collateral. This equity represents the amount of money that a TALF  borrower would lose by surrendering the collateral and not repaying the  loan. For example, if the ABSs a borrower seeks to use as collateral on a  TALF loan were initially valued at $100,000, a haircut of 10 percent would  provide the TALF borrower with a $90,000 loan and require $10,000 of its  own funds to acquire the securities. This $10,000 represents the borrower’s  equity in the securities. If the value of the collateral were to decline—such  that the borrower could sell the securities only for some amount less than  $90,000—and especially if it declined dramatically, the borrower could  decide to cut further losses by stopping payments on the loan and  surrendering the collateral. The borrower is particularly likely to make this  choice if such a situation occurs at the point when the loan matures.
As TALF currently works, TALF borrowers earn the difference between  the ABS’s return and the cost of borrowing from FRBNY on the TALF loan,  multiplied by the inverse of the borrower’s percent equity stake. However,  if the returns on TALF collateral are less than initially anticipated, the  TALF loan costs could exceed them, providing another incentive to stop  making payments. This situation would be most likely to develop if the  underlying loans in the securities defaulted or otherwise failed to meet the  terms of the original loan agreement. In this situation, if the returns were  less than the total cost of the TALF loan—the interest and principal due— a borrower might stop payment on the loan or surrender the collateral to  FRBNY.
Investors might also choose to surrender collateral at the maturity of their  TALF loan if overall interest rates on credit increased significantly above  levels available at the time the underlying securities were issued. A large  increase in interest rates would lower the market value of the securities,  especially for those with a fixed interest rate, because future cash flows  would be worth less. In this scenario, a borrower could wind up owing  more to FRBNY at maturity than the securities were worth. The borrower  would need to raise funds at higher interest rates to pay back the TALF  loan, but the collateral would be worth less than the new loan, potentially  making it difficult to find a lender. This situation would provide an  economic incentive for the borrower to surrender the collateral and walk  away from the loan. Nevertheless, many of the longer-term securities  pledged as collateral for TALF loans have floating interest rates. Generally,  floating rate securities do not decline in value when interest rates increase  because the interest rates on the securities also increase.
TALF borrowers will not necessarily stop payment on a loan even with  one or more of these economic incentives. For example, a market  participant and a Treasury official told us that TALF borrowers wanted to  avoid “reputation risk” by not walking away from their loans—even if it  might be in their financial interest to do so. By continuing to pay on their  loans, even at some loss, borrowers could protect their reputations. Other  market participants we spoke with, however, did not mention concerns  about reputation, though they thought it was unlikely that TALF borrowers  would stop payment on their loans.
Moreover, FRBNY and Treasury officials believe that the most important  disincentive for borrowers to stop payment on a TALF loan and surrender  collateral is maintaining a positive return based on the difference between  the cost of the TALF loan and the return of the underlying ABS collateral.  Even if the value of the collateral declines and removes the borrower’s  equity, these officials stated that borrowers were not likely to walk away  from the loan if they were still receiving positive cash flow from the asset.  While this assumption may be reasonable, it is conceivable that investors  subject to mark-to-market accounting might choose to walk away from an  ABS that was still paying the required scheduled interest and principal  payments but had lost sufficient market value. Investors would be most  likely to walk away if they owed significantly more on the loan than the  current value of the asset so that walking away from the asset would have  positive implications for the borrower’s reported profitability. As of  January 8, 2010, no TALF borrowers had surrendered collateral to FRBNY.  Nevertheless, because the behavior of individual borrowers is difficult to  predict, it remains unclear whether and why borrowers might stop  payment on TALF loans based on their own investment strategies and  other objectives.
section_title: TALF Has Several Features That Likely Protect Taxpayers
paragraphs: Certain TALF features help protect TALF funds and also taxpayer  exposures through TARP. We discussed these protections with FRBNY  officials but did not evaluate FRBNY compliance with them because of the  limitation of our statutory audit authority. FRBNY officials told us that  risks in TALF are managed based on four pillars: credit protection, credit  ratings, FRBNY due diligence, and market discipline.
Credit protection is provided primarily by the borrower’s equity in the  security (set by the haircuts) and a portion of the interest rate on TALF  loans that provides accumulated excess interest in TALF LLC. FRBNY  officials said that haircuts were designed to approximate multiples of  stressed historical impairment rates for ABSs. The size of the haircut is  important, because if it is set too low, the borrower will have less equity in  the collateral and, in the circumstances that we have discussed, could  have an incentive to walk away. The excess interest from TALF loans  accumulated in TALF LLC also protects taxpayers, because this money  would be used before TARP funds to purchase collateral surrendered from  unpaid loans. FRBNY officials said that such features were designed to  ensure that the haircuts and excess interest would result in no credit  losses for Treasury or the Federal Reserve.
The Federal Reserve requires that TALF collateral be rated AAA or its  equivalent by two of the nationally recognized statistical rating  organizations that it deems eligible to provide credit ratings for TALF,  among other requirements for credit ratings. Collateral that is offered  that has a lower rating is not eligible for TALF. The rating requirement  helps ensure that the securities TALF accepts as collateral present  minimal credit risks.
FRBNY due diligence serves as another pillar of taxpayer protection. As  discussed earlier, FRBNY, with the support of its collateral monitors,  reviews the credit risks related to individual assets FRBNY might consider  accepting as TALF collateral. In addition, for legacy CMBSs, FRBNY  reserves the right to reject any collateral and has not disclosed its  selection criteria to reduce the likelihood that only the poorest-performing  collateral is put forward for TALF loans.
The final pillar, market discipline, includes the TALF borrowers’ due  diligence conducted on the risks related to the underlying collateral, given  their equity in the collateral, as set by the haircut. Such discipline includes  reviewing the prospectuses and understanding how the structure of the  underlying securities impacts its overall risks. Investors purchasing ABSs  would generally review the terms of the security, the anticipated risks, and  the likely return. In addition, TALF borrowers help to facilitate price  discovery.
These design features are intended to help ensure that TALF borrowers  hold equity in the underlying TALF collateral, that such collateral is highly  rated, and that TALF borrowers carry out the same due diligence on TALF  collateral that they would conduct on any other security.
section_title: Rates of Return for TALF Borrowers on TALF Collateral Have Declined for Most TALF Collateral from Their Highs Earlier in 2009
paragraphs: As noted earlier, TALF borrowers earn the difference between the ABS’s  coupon rate of return and the cost of borrowing from FRBNY on the TALF  loan. According to FRBNY officials, they, along with officials from the  Federal Reserve and Treasury, were aware of the importance of striking a  balance between achieving returns on equity that would encourage  program participation in the stressed market conditions when TALF was  announced, while also ensuring that investors had incentives for due  diligence and that the program would be less attractive during times of  less market stress. If borrowers saw an opportunity to earn excessive  returns due to a poorly designed program, borrowers might not conduct  appropriate due diligence on the underlying securities, which could put  taxpayers at risk. Moreover, because the loans are nonrecourse much of  the borrowers’ risk is shifted to FRBNY and Treasury, while most of the  earnings potential remains with borrowers. FRBNY gathered information  on the rates of return that would entice potential TALF participants by  surveying market participants about expected returns for TALF-eligible  asset classes.
To understand the changes in returns on equity over time and the  reasonableness of those returns from the perspective of helping to ensure  that taxpayers were not subsidizing high returns, we analyzed fluctuations  in returns on TALF eligible collateral from March 2009 through September  2009. As seen in figure 4, returns generally decreased for select classes of  TALF-eligible collateral between the first TALF operation in March 2009  and September 2009, with limited exceptions.
Most asset classes demonstrated a significant decline in returns, from a  peak of 43 percent among the first student loan ABS accepted under TALF  to lows of -5 percent for 1-year prime auto tranches and 2-year auto  leases, suggesting that if investors had used TALF to finance the purchase  of these auto-related TALF eligible securities they would have locked in  losses. However, in a sign that health may be returning to the ABS  markets, no TALF borrowings were needed to finance the purchase of  these negative return securities as the issuances were fully funded by non- TALF investors. The most dramatic decreases in returns have been in the  auto loan tranches with longer-term maturities and private student loan  ABSs. The average expected return for TALF borrowers that used prime  auto loan ABSs as TALF loan collateral declined by nearly a fifth after  March 2009. All of the TALF-eligible private student loan ABS transactions  that were completed between May 2009 and August 2009 had a unique  option feature that significantly lessened investor’s expected returns on  equity. Additionally, the September 2009 increase in return for subprime  credit cards was primarily due to the unique structure of an issuance by a  large subprime issuer.
The trend of decreasing returns on equity in the overall market for most  asset classes indicates that the returns required to attract investors have  decreased since TALF’s implementation, as ABS investors perceive the  assets to be less risky. In addition, the trend demonstrates that taxpayer  subsidies to TALF borrowers have not, over the course of the program,  provided what might be considered excessive returns. Although returns  were high in the beginning, they diminished once the ABS markets started  to revive and overall perceived risk began to decrease. Moreover, the trend  toward negative TALF returns on equity have coincided with a drop in  TALF participation by TALF borrowers in those asset classes as the rate  on the securities’ bonds falls below the loan rate charged by the FRBNY.  This occurrence is consistent with FRBNY’s intention for TALF financing  to become less attractive as the ABS market improves and can be viewed  as indicating normalization in the market, since investors can purchase  such ABSs without TALF funding.
section_title: New Securitizations Have Generally Been Structured with More Credit Protections since the Credit Crisis Began
paragraphs: Certain elements of the securities themselves also reduce the risk of loss  to TALF and the taxpayer. Among these features are credit enhancements,  which have increased since the credit crisis began in the second half of  2008. Credit enhancements are features in the structure of a securitization  that protect investors from losses due to defaults on the underlying loans  in the securities. Two main forms of credit enhancement include  subordination, which helps ensure that more highly rated tranches in a  security receive priority of payment, and overcollateralization, which  ensures that funds are available if a borrower stops paying or other credit  problems develop with the underlying loans. For additional details on the  various types of credit enhancement, see appendix V.
Credit enhancements offer several benefits. First, they provide a cushion  against losses, making it less likely that TALF borrowers will decide not to  repay their loans and surrender the collateral because of credit  performance problems in the ABS or CMBS markets. Second, credit  enhancements reduce the probability that TALF LLC will suffer principal  losses on surrendered ABSs and CMBSs from unpaid loans. For this  reason, credit enhancements also provide TALF LLC with an incentive to  decide to hold surrendered collateral to maturity. This reduces potential  losses to TARP funds, which would finance TALF LLC’s purchase of such  ABS and CMBS.
We reviewed the credit enhancements on every TALF-eligible ABS issued  between the program’s initiation in March 2009 and September 2009 and  compared them with credit enhancements on ABSs by the same issuer  between 2006 and 2008 to identify any changes. As shown in figure 5, the  level of enhancement for every TALF-eligible asset class increased.
In particular, credit enhancements on ABSs backed by private student  loans, nonauto floor plans, auto leases, and motorcycle loans at least  doubled after the credit crisis. In other words, from the perspective of  protecting TARP funds, taxpayers would receive more than double the  amount of credit protection for these particular asset classes compared  with these issuers’ ABSs before the financial crisis. This increase was a  combination of market demands and credit rating agencies’ more stringent  requirements for achieving AAA ratings on many ABSs. TALF agents and a  TALF issuer confirmed that credit enhancements had increased since the  onset of the financial crisis, even for non-TALF issuances, and noted that  requirements from the credit rating agencies had contributed to the  increases.
section_title: TALF Poses Minimal Risks to TARP Even in Adverse Market Conditions; CMBS Risks are Potentially Higher
paragraphs: While TARP funds designated for TALF are exposed to potential loss if  TALF LLC uses them to purchase ABSs or CMBSs used as collateral for  unpaid TALF loans, Treasury and FRBNY analyses suggest that the risks of  loss are minimal. According to the Federal Reserve’s analysis, the  accumulated excess interest from TALF loans will likely cover any ABS or  CMBS purchases for TALF LLC, and Treasury will not need to provide any  TARP funds for such purchases. Accordingly, the total expenditures from  TARP funds would include only the $100 million placed in TALF LLC,  which is in the form of a loan that would be repaid. According to the terms  of the agreement between FRBNY and Treasury, Treasury will receive 90  percent of the monies accumulated in TALF LLC when the program  expires. In particular, if TALF LLC has not purchased any collateral, the  excess interest that has accumulated—along with interest income from  investing such money—will go mainly to Treasury; therefore, Treasury  could potentially gain from its commitment to TALF if losses were  minimal.
subsections: section_title: Treasury Currently Expects to Earn a Profit on TALF
paragraphs: Treasury hired a contractor to provide an estimate of potential losses to  TARP funds from TALF. According to one analysis conducted by the  contractor, any losses to TARP are likely to be far below the $20 billion  that has been set aside for TALF and in fact are unlikely to exceed about  $190 million. Any assets purchased by TALF LLC would first be paid for  with the excess interest and related interest income that had accumulated  in TALF LLC, which totaled almost $200 million at the end of December  2009. According to the contractor, the analysis of potential loss of TARP  funds did not include this excess interest, so the total estimated losses  could be largely offset by accumulated interest. In fact, the contractor and  Treasury officials said that a subsequent analysis that included projections  for the accumulation of excess interest—and is updated on a quarterly  basis—currently projects more than $1 billion in profit related to  Treasury’s TALF exposure.
To assess the reasonableness of Treasury’s position that TALF may  actually earn money rather than expose the taxpayer to any losses, we  reviewed the Treasury contractor’s model—which is central to estimating  losses for the various asset classes accepted in TALF. We found this model  appeared to incorporate generally reasonable loss assumptions for the  three asset classes that we reviewed and that comprise the largest portion  of the TALF portfolio: credit cards, auto loans, and student loans. That is,  many of the loss estimates were fairly conservative when compared to  recent historical results for these specific assets. For each asset class, the  contractor estimated expected loss percentages based on its own research  and analysis, which was used to generate total-loss estimates. The model  calculates total losses for each TALF borrower on each asset held in the  TALF portfolio. The portfolio includes current TALF collateral and  projections for future TALF collateral that borrowers will use for TALF  loans, based on information the contractor received from Treasury.  Potential Treasury losses from these various scenarios were calculated by  taking the total loss for the TALF borrower and subtracting the equity that  the TALF borrower holds in ABSs. Any difference is considered a loss,  first to TALF LLC and potentially to Treasury (through TARP funds) if  loans extended to TALF LLC for its purchase of TALF collateral are not  repaid. While some of the scenarios generated by the model estimated  losses from asset classes that did not have government guarantees, none  of the possible scenarios estimated losses to Treasury from CMBSs.
section_title: Uncertainty in the Commercial Real Estate Market Could Create the Potential for Losses if Conditions Deteriorate
paragraphs: While Treasury has determined that CMBS-related losses are unlikely for a  number of reasons, our analysis shows that if the commercial real estate  markets were to be affected similarly to real estate markets in 2008, the  potential for loss exists under a worst-case scenario. Treasury and its  contractor said that CMBS losses were unlikely for a number of reasons  ranging from the relatively large haircuts (at least 15 percent) required on  CMBS loans to the level of credit enhancement associated with CMBSs  accepted for TALF. However, due in part to the recently weak economy,  commercial real estate continues to undergo price deterioration that  potentially poses risks to the TALF legacy CMBS portfolio and could lead  to increased delinquencies and defaults on commercial real estate  mortgages. For example, the potential risks that CMBSs pose to TALF, and  thus to TARP, are underscored by the fact that 63 percent of TALF’s CMBS  portfolio was underwritten in 2006 and 2007, when underwriting standards  were at their worst. Moreover, as figure 6 shows, commercial real estate  prices have been falling since early 2008, following the deterioration in the  overall U.S. economy, and shortly thereafter CMBS delinquencies began to  rise sharply. The Federal Reserve and Treasury have continued to note  their ongoing concerns about this segment of the market.
In addition, prices on CMBSs experienced volatility between May 2008 and  November 2009. Even the highest credit quality AAA legacy CMBSs that  were used as collateral for TALF loans during the third quarter of 2009 had  dropped by one third, on average, between May and November 2008  during the most severe period of the credit crisis. While prices have  recovered since the expansion of TALF to include CMBSs in the second  quarter of 2009, market observers project that the sector will continue to  perform poorly into 2010.
In light of the ongoing distress in the commercial real estate market, we  analyzed the prices and values of 99 percent of the CMBS collateral  backing loans made by FRBNY during the third quarter of 2009. We  compared the prices at the time the loans were made with the lowest  prices in November 2008, a period of extreme stress for CMBSs. Our  analysis revealed that if legacy CMBSs accepted as TALF collateral as of  September 2009 reached market values equivalent to November 2008  levels, about 88 percent of such collateral would have fallen to levels at  which the TALF borrower’s equity would be eliminated. Moreover, more  than $3.5 billion owed by TALF borrowers—or about 85 percent of the  total value of TALF legacy CMBS loans—would have negative equity in  this scenario. This extreme market stress scenario would result in a loss in  market value on the part of these TALF borrowers of nearly $1.2 billion.  The haircut investment for these borrowers totals $665 million, providing  significant economic incentive to walk away, which would result in a  worst-case loss of about $500 million for TALF.
While this worst-case scenario provides useful information for Treasury to  consider as it monitors risk associated with TALF, we agree with the  Federal Reserve and Treasury that there are a number of factors that  affect whether such losses would be realized even in this adverse scenario.  First, as discussed in the ABS analysis, the accumulated excess interest in  TALF LLC would help offset potential losses. As of December 31, 2009, the  fund had almost $200 million in excess interest, which will continue to  increase every month in the absence of any asset purchases. Second, the  risk that all or a large portion of CMBS assets would be surrendered is  significantly mitigated by an FRBNY requirement that legacy CMBSs  prepay a portion of any returns in excess of certain limits. In short, the  requirement helps ensure that the TALF borrower will retain an equity  interest in the underlying CMBSs. The longer the term of the TALF loan  (assuming that the underlying collateral provides a return) the more equity  the borrower holds, and the less likely the borrower is to surrender the  CMBS collateral. Third, as with ABSs, and as indicated by Treasury  officials, TALF LLC could hold the securities acquired at a discount from  par—instead of selling them—and earn interest income and the equity  forfeited by the borrower as long as the underlying mortgages in the  security continue to perform well. Fourth, the estimated loss represents  less than 1 percent of total TALF loans as of December 2009, and total  TALF CMBS loans represent about 14 percent of all TALF loans. Because  CMBSs is a small portion of the portfolio, it would present a smaller  proportion of total losses. However, if recent TALF borrowing trends hold,  CMBS loans are likely to increase as the percentage of total TALF loans.  Finally, only senior credit-enhanced tranches within each CMBS can be  accepted as collateral. Thus, even if credit losses on the commercial  mortgages underlying the TALF CMBS securitizations are significantly  higher than currently expected in today’s stressed commercial real estate  environment, these senior tranches are unlikely to experience principal or  interest payment interruptions. While losses associated with CMBSs  currently appear unlikely, these securities warrant ongoing scrutiny  because of continuing economic uncertainty and the distressed conditions  in the commercial real estate market.
section_title: Treasury Worked with the Federal Reserve and FRBNY to Analyze Risks Related to TALF but Did Not Fully Document Analysis Supporting Final Decisions
paragraphs: FRBNY, the Federal Reserve, and Treasury worked in a collaborative  manner to design certain elements of TALF, according to these agency  officials. The Federal Reserve led the initial efforts to determine collateral  eligibility and Treasury recommended one asset class and assessed the  risks of others. As part of this work, Treasury hired a contractor to  conduct independent analyses, and the contractor raised concerns about  accepting certain assets as TALF collateral, the size of the haircuts that  were required, and other program terms. While Treasury officials said that  the contractor’s concerns were ultimately resolved, they could not provide  documentation showing how Treasury resolved the contractor’s concerns,  or how the contractor’s analysis informed Treasury’s final decisions.  Treasury also did not document how they reached major decisions that  were made with FRBNY and the Federal Reserve. The lack of an effective  process to make and document decisions may inhibit transparency and  accountability of Treasury’s monitoring of the $20 billion of taxpayer  funds at risk through TARP.
subsections: section_title: The Federal Reserve and Treasury Worked Together to Determine the Eligibility of Proposed TALF Collateral and Their Potential Risks
paragraphs: Treasury, the Federal Reserve, and FRBNY officials with whom we spoke  said that the agencies have a positive working relationship when making  decisions on TALF. For example, Federal Reserve and FRBNY officials  said that they consulted with Treasury to select the types of ABSs to  include in TALF as eligible collateral. Under this process, the Federal  Reserve identified all eligible collateral except SBA loan guarantees.
Treasury officials said that one asset class that FRBNY proposed— insurance premium finance loans—required additional analysis to assess  the risks. These loans are not as widely traded or as well understood as  other asset classes. Treasury officials worked with Federal Reserve  officials to better understand the asset class, including its risks and factors  mitigating such risks, and its importance to small businesses. Treasury’s  contractor also reviewed risk information on this class of ABSs. Treasury  and Federal Reserve officials determined that this asset class should be  eligible for TALF. According to Treasury officials, other asset classes were  also reviewed by both agencies and not included in the program because  of their risks.
According to Treasury officials, the following criteria were used by  Treasury to evaluate the eligibility of asset classes for inclusion in TALF:  (1) whether including certain asset classes would have a significant or  beneficial effect on the broader economy, small businesses, or consumers;  and (2) whether assistance was needed because of a market failure in  what were otherwise safe asset classes. Based on these criteria, Treasury  recommended to the Federal Reserve and FRBNY that TALF accept as  collateral securities backed by SBA loan guarantees. SBA has two loan  guarantee programs—section 7(a) and section 504—that support financing  for small businesses. Treasury requested that these securities be included  because they would assist in carrying out TARP’s goals of supporting small  businesses and the risks were deemed to be low because of their  government guarantees.
As part of the asset class selection process, the Federal Reserve and  Treasury each analyzed the potential for loss that the TALF assets  presented. Treasury hired a contractor to, among other things, conduct an  independent analysis of the credit and other risks of the TALF asset  classes and to determine appropriate haircuts for each of the asset classes.  In its initial reports to Treasury, the contractor raised some concern about  accepting certain asset classes for TALF, provided suggestions for  program changes, and, in a few instances, disagreed with haircuts that  FRBNY suggested. According to Treasury officials and the contractor, any  differences were ultimately reconciled.
As an example, the contractor’s report noted that auto floor plan ABSs  faced risks because of the financial problems that the major domestic auto  manufacturers faced, and the nationally recognized statistical rating  organizations were in many cases unwilling to provide AAA ratings on  these securities. The contractor recommended a higher haircut to  encourage TALF borrowers to conduct thorough due diligence for this  asset class. Treasury questioned the contractor’s methodology and asked  the contractor to redo its analysis of auto dealer floor plan ABSs. After  working with Treasury and FRBNY to understand the differences in  methodologies between its analysis and FRBNY’s for this asset class, the  contractor agreed with FRBNY’s estimates on haircuts and even suggested  a haircut lower than FRBNY’s.
section_title: Treasury Did Not Fully Document Its Analysis or Basis to Support All Major Agreements with the Federal Reserve and FRBNY
paragraphs: Although Treasury told us what its reasons were for not accepting all of  the contractor’s recommendations, Treasury officials were unable to  provide documentation showing when the contractor conducted the  analyses or when or how Treasury made decisions based on these  analyses. Further, no documentation was available showing how major  differences were resolved, including those involving program terms, the  eligibility of asset classes, and differences in haircut estimates among  Treasury, Treasury’s contractor, the Federal Reserve, and FRBNY.
Additionally, Treasury officials could not provide documentation on the  rationale for major program decisions that Treasury, the Federal Reserve,  and FRBNY officials reached. Treasury officials told us that FRBNY, the  Federal Reserve, and Treasury had a positive working relationship when  making decisions on TALF and described the process as “fluid;” therefore,  there was not always documentation of discussions and final outcomes.  Moreover, Treasury officials said that they spoke almost daily to Federal  Reserve and FRBNY officials. In some cases, according to Treasury  officials, FRBNY and the Federal Reserve consulted Treasury, although  technically no consultation was required. Treasury and the Federal  Reserve did not formally document their conversations, but the end result  of those conversations was documented and reflected publicly on the  TALF Web site administered by FRBNY.
Finally, some of the early decisions on TALF were made by Treasury  officials who are no longer at the agency. Without documentation, there  are no records to show, for instance, how certain suggestions made by  these officials about asset classes or program terms were incorporated  into policy choices for TALF.
Our Standards for Internal Control in the Federal Government states that  internal control activities help ensure that government management  directives are carried out. Such activities are critical to helping ensure  accountability and stewardship for government resources, and include  proper documentation of major decisions. In the context of the Emergency  Economic Stabilization Act of 2008—and the unprecedented size and  scope of government assistance to support the financial sector— transparency and accountability are of the utmost importance. As an  example, for the largest program in TARP—the Capital Purchase  Program—all major decisions are recorded in meeting minutes that report  who was present, what decisions were made, and when they were made.  In past TARP reports, we recommended that Treasury increase the  transparency and accountability of TARP, in part by documenting and  reporting certain processes and decisions.
As we noted in past TARP reports, given the economic environment  surrounding the creation of TARP, and subsequently TALF, during the fall  of 2008, the change in administrations and the lack of staff that Treasury’s  administrative office for TARP—the Office of Financial Stability—faced,  Treasury may have initially had difficulty establishing its decision-making  processes for TALF and recording decisions and important meetings on  TALF program terms. At the time that TALF was created, the Office of  Financial Stability had been in existence for barely a month, and its  strategy and overall staffing needs were not yet in place. The broader  context at the onset of the program—with unprecedented economic  challenges and low, impermanent staffing—may help explain why such  processes were not established and documented when the program was  first established.
However, for TALF decision-making processes and the activities of TALF  LLC to be viewed as credible, Treasury needs to ensure that it has  developed an effective process to document the basis for its decisions. A  year has passed since Treasury began rolling out TARP-related programs,  and other larger programs—such as the Capital Purchase Program—have  established systems for documenting decisions and the rationale for  decisions. But Treasury’s decisions for TALF still lack a clear process for  tracking how important program decisions are made and why. Without  such documentation, ascertaining what information has been considered  to protect TARP funds committed to TALF is difficult. Further, the lack of  documentation inhibits transparency and accountability.
section_title: Treasury’s and FRBNY’s Indicators Suggest That Credit Market Conditions Have Shown Some Improvement, but Treasury Lacks Performance Indicators in the Event that It Must Purchase TALF Assets
paragraphs: FRBNY, in conjunction with Treasury, monitors TALF by tracking  indicators—such as securitization volumes, changes in pricing, and TALF  loan volumes—by amount and borrower type to identify any possible  impact from TALF. Our analysis of these and other indicators suggests that  market conditions have begun to improve for some TALF-eligible asset  classes, but that others, such as CMBSs, continue to show weakness.  However, any assessment of the effectiveness of an individual program  presents challenges. As we have reported, no indicator can provide a  definitive measure of TALF’s impact because a myriad of programs have  been initiated to stabilize the markets, including actions taken under the  Capital Purchase Program and the Automotive Industry Financing  Program. Challenges remain for some of the TALF-eligible asset classes,  and FRBNY and Treasury monitor the performance of TALF loans and  collateral to be aware of all potential risks to TARP funds. However,  according to Treasury officials, Treasury has not yet developed a plan for  tracking assets that might be surrendered to TALF LLC or for publicly  disclosing how up to $20 billion in TARP funds would be monitored.
subsections: section_title: Treasury, FRBNY, and the Federal Reserve Collaborate on Monitoring Market Indicators
paragraphs: Federal Reserve and Treasury officials said that they collaborated on  monitoring indicators that could help measure TALF’s effectiveness in  improving conditions in the securitization markets and, in turn, its impact  on the availability of credit to households and small businesses. Although  the officials have said they do not have specific benchmarks or targets  they hope to achieve for ABS issuance volumes or volumes of TALF loans,  they are monitoring those indicators. Officials also track interest spreads  for TALF-eligible asset classes, the number of borrowers accessing the  facility, and information about TALF borrowers, such as investor type.  FRBNY collects data on these indicators to monitor TALF’s impact.  According to Treasury officials, they review FRBNY’s metrics related to  TALF, including cash flows from TALF loans that it receives monthly from  FRBNY, and speak daily with FRBNY officials.
section_title: New Issuances in Various Asset Classes Increased after TALF’s First Subscription in March 2009
paragraphs: To determine the condition of the securitization markets, we also have  been monitoring similar indicators, such as new ABS issuances and  changes in interest rates, types of investors, and spreads—using data from  before and after TALF’s implementation. In general, data from the  indicators that we have collected show increases in securitization  volumes, little change in the cost of credit, and declines in perceptions of  risk in certain asset classes since TALF began. ABS issuances in all of the  most liquid TALF-eligible sectors dropped sharply in 2008 from their peak  levels in 2006 and 2007. As figure 7 indicates, new issuance of ABSs had  come to a virtual halt in 2008, significantly reducing a major source of  credit for consumers and businesses. While securitization volumes  increased since the end of 2008, these increases have not been sustained  throughout 2009.
After having shown little activity since the last quarter of 2008, issuance of  credit card, auto, and student loan ABSs increased after the initial TALF  subscription in March 2009 (shown as first quarter 2009 in figure 7). The  majority of ABS issuances in the credit card and auto sectors have been  supported by TALF loans. Specifically, of the $46 billion in ABSs issued on  credit card debt in 2009, $29.7 billion, or about 65 percent, have been  eligible for TALF financing. Similarly, about 88 percent—or $44.9 billion— of the $51.2 billion in ABSs issued on auto loans in 2009 were TALF- eligible deals. For more detailed information on securitization volumes,  see appendix VII.
By the third quarter of 2009, credit card and student loan issuances had  declined again in dollar terms, while auto issuances continued to increase.  A number of factors—such as the combined effects of the numerous  stimulus programs, changes in consumer demand for credit, and investor  willingness to invest—also may have contributed to the trend in  securitization volumes in these sectors. Federal Reserve officials  suggested that some companies may have been hesitant to issue credit  card ABSs because of uncertainty regarding the continued availability of  the FDIC’s “Safe Harbor” rule in light of new accounting rules effective for  annual financial periods beginning after November 15, 2009.
section_title: Interest Rates in Most Asset Classes Have Generally Not Decreased Since TALF Was Announced
paragraphs: One of TALF’s goals is to increase the availability of credit to consumers  and businesses. TALF assistance to the securitization markets is intended  to result in lower loan rates and increased credit availability to businesses  and individual consumers, including the auto loan, credit card, and student  loan sectors that account for the majority of securitizations.  Recent  increased activity in the securitization markets has been accompanied by a  substantial decrease in interest rates for loans originated by auto finance  companies. However, there have been few changes in credit card rates or  interest rates for consumers in auto loans originated by commercial banks.  Consumer interest rates remain flat.
Because auto finance companies rely more heavily on securitizations for  funding than commercial banks, the effects of positive changes in the  securitization markets are more likely to be reflected in their loan rates  than in those of commercial banks. As figure 8 shows, auto loan rates  offered by commercial banks remained fairly steady before and after the  implementation of TALF. The average finance company auto rate has been  consistently below commercial bank auto rates, with the exception of the  fourth quarter of 2008, perhaps reflecting the financial challenges facing  the auto industry at that time. Since then, rates at auto finance companies  have declined from an average of 7 percent to approximately 3 percent.  This reduction coincides with the launching of TALF but may also reflect  assistance from the numerous government stimulus programs, especially  those focused on the auto industry. While fixed credit card rates have  remained fairly flat in recent years, variable credit card rates have  increased by approximately one percent since TALF’s inception. FRBNY  officials attributed the elevated credit card rates to increased charge-offs,  which have raised companies’ costs of funds. These rate changes could  also be the result of credit card companies’ efforts to anticipate the  implementation of the remaining part of the Credit Card Accountability  Responsibility and Disclosure Act of 2009, which will take effect in  February 2010.
FRBNY officials said that it is possible that without TALF interest rates on  loans to consumers and small businesses would be much higher than they  are now. Issuers of TALF-eligible ABSs have told FRBNY that without  TALF they would have made fewer loans and those loans would have been  at higher rates. Data on private student loan rates are difficult to obtain,  but FRBNY officials said that Sallie Mae has reduced its rates on private  student loans over the past few months.
section_title: TALF Loan Volumes and the Composition of TALF Participants Have Changed since the Program Began
paragraphs: As illustrated in table 3, the volume of TALF loans made since the  inception of the program has fluctuated by month, with loan volumes  peaking in May 2009 and June 2009. As of December 31, 2009, a total of  $61.6 billion in TALF loans had been granted; however, the balance of  loans outstanding at that date was $47.5 billion due to loan prepayments  and principal paydowns. As we reported previously, agency officials  indicated that improvements in securitization and loan markets had made  issuers less dependent on TALF support. However, according to FRBNY  officials, other issuers remain more heavily dependent on investor access  to TALF financing. FRBNY officials noted that there have been a number  of prepayments, and market participants also told us that financing under  TALF was now less favorable because better financing terms could be  found in the private sector for certain asset classes. Notably, the first and  only subscription for new-issue CMBSs occurred in November 2009.  FRBNY and Treasury officials stated that the slow new-issue CMBS  activity may be due to the length of time it takes to complete a deal.
As shown in figure 9, approximately 75 percent of TALF loans involved the  purchase of ABSs backed by auto loans and leases, credit card receivables,  and student loans. This activity reflects the historical trends in auto, credit  card, and student loan securitizations, which represent the majority of the  ABS markets.
CMBS (legacy 14%; new issue 0%)
According to Treasury and Federal Reserve officials, TALF was designed  to encourage broader investor participation in the securitization markets,  with the goal of reviving consumer lending. These officials noted that the  securitization markets stopped functioning in 2008 when many investors  stopped purchasing these securities. The lack of securitization market  activity disrupted a significant source of funding for businesses and  consumers. Gradually, some of these investors have returned to the  markets, but at a slower rate than during past market downturns.  Specifically, Treasury officials noted increasing participation in TALF  securitization by asset managers, hedge funds, and traditional institutional  investors such as pension funds and insurance companies. They consider  the return of investors to the securitization markets to be a measure of the  program’s success. Hedge funds traditionally have not invested in ABSs  because of the low returns relative to other opportunities. However,  FRBNY officials believe the access to low-cost financing through TALF  made ABS returns attractive to hedge funds. FRBNY also noted  participation by private investors and banks.
section_title: Differences in Prices and Benchmarks Have Decreased for Most TALF- Eligible ABS Collateral
paragraphs: As we have discussed, one method of measuring market participants’  perceived risk of a security is to compare the difference between the  security’s yield and a benchmark yield. The difference is called a spread,  and wide spreads, or large differences, generally indicate that participants  perceive high risk in the market that requires a high rate of return. As  perceived risk declines, differences in such prices decrease, or narrow.  During the fourth quarter of 2008 and first quarter of 2009, spreads likely  reflected high expected costs of selling securities prior to their maturity,  which contributed to low desirability for those securities. Figure 10 shows  the change in spreads in the following TALF-eligible asset classes: auto  loan, credit card, student loan, and CMBS. A trend of widening spreads in  these asset classes began in mid-2007, indicating negative perceptions  about risk. Although there were fluctuations throughout 2008, spreads  began to narrow in early 2009, indicating a perceived decline in risk by  market participants and potentially improved credit market conditions.
section_title: Treasury Reviews TALF- Related Data from FRBNY’s Indicators but Has Not Developed Indicators to Collect and Disclose Data on Future TALF LLC Assets
paragraphs: Treasury reviews the data that FRBNY collects on TALF loan volumes and  borrowers by type, securitization volumes, and changes in pricing.  Treasury officials noted that personnel at both agencies were responsible  for a variety of tasks in tracking TALF-related metrics. We found that  Federal Reserve officials, particularly at FRBNY, typically took the lead in  collecting data and calculating metrics. We also found that Treasury  officials did not have a plan to collect and analyze information related to  assets that might be placed in TALF LLC—assets to which Treasury would  have an exposure. Such information might include the purchase and sale  price of the assets, their current market value, total outstanding loans by  Treasury to TALF LLC for the ABS purchases, and the rationale behind  TALF LLC’s possible future sale of assets. Treasury has not yet developed  such a plan because no TALF collateral has been surrendered thus far, and  Treasury believes it is unlikely that it will have to use TARP funds to  finance TALF LLC’s purchase of surrendered collateral. Moreover,  Treasury does not have a plan to publicly communicate such information  in the event that collateral is surrendered and placed there. In previous  TARP reports and in this report, we have discussed the importance of  improving the transparency and accountability of TARP programs. We  have also recommended that Treasury build on existing oversight  procedures to better monitor and report on the use of TARP funds and to  better quantify program results.
Although Treasury is not responsible for implementing or administering  TALF, it has pledged support to TALF LLC with the first $20 billion of  potential loans to allow it to purchase surrendered TALF collateral. As  discussed earlier, commercial real estate continues to show weakness and  could potentially pose greater risks to TARP funds. Without a system for  tracking and reporting on any potential assets such as CMBSs that are  surrendered to TALF LLC, Treasury cannot assure transparent  management of these assets or determine if it is achieving its goals under  CBLI with respect to the use of TARP funds for TALF-related activities.  Further, without properly planning for its role in managing the collateral  should they have to be purchased by TALF LLC, Treasury may not be able  to effectively assess any risks associated with such assets or exercise  appropriately its decision-making responsibilities regarding the potential  sale of any assets.
section_title: Conclusions
paragraphs: TALF is one of several programs created by the Federal Reserve to help  address the recent crisis in the financial sector. Specifically, this program  was designed to restart securitization markets, a critical part of financial  markets. Given the myriad of programs initiated to stabilize the financial  system and increase credit availability, it is difficult to attribute  improvement in markets to any one program. Nevertheless, according to a  variety of indicators, TALF appears to be contributing to measured  improvements in the securitization markets. As of December 31, 2009,  $61.6 billion in loans were made through TALF and TALF LLC had  received $100 million of the $20 billion in TARP funds committed to the  program. In addition to the $20 billion, funds provided by FRBNY to  operate TALF could expose additional risks. However, because we are  statutorily prohibited from auditing the Federal Reserve’s monetary policy  activities, we believe our ability to completely assess and report on  taxpayers’ exposure to the entire program or the Federal Reserve’s  management of the program is limited.
Although the government has taken a number of steps to mitigate the risk  of loss from TALF, in the long term risks remain. For example, while  analyses by the Federal Reserve and a Treasury contractor that were  based on predictions of market performance and other factors estimated  that a loss of a substantial portion of the $20 billion TARP commitment  would be unlikely based on current conditions in the securitization  markets, we found that until the TALF borrowers repay their loans, TALF  still presents risks. While we acknowledge that overall market conditions  have generally improved since 2008, some asset classes—specifically  CMBS—are still performing poorly and may continue to perform badly for  the foreseeable future. Moreover, markets remain fragile and predicting  how the overall ABS markets will perform in the future and how  borrowers might respond to new declines in the markets is difficult. A  return to 2008 conditions could have adverse impacts on the program,  such as significantly reducing the value of TALF collateral, providing an  economic incentive for borrowers to walk away from their loans, and  requiring TARP funds be used to buy TALF collateral. However, several  TALF program features make this less likely.
Treasury, which worked with FRBNY and the Federal Reserve on certain  decisions related to TALF, was not able to provide documentation on how  these decisions were made. As we noted in past TARP reports, Treasury  has yet to develop systems to ensure the transparency and accountability  for TARP activities by implementing a strong, transparent strategic  framework with appropriate oversight mechanisms. Among other things,  these mechanisms would ensure accountability by tracking why decisions  are made, and whether goals are being achieved. Documenting the basis  for decisions is an important part of the decision-making process.  Moreover, documenting the rationale for major program decisions would  help ensure that the program objectives are being met and that it is  functioning as intended. Unless Treasury documents the rationale for  major program decisions that it made with the Federal Reserve, it cannot  demonstrate accountability for meeting the goals of TALF and could  unnecessarily place TARP funds at risk.
Believing it is highly unlikely that it will have to use TARP funds to finance  ABS purchases by TALF LLC, Treasury has not taken steps to develop a  set of metrics or a plan for tracking and reporting on the performance of  the collateral that could be placed in TALF LLC. While TARP funds may  never be used to finance purchases of ABS or CMBS used as TALF  collateral, Treasury should at least be prepared for the possibility. Without  a plan for collecting and analyzing such data, Treasury would have to  develop one as it is financing or after it has financed collateral purchases  by TALF LLC and risks being ill prepared to make informed decisions on  whether TALF LLC should keep collateral until the securities mature or  sell them. Unlike many other programs that were developed and  implemented in the midst of the crisis, Treasury has an opportunity to be  strategic by developing a plan in the event that its role in TALF is  triggered. In addition, without a plan Treasury cannot measure TALF’s  success in meeting its goals under CBLI with respect to any assets that are  placed in TALF LLC. Finally, without a plan for communicating the  findings that result from tracking and analyzing such metrics, the public  will not be aware of how the assets are managed and financed,  undermining Treasury’s efforts to be fully transparent about TARP  activities.
section_title: Matter for Congressional Consideration
paragraphs: To enable GAO to audit TARP support for TALF most effectively, we  recommend that Congress provide GAO with audit authority over all  Federal Reserve operational and administrative actions taken with respect  to TALF, together with appropriate access authority.
section_title: Recommendations for Executive Action
paragraphs: To improve transparency of decision making on the use of TARP funds for  TALF and to ensure adequate monitoring of risks related to TALF  collateral, we recommend that the Secretary of the Treasury direct the  Office of Financial Stability to take the following actions:  1.  Given the distressed conditions in the commercial real estate market,  as part of its ongoing monitoring of TALF collateral, continue to give  greater attention to reviewing risks posed by CMBSs. 2.  Strengthen the process for making major program decisions for TALF  and document how it arrives at final decisions with the Federal  Reserve and FRBNY. Such decisions should include how Treasury  considers expert and contractor recommendations and resolves those  recommendations that differ from those of the Federal Reserve and  FRBNY.  3.  Conduct a review of what data to track and metrics to disclose to the  public in the event that TALF LLC purchases surrendered assets from  FRBNY. Such data and metrics should relate to the purchase,  management, and sale of assets in TALF LLC that potentially impact  TARP funds. Metrics related to TALF LLC could include periodic  reports on the date and purchase price of assets; fluctuations in the  market value of assets held; the date, price, and rationale when assets  are sold; and the total amount of loans outstanding to Treasury.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to Treasury for its review and comment.  We also provided the draft report to the Federal Reserve to verify the  factual information they provided to us about TALF. Treasury and the  Federal Reserve provided written comments that we have reprinted in  appendixes VIII and IX, respectively. Treasury and the Federal Reserve   also provided technical comments that we have incorporated as appropriate.
In their response Treasury welcomed our recognition that TALF  contributed to improvements in the securitization markets but believed  that the draft report understated the success of the program. In so doing  Treasury reiterated several points that were already underscored in the  draft report. For example, as discussed in the draft report and Treasury’s  response, we acknowledged that securitization volumes in markets had  come to a complete halt in 2008, but increased after TALF’s first  subscription in March 2009. Moreover, we also noted that recent TALF  subscription levels for the majority of eligible asset classes have tapered  off, which is an indication that investors’ perception of risk has decreased.  As we have noted in our previous TARP reports, any assessment of the  effectiveness of TALF is complicated by the fact that a variety of programs  have been established by the Federal Reserve, Treasury, and others to  stabilize the markets—making it virtually impossible to definitively single  out and measure TALF’s impact.
Treasury also stated that it disagreed with our methodology related to  potential losses for CMBSs.  As we discussed in the report, the adverse  scenario analysis of the TALF CMBS portfolio was not intended to project  an expected loss amount for this portfolio but to help assess the possible  range of losses in TALF.  We used a stress scenario and selected loss  assumptions that were similar to those the Federal Reserve imposed on  the 19 bank holding companies that participated in the 2009 stress test.  Treasury states that it would take a 65 percent loss on underlying  commercial real estate prices to experience losses. While we agree that  this is an unlikely event, commercial real estate prices have already fallen  by an average of 43 percent since prices peaked. Combined with the fact  that CMBSs have much longer time horizons than other TALF ABS asset  classes and hence greater uncertainty of outcomes, we continue to believe  that CMBS warrants ongoing attention.
Treasury also noted that it appreciates the recommendations GAO makes  in the report to strengthen the documentation of decisions Treasury made  concerning changes to the program.  Treasury stated it is committed to  ensuring that not only TALF, but TARP as a whole, is administered in a  way that protects the taxpayer. We believe that development of a sound  decision-making process that includes steps for formal approval and  documentation of the basis of the final decisions at an appropriate  management level will improve transparency and accountability of the  TALF program. As we noted in past TARP reports and most recently in the  October 2009 report, Treasury has yet to develop systems to ensure the  transparency and accountability for TARP activities by implementing a  strong, transparent strategic framework with the appropriate oversight  mechanisms. Among other things, these mechanisms would ensure  accountability by tracking why decisions are made and whether goals are  being achieved.
Finally, regarding our recommendation that Treasury review what data to  track and metrics to disclose to the public in the event that TALF LLC  purchases surrendered assets from FRBNY, Treasury noted that it will  continue to enhance its existing reporting on its investments in TALF that  strikes an appropriate balance between its goal of transparency and the  need to avoid compromising either the competitive positions of investors  or Treasury’s ability to recover funds for taxpayers. We believe that having  a plan in place for tracking and reporting on the performance of any  collateral that could be placed in TALF LLC will help Treasury strike that  balance.
In its comments, the Federal Reserve did not agree with our  recommendation that Congress consider providing GAO with authority to  audit the Federal Reserve’s TALF operational and administrative actions  because it disagreed that there are limitations on GAO’s authority to audit  these Federal Reserve activities.  The Federal Reserve also noted that it  fully cooperated in GAO’s conduct of this audit and provided us access to  records and personnel.
The Federal Reserve did cooperate and voluntarily provided all access we  requested in this audit of Treasury.  We appreciate this cooperation, which  enabled us to factually describe the TALF program and to evaluate  Treasury’s involvement in it.  However, we believe the express statutory  prohibition in 31 U.S.C. § 714(b) on GAO auditing the Federal Reserve’s  monetary policy and discount window activities, which the Federal  Reserve believes include TALF’s operation and administration, prohibits  us from auditing the Federal Reserve’s TALF activities, even from the  perspective of TARP. We limited the scope and conduct of this audit  accordingly, and thus did not request access to information to audit the  Federal Reserve’s performance of these activities.  Further, the Federal  Reserve’s decision to voluntarily provide requested access in this instance,  while helpful, does not create GAO authority for access to information the  agency may not volunteer, nor GAO authority to audit the Federal  Reserve’s TALF operational activities or other performance.  In our view,  our lack of authority to audit the Federal Reserve’s actions limited our  ability to fully assess the risk to taxpayer funds presented by TALF.   Accordingly, we continue to believe that Congress should provide GAO  with authority to audit the Federal Reserve’s operation and administration  of the TALF program.  Our detailed response to the Federal Reserve’s  comments on these issues is contained in appendix X.
We are sending copies of this report to the Congressional Oversight Panel,  Financial Stability Oversight Board, Special Inspector General for TARP,  interested congressional committees and members, Treasury, the federal  banking regulators, and others. The report also is available at no charge on  the GAO Web site at http://www.gao.gov.
If you or your staffs have any questions about this report, please contact  Orice Williams Brown at williamso@gao.gov or (202) 512-8678. Contact  points for our Offices of Congressional Relations and Public Affairs may  be found on the last page of this report. GAO staff who made major  contributions to this report are listed in appendix XI.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: The objectives of this report are to (1) analyze the risks that the Term  Asset-Backed Securities Loan Facility (TALF) presents to Troubled Asset  Relief Program (TARP) funds and therefore to taxpayers, (2) evaluate how  the Department of the Treasury (Treasury) analyzed the risk of TALF  assets and used this information in making decisions on TALF with the  Board of Governors of the Federal Reserve System (Federal Reserve) and  the Federal Reserve Bank of New York (FRBNY), and (3) assess the  condition of securitization and credit markets before and after TALF’s  implementation based on indicators tracked by Treasury and FRBNY.
GAO has statutory limitations on auditing certain functions of the Federal  Reserve. Because of these limitations, the evaluative content of this report  is limited to Treasury’s role of safeguarding TARP funds related to TALF  and we did not review or evaluate any monetary policy actions taken by  the Federal Reserve or FRBNY with respect to TALF. We collected  information on Federal Reserve practices related to TALF, but did not  audit those practices. Specifically, we did not evaluate the sufficiency of  how certain TALF program terms, such as haircuts and interest rates, were  arrived at. In addition, we did not assess FRBNY’s system of internal  control or the role of TALF participants such as agents, borrowers, and  auditors in certifying and validating compliance with certain TALF terms.  Finally, we did not validate the comments or background information  provided to us by Federal Reserve and FRBNY officials about TALF.
To address the first objective, we first reviewed publicly available  documentation on the Web sites of the Federal Reserve and FRBNY. We  also interviewed Treasury, FRBNY, and Federal Reserve officials to  understand how TALF fits in to Treasury’s Financial Stability Plan and  how risks to the taxpayer were reduced in TALF’s design. Next, we  assessed how Treasury reviewed the risks of the various asset classes  considered for TALF eligibility by collecting and analyzing reports that  Treasury requested through a contractor, Bank of New York Mellon, which  in turn subcontracted the work to NSM Structured Credit Solutions, which  has since been acquired and is now known as RangeMark. We also  reviewed the subcontractor’s methodology for assessing the likelihood of  loss to TARP funds and interviewed the subcontractor, contractor, and  Treasury officials about the assumptions in the loss model. We also  reviewed other factors that have an impact on the risk to TARP funds and  taxpayers, including the return on equity for TALF borrowers, credit  enhancement of TALF securities, and the risks of asset-backed securities  (ABS) and commercial mortgage-backed securities (CMBS).
To assess the changes in return on equity (ROE), we analyzed the returns  based on information collected from prospectuses for TALF-eligible ABSs  on credit cards, auto loans, auto leases, and private student loans issued  between March and September 2009. Some of these prospectuses were  provided by the Federal Reserve. We also used information collected from  reports from Moody’s Investors Service and Standard & Poor’s. We  calculated returns for fixed-rate bonds by using the tranche-level interest  rate paid to the FRBNY. For floating-rate bonds, we used a spread  between the interest rate paid to the FRBNY and an index, such as the  London Interbank Offered Rate. This is the “coupon” variable in the  equation below:  ROE = Coupon – (1 – Haircut%)* Rate _ on _ loan _ paid _ to _ FRBNY    To assess the levels of credit enhancement for TALF securities, we  analyzed information collected from prospectuses related to public and  private offerings of TALF-eligible securities issued between March and  September 2009, along with related reports from Standard & Poor’s and  Moody’s Investors Service. For each security, we compared the level of  credit enhancement for the TALF issuance with that issuer’s most recent  securitization prior to TALF, which ranged from 2004 through 2008.
To understand the recent activity in CMBS markets, we collected  information from Moody’s Investors Service on commercial real estate  prices (Moody’s/REAL Commercial Property Price Index) and on CMBS  delinquency (Moody’s CMBS Delinquency Tracker). We determined that  the data was reliable for our purposes of demonstrating recent trends in  the commercial mortgage sector. In addition, we collected CMBS price  performance data from Thomson Reuters DataScope and determined that  the information on the price, yield, and performance of securities was  reliable for our purposes of understanding trends in CMBS prices and  vintages for the TALF portfolio.
We interviewed a range of market participants and market observers about  the taxpayer protections and other features of TALF, to include three  dealers that also serve as TALF agents; three issuers (one for credit cards,  one for auto loans, and one for student loans) and an SBA securities  dealer; three industry associations representing the CMBS market, the  hedge fund industry, and small and regional banks; a buy-side investment  firm with interest in TALF; two large auditing firms that provide auditor  attestations for TALF; an attorney with securitization market expertise;  two TALF-qualified credit rating agencies, or nationally recognized  statistical rating organizations; an academic in banking and securitization  at the Massachusetts Institute of Technology; an analyst from Brookings  Institution; an analyst from a student loan firm; and a representative of a  consumer advocacy organization.
For details on our methodology for assessing adverse scenario losses from  TALF ABSs and CMBSs, see appendix II.
To address the second objective on Treasury’s analysis of the risk  associated with TALF assets and how that analysis was used to make  decisions with the Federal Reserve and FRBNY related to TALF, we  analyzed reports from a subcontractor with Treasury—NSM Structured  Credit Solutions—that provided assessments of various risks of TALF to  TARP funds. In analyzing these reports, we reviewed the asset class risk  assessments, the recommendations made to change TALF program terms,  and the suggested haircuts for each asset class. We also interviewed  Treasury’s contractor and the subcontractor for clarification on the  reports and to understand Treasury’s interaction with both. In addition, we  interviewed Treasury officials about their role in reviewing and shaping  the terms of TALF, how they considered the analysis and  recommendations of the subcontractor, how they decided to include  certain asset classes, and how they came to agree on haircuts and other  program terms with the FRBNY and Federal Reserve. We also interviewed  officials from FRBNY and the Federal Reserve about the reasons for  differences in haircuts and other TALF program terms and how they were  resolved with Treasury and the subcontractor.
To address the third objective on changes in the securitization and credit  markets before and after TALF was created, and to understand how  Treasury tracks the impact of TALF and its potential risks to TARP funds,  we collected and analyzed information from a variety of data sources  relevant to the ABS, CMBS, and credit markets. Specifically:    To review changes in securitization markets for ABSs backed by auto  loans, credit cards, student loans, and commercial mortgages, we  collected data from Thomson Reuters IFR Markets, a database that  collects information on activity in the securitization markets. To analyze  changes in interest rates for auto loans and credit cards, we reviewed  quarterly data from the Federal Reserve’s G.19 Consumer Credit Release, a  widely used data source, as well as weekly data provided by  BankRate.com. We selected the auto, credit card, student loan, and CMBS  asset classes because they were the most widely traded in securitization  markets and the latter had recently experienced significant trading and  price volatility. Because reliable interest rate data for private student loans  and commercial mortgages were more difficult to obtain, we collected and  analyzed data only on auto loans and credit cards. We validated the  securitization and interest rate information against reports and data  provided by credit rating agencies, issuers, and dealers. We determined  that the data sources were sufficient for our purposes of demonstrating  trends in the markets before and after TALF was created.
To report on the amount of TALF loans settled, we accessed data publicly  available on the FRBNY Web site and also information provided to us from  FRBNY for periods when FRBNY did not publicly report the settled loan  amounts, but only the requested amounts. Because of the limitations on  our audit authority, we did not review the internal systems that generated  this information.
To analyze spreads for ABSs backed by auto loans, credit cards, student  loans, and CMBSs, we analyzed dealer-provided data from three dealer  banks. Because this spread information is not available from one data  provider, we determined that collecting data from three dealers—and   ensuring that the numbers were within an acceptable range of each  other—would ensure the reliability of such data for our purposes.
To determine what information Treasury collects to assess TALF’s impact  on securitization and credit markets and the risks TALF poses to TARP  funds, we interviewed officials from the Treasury about what data they  collect and received reports that Treasury’s subcontractor provided on the  various risks of TALF activities. We also interviewed Federal Reserve and  FRBNY officials about what type of data they collect related to TALF’s  impact on the securitization and credit markets.
section_title: Appendix II: Methodology for Market Value Analysis of ABSs and CMBSs
paragraphs: To understand the possible range of losses to Troubled Asset Relief  Program (TARP) funds from the Term Asset-Backed Securities Loan  Facility (TALF), we conducted an analysis based on extreme market value  losses, similar to those experienced in the asset-backed securities (ABS)  and commercial mortgage-backed securities (CMBS) markets in  November 2008. This provides an alternative approach to the Department  of the Treasury (Treasury) subcontractor’s analysis, and provides an  estimate of how large losses potentially could be in the event that the  markets returned to their November 2008 lows. Selecting November 2008  as the market low point is generally consistent with the approach used by  the Board of Governors of the Federal Reserve System (Federal Reserve)  in its “stress tests” for determining the capital that large bank holding  companies must maintain. Our scenario provides a more-adverse than  expected loss estimate for our sample of ABSs and all of the CMBS loans  remaining as of September 30, 2009.
Our first analysis focused on ABSs. We conducted a market value analysis  on a sample of the three largest asset classes—ABSs backed by credit  cards, auto loans, and student loans—because they make up the majority  of TALF’s portfolio. Of the $42.5 billion in TALF loans backed by credit  card, auto loan, and student loan ABSs that had been disbursed as of  September 30, 2009, we took a sample of $16.5 billion, or 39 percent. The  sample was selected to broadly match the makeup of these asset classes in  this subset of the TALF portfolio (see table 4).
Within each asset class the sample was selected to include ABSs that gave  the largest sample size on a TALF loan dollar basis; hence larger deals  predominate. In addition, TALF loans were spread across 6 of the 7 TALF  ABS subscription months between March and September. Nevertheless, it  is a nonprobability sample and is not necessarily generalizable to all TALF  deals.
We modeled TALF collateral cash flows using assumptions consistent with  the FRBNY’s assumptions on the rate at which ABS principal is paid back  to investors. Then we calculated the discount rate that brought the price  back to par as of the issuance date. To this discount rate, we added the  incremental yield (or spreads) that would be required to deplete the  borrowers’ entire equity investment and any excess interest that had built  up in TALF LLC as of September 30, 2009, for that specific tranche. These  incremental spreads were compared with the widest levels seen in  November 2008 for the appropriate asset class and expected average life.  November 2008 spreads were obtained from Wall Street ABS-dealer  weekly price data that are published for the more widely traded ABS  classes. If the spread seen in November 2008 was greater than that  required to deplete the borrower’s equity and TALF’s excess interest, a  stress loss was calculated. No loss was assumed if the required spread  widening was less than the extremes of November 2008.
Our analysis makes the following assumptions: (1) excess interest has  accumulated as of September 30, 2009 at the tranche level of each TALF  security; (2) borrowers will surrender their TALF ABS collateral to the  FRBNY and stop paying the TALF loan when the ABS market value falls  below the TALF loan balance; (3) TALF will mark-to-market the  surrendered collateral, ignoring any recovery that Treasury might make if  the ABS collateral fully pays all cash flows over the life of the securities;  and (4) the change in market value is strictly based on mark-to-market,  with no assumption about the underlying credit performance of the ABS.
For the separate analysis on the risks that legacy CMBS collateral may  pose to TARP funds, we compared the prices on the 139 legacy CMBS  CUSIPs that were accepted by FRBNY as of September 30, 2009, with the  exception of 2 for which no price information was available. These prices  were then compared with the lowest prices that, on average, most CMBS  across the TALF portfolio reached in November 2008. This CMBS analysis  did not include consideration of the excess interest accumulated in TALF  LLC but otherwise made the same assumptions noted above for the ABS  analysis. As discussed earlier, the $198 million of excess interest that had  accumulated in the cash collateral account as of December 31, 2009,  would be available to absorb the first losses bourn on surrendered  collateral prior to any outlay by Treasury, and this amount is expected to  increase over time. In conducting this analysis we utilized certain data  from Thompson Reuters Datascope and the Federal Reserve.
section_title: Appendix III: The Securitization Process Explained
paragraphs: Securitization is a process that packages relatively illiquid individual  financial assets—such as loans, leases, or receivables—and converts them  into interest-bearing, asset-backed securities (ABS) that are marketable to  capital market investors. As outlined below, the market participants in  securitization—borrowers, consumer and small business lenders,  investment banks or pool assemblers, credit rating agencies, and  investors—each derive specific benefits from the transaction. For  example, borrowers might gain access to loanable funds with more  favorable terms, such as longer repayment periods and lower interest  rates, than may otherwise be available. Similarly, securitization offers  consumer and small business lenders a funding source for making new  loans, improving balance sheet and capital management, and diversifying  fee or income streams. Securitization also allows the cash flows from asset  pools to be structured to satisfy the maturity, risk, and return preferences  of investors.
The degree to which participants receive these benefits depends, in large  part, on how efficiently the markets for securitized assets are functioning.  With accurate and more comprehensive performance data regarding  financial assets, capital markets can more easily profile the risk of a pool  of similar assets. This risk can be divided and sold to investors who are  willing to purchase it at an acceptable risk-adjusted return, sometimes  called the “investor-required yield.” As the markets for securitized asset  classes grow in volume and liquidity, and as the performance and risk  characteristics of those assets become better understood, investor- required yields on particular ABSs and transaction costs of securitizing  those assets may decline. Declining investor-required yields and  transaction costs can lower the cost of financing for consumer and small  business lenders and ultimately borrowers. Conversely, with inadequate  performance data, and low volumes of similar financial assets, these  benefits may not sufficiently materialize for securitization to be a viable  financing arrangement for consumer and small business lenders or  borrowers.
section_title: Appendix IV: Descriptions of Asset-Backed Securities
subsections: section_title: Auto Loan and Lease
paragraphs: Asset-backed securities (ABS) for the auto market compose the largest  share of ABS issuances. Auto securitizations are collateralized with a fixed  pool of loans. In most cases, these transactions are divided into at least  four senior segments, or tranches, which have the same payment priority  in the event of default but different priorities for principal repayment (with  the exception of the shortest pay securities or A1 tranche designed to be  marketable to money market funds, which take priority). Tranches are  structured so that all scheduled principal amortization and prepayments of  principal are paid back first to the tranche with the lowest interest rate.  This tranche is generally designated the A1 tranche. Once the principal on  the first tranche is paid off, subsequent principal is paid to the A2, A3, and  A4 bondholders. The sizes of the tranches are designed so that the  expected average life on these securities is generally consistent within  each tranche—for instance, the A1 average life is usually 3 months, the A2  average life 1 year, the A3 average life 2 years, and the A4 average life  approximately 3 years or more. In some deals, there are also “subordinate  tranches,” or tranches that receive ratings below AAA. In many cases, the  issuer retains subordinate tranches rather than selling them to the public.  Auto ABSs include the following subasset classes: prime auto loans,  subprime auto loans, auto leases, and motorcycle loans.
section_title: Credit Card
paragraphs: Credit card ABSs tend to use a master trust structure through which a  credit card issuer collateralizes a series of ABS issuances with receivables  from a large pool of credit card accounts. This pool is not a static set of  account balances but absorbs new receivables as they are created. New  issuance can be used to support an increase in the size of the receivables  collateralizing the securitizations. Investments in credit card ABSs are  usually divided into senior and subordinated, or junior, tranches where the  investors in the senior tranches are paid first.
section_title: Student Loan
paragraphs: Student loan ABSs can be collateralized with either federally guaranteed  Federal Family Education Loan Program (FFELP) loans or consumer  loans that are not part of a government guarantee program. Student loan  ABSs tend to have longer terms to maturity than other ABS classes due to  the longer repayment terms and the fact that students do not tend to pay  any principal or interest until at least 6 months after they graduate, thus  lenders might not receive cash flows on a student loan for years after the  initial cash disbursement.
section_title: Insurance Premium Finance
paragraphs: Insurance premium finance ABSs are collateralized with loans made to  businesses to finance their property and casualty insurance coverage. The  typical commercial insurance policy requires a down payment, with equal  monthly payments, typically over a time frame shorter than the term of the  insurance policy, which in effect creates overcollateralization. When a  policy is cancelled, refunds of unearned premiums will be used for making  payments to the securitization trust for the remaining term of the loan to  protect the ABS holders.
section_title: Commercial Mortgage-Backed Securities
paragraphs: Cash flows on commercial mortgage-backed securities (CMBS) are  generally backed by principal and interest payments on a pool of  commercial mortgage loans. Most commercial mortgage loans are  structured with a 30-year amortization term, but CMBS terms are generally  shorter than the corresponding amortization terms. However, recent years  have seen an increase in the number of loans with interest-only periods  during which the mortgagee pays no principal on the mortgage.  Commercial mortgages are made on a wide variety of different property  types, including rental apartment buildings, industrial properties, office  buildings, hotels, healthcare related properties, and retail properties such  as shopping malls, strip malls, and freestanding outlets. CMBSs are highly  structured and frequently have more than 20 tranches in their capital  structure. The coupon payment generally is positively correlated with both  the expected average life of the tranche and the risk that the bondholder  will not receive the entire principal amount. Also differentiating CMBSs  from other asset classes is their sensitivity to the underlying commercial  real estate prices and the cash flow generated from the commercial  properties backing the mortgages.
section_title: Commercial Fleet Leases
paragraphs: Unlike other ABS classes for which investors own direct stakes in the trust  assets, commercial fleet lease ABSs are collateralized with special units of  beneficial interest (SUBI) in open-ended leases and fleet management  receivables on a pool of vehicle leases mainly for commercial trucks,  trailers, and equipment. The leases are made on a per-vehicle basis to large  corporate customers with fleets that may have more than 5,000 vehicle  leases with the issuer. Open-ended leases require the lessee to reimburse  any loss in a vehicle’s residual value to the lessor. Commercial fleet ABSs  usually are structured out of a master trust with the ability to issue  numerous term securities. Collateral in the master trust can be replenished  with new or renewed leases as older contracts prepay and expire. The  lease SUBI entitles the ABS holders to receive the monthly lease  payments. This SUBI also includes beneficial interest in all the vehicles  that are being leased or are in the process of being leased but have not  completed the process. The fleet management receivables SUBI includes  beneficial interest in the receipt of management and other fees that the  lessees pay to the lessor.
section_title: Mortgage Servicing Advances
paragraphs: Mortgage servicing advance ABSs are collateralized with receivables owed  to the servicer for servicing advances made by the servicer to and on  behalf of the residential mortgage-backed securitization (RMBS) trusts.  There are three types of advances: principal and interest, which cover  these types of payments on delinquent loans; escrow advances, which  cover expenses related to maintaining ownership of a mortgaged property,  including property taxes and insurance premiums; and corporate  advances, which are costs for the process of foreclosure, including  attorney and other professional fees and expenses related to maintaining a  repossessed home. As there is no interest paid to the RMBS trusts when  advances are paid back out of either the proceeds of the liquidation of a  repossessed property (loan-level servicing advances) or broader pool level  cash flows (pool-level servicing advances), a discount factor is applied.  The discount factor reflects the estimated time frame for repaying the  loan. As a result of this discount factor, the issuer receives less than the  face value of the servicing advance at the time of securitization.
section_title: Dealer Floor Plans
paragraphs: Floor plan ABSs are collateralized by loans made to finance either  automobiles or nonautomotive durable goods. Nonautomotive floor plan  inventory includes, among other things, recreational vehicles, boats,  motorcycles, industrial equipment and farm equipment, appliances, and  electronics. Automotive dealer floor plan arrangements tend to be  between a single financial entity and a dealer network. Nonauto dealers  can have multiple floor plan arrangements with several capital providers.  Financing could be in the form of revolving or nonrevolving lines of credit.  Once a floor plan agreement is in place, dealers place orders for inventory  from the manufacturer and specify that a lender will provide the financing.  The loan is repaid by proceeds from inventory sales, or the dealer can  arrange to repay the loan in monthly installments.
section_title: Equipment
paragraphs: Equipment ABSs are collateralized with retail installment sale contracts,  loans and leases secured by new and used agricultural equipment,  construction equipment, industrial equipment, office equipment, copiers,  computer equipment, telecommunications equipment, and medical  equipment, among other things.
section_title: SBA-Loan Backed ABS
paragraphs: The Small Business Administration (SBA) provides guarantees on loans  made to small businesses. The most common SBA loan programs are 7(a)  and 504. In the 7(a) program, SBA guarantees up to 85 percent of the loan  amount made by participating lenders. 7(a) loans are usually made for  general business purposes, including working capital, equipment, furniture  and fixtures, and land and buildings. 504 program loans are typically long- term, fixed-rate loans for the purpose of expanding or modernizing a small  business. When pooled together for securitization purposes, underlying  loans must have similar terms and features—for example, similar maturity  dates.
section_title: Appendix V: Credit Enhancement
paragraphs: Credit enhancements are features in the structuring of a securitization that  protect investors in the securitization from losses due to defaults on the  underlying loans. The following are some methods of credit enhancement  that have been used on asset-backed securities (ABS) eligible for the Term  Asset-Backed Securities Loan Facility (TALF).
Subordination: This feature is a method of prioritizing cash flows from  the underlying loan collateral. The senior tranches within a securitization  get priority over subordinate, or junior, tranches in the event of a default  on the underlying collateral. All TALF-eligible securitizations must have a  AAA rating from at least two TALF-eligible nationally recognized statistical  rating organizations, and all of the AAA-rated ABSs have first priority for  cash flows. While most AAA tranches or bonds within an ABS have the  same priority in the event of a default, the sequential nature of the  principal paydown for certain classes of ABSs (for example, auto loans)  leads to higher risk of default for the tranches with weighted average lives  that extend further into the future. This higher risk requires the issuer to  pay a higher interest rate or coupon on longer tranches. Any losses are  applied to the most subordinate tranche first.
Overcollateralization: When the total face value on the loan collateral  underlying an ABS is greater than the face value of the bonds, the  securitization is said to be overcollateralized. These assets are maintained  on the balance sheet of the issuer and are the first to absorb credit losses  on the collateral.
Reserve account: This is a cash account set up at the origination of an  ABS. This account is accessed when the cash flows from the collateralized  loan assets are insufficient to cover the contractual payments on the  bonds, including servicing and other fees.
Excess spread: Excess spread refers to the funds leftover after payments  to bondholders and other contractual obligations have been met. This can  be used to make up for insufficient cash flows if the underlying borrowers  are delinquent or default on the loan.
Yield-supplement overcollateralization: This feature applies to  securitizations with assets in the underlying pool that are paying interest  that is below the coupon rate on the bonds. For example, borrowers  frequently pay very low interest rates on loans within certain auto loan  securitizations. These loans are often extended with advantageous  borrower terms as part of a sales promotion. Generally, the issuer will set  up a yield-spread overcollateralization account to make up the difference  over some portion of the life of the securitization. The initial balance in  this account is set as the present value of the shortfall on those loans for  the life of the loans.
Mortgage servicing advance discounts: A form of enhancement that is  implicit in the discounted price at which the securitization trust purchases  the servicing advance receivables from the mortgage servicing company  issuing the security. The servicing advances are segregated into several  classifications based on whether the servicing advances are treated at the  pool- or loan-level in order of repayment, whether the underlying mortgage  is located in a state that has a judicial or nonjudicial foreclosure regime,  and the type of cash flow for which the servicer is advancing payment. The  servicing advance is classified into one of three classes: principal and  interest advance, escrow advances, and corporate advances. Principal and  interest advances are made by mortgage servicers to holders of residential  mortgage-backed securities for mortgages whose underlying borrowers  are delinquent on their monthly payments. Escrow advances are used to  pay the property taxes, insurance premiums, or other property-related  expenses that the borrowers should have paid. Corporate advance costs,  usually in the form of attorneys’ and other professional fees, are also  accounted for in the event that the servicer incurs them while foreclosing  on and liquidating repossessed real estate.
The advance discount percentage is calculated based on assumptions  about the length of time it will take to repay that particular type of  advance and the risk that it might not be paid back. Pool-level servicing  advances have the lowest discount percentage, because the advances can  be repaid to the servicer out of the entire pool’s available funds, including  principal and interest payments received for nondelinquent mortgages.  Loan-level servicing advances are not repaid until the borrower repays all  the money advanced or from the proceeds of the sale of the repossessed  property (the likely scenario in a default). Servicing advances on  mortgages secured with properties in judicial foreclosure states have  higher discount rates than those in nonjudicial states, because judicial  foreclosures take longer. Principal and interest servicing advances are   viewed as the safest instruments and have lower discount rates than  escrow, which in turn has slightly lower discount factors than corporate  advances.
section_title: Appendix VI: Additional Information on TALF Compliance
paragraphs: According to Federal Reserve Bank of New York (FRBNY) officials,  FRBNY has in place a number of compliance measures to (1) ensure that  borrowers and collateral are eligible for the Term Asset-Backed Securities  Loan Facility (TALF); (2) protect FRBNY from fraudulent activity;   (3) reduce the risk of fraud and address conflicts of interest; (4) ensure  that agents have adequate compliance regimes; and (5) build multiple  layers of compliance where possible.
TALF has a certification regime in place for a number of TALF  participants. TALF agents and sponsors must certify that they are  complying with certain TALF requirements, and TALF agents review the  eligibility of TALF borrowers. According to FRBNY officials, TALF agents  are the first line of defense against fraudulent participants in TALF, as they  conduct “Know Your Customer” reviews of potential TALF borrowers.  FRBNY noted that it had antifraud measures in place and receives  referrals for those investors that TALF agents raised concerns about.  Moreover, FRBNY officials stated that they have developed an inspection  program to conduct on-site reviews of TALF Agent’s “Know Your  Customer” programs and files. The entire process is under the  management of FRBNY, without the Department of the Treasury’s  (Treasury) participation.
Sponsors and issuers must include in any offering document a certification  required by FRBNY. Borrowers must also provide representations to the  TALF agent, who conducts the review of the borrower. According to  FRBNY officials, because the issuers and sponsors include certification to  TALF eligibility and acknowledge certain responsibilities related to the  TALF collateral in the offering documents, any material  misrepresentations would be covered under relevant securities laws. In  addition, the TALF agents and borrowers also make certain  representations on their eligibility and the eligibility of the collateral.  Though this is a certification and self-disclosure regime, FRBNY officials  told us they have established additional measures to detect and address  noncompliance. First, FRBNY has a 24-hour fraud hotline. Second, it has  hired a law firm to assist in assessing fraud risks associated with the  program. Third, it is cooperating with other government and law  enforcement agencies to gather additional information on potential TALF  participants.
In addition to certifications, FRBNY requires auditor attestations for non- CMBS collateral, which state that the Report on Management Compliance  fairly states compliance with certain TALF program criteria specified by  FRBNY. For CMBS collateral, agreed upon procedures (AUP) are required  to provide more detailed specifications on what to review. FRBNY has  published broad guidelines to the auditors for carrying out these  responsibilities, which are paid for by the issuers of TALF-eligible  securities. In addition, FRBNY requires that the attestation and AUP  processes follow standards issued by the Public Company Accounting  Oversight Board and the American Institute of Certified Public  Accountants. Most of the information that the auditors review is provided  by the issuers and is not verified independently, according to auditors we  spoke with. FRBNY officials added that loan-level testing is required and  this includes a review of original loan files or electronic versions thereof.
According to Treasury officials, Treasury provided some input into the  design of the auditor attestations and AUPs but primarily leaves oversight  of this function to the Board of Governors of the Federal Reserve System  and FRBNY, which are responsible for designing and implementing TALF.  Treasury does not review these documents; however, should the assets be  placed to TALF LLC, Treasury may review them.
section_title: Appendix VII: New Securitization Volumes Have Increased since the Inception of the TALF Program
paragraphs: Since the Term Asset-Backed Securities Loan Facility’s (TALF) March  2009 inception, securitization volumes have increased in some TALF- eligible sectors. For auto loan securitization, new issuance dropped off  significantly in the third quarter of 2008, bottoming in the fourth quarter  (see table 5). By 2009 issuance began to pick up, especially in the second  and third quarters, when most were TALF-eligible. There were 45  issuances through December 2, 2009, a marked contrast to the peak of 85  in 2005.
Credit card securitization volumes show a similar pattern (see table 6).  The peak in credit card securitizations occurred in 2007, with 112  issuances, a sharp contrast to 2009 when only 35 securitizations were  issued through December 2, 2009. The majority of credit card ABSs  issuances in 2009—about 65 percent—have been TALF supported.
Student loan securitization volumes show similar patterns to the auto and  credit card asset classes, with a marked low of no new deals in the last  quarter of 2008 (see table 7). Lenders may be tightening their lending  standards, potentially resulting in fewer loans and reducing the need to  access the securitization markets as frequently as in the past. Although  both Federal Family Education Loan Program (FFELP) and private loan  securitizations are TALF eligible, to date no FFELP deals have been  underwritten to TALF eligibility standards. There have been five TALF  private student loan securitizations since the program’s inception.
This report discussed the severe disruption in the commercial real estate  sector following the economic downturn. Table 8 shows that commercial  mortgage-backed securities (CMBS) volumes peaked in 2006 with 97  issuances before dropping dramatically to just 7 by 2008. These sharp  declines in part motivated the inclusion of CMBSs as a TALF-eligible asset  class. Three new-issue deals have been offered since TALF was expanded  to CMBSs, and only one used TALF for financing. Other CMBS deals in  2009 were repackaging of existing securitizations. Part of the sluggish  activity in the CMBS sector could be attributed to the length of time it  takes to put together a deal, which officials have noted is considerably  longer than for the other asset classes. There could be other reasons as  well. As we discussed in this report, the CMBS sector continues to show  signs of volatility resulting from sharp declines in commercial real estate  prices and increases in CMBS delinquency rates.
section_title: Appendix VIII: Comments from the Department of the Treasury
section_title: Appendix IX: Comments from the Board of Governors of the Federal Reserve System
section_title: Appendix X: Analysis of Legal Comments Submitted by the Federal Reserve
paragraphs: As noted, in its comments, the Board of Governors of the Federal Reserve  System (Federal Reserve) did not agree with our recommendation that  Congress consider providing GAO with authority to audit the Federal  Reserve’s operational and administrative actions because it disagreed that  there are limitations on GAO’s authority to audit these Federal Reserve  activities.
However, we believe the express statutory prohibition in 31 U.S.C. §  714(b) on GAO auditing the Federal Reserve’s monetary policy and  discount window lending activities, which the Federal Reserve believes  includes the Term Asset-Backed Securities Loan Facility’s (TALF)  operation and administration, prohibits us from auditing the Federal  Reserve’s TALF activities, even from the perspective of the Troubled Asset  Relief Program (TARP). We limited the scope and conduct of this audit  accordingly, and thus did not request access to information to audit the  Federal Reserve’s performance of these activities. Further, the Federal  Reserve’s decision to voluntarily provide requested access in this instance,  while helpful, does not create GAO authority to audit the Federal  Reserve’s TALF operational activities or other performance. In our view,  our lack of authority to audit the Federal Reserve’s actions limited our  ability to fully assess the risk to taxpayer funds presented by TALF. information directly from banks and other firms receiving TARP funds, the  amendment provided GAO with such access to enable us to more  effectively review Treasury’s actions under our existing TARP audit  authority. As the Federal Reserve correctly noted in its comments, section  601 included access to records of any entity “that is established by a  Federal reserve bank and receives funding from the TARP,” thus covering  records of TALF LLC, the special purpose vehicle created by the Federal  Reserve Bank of New York to which Treasury has committed up to $20  billion of TARP funds. But GAO’s authority to obtain access to records of  TALF LLC does not provide GAO access to other TALF program  information, nor GAO authority to audit the Federal Reserve’s operation  or administration of TALF.
As support for its view that the May 2009 amendment in section 601  authorized GAO to audit the Federal Reserve’s TALF performance, the  agency quoted a portion of remarks made by Senator Grassley, a lead  sponsor of the amendment. As Senator Grassley noted, however, he was  describing the Federal Reserve’s position. The Senator provided material  for the record stating in part, “According to Federal Reserve staff, . . .   amendment No. 1020  would expand GAO’s authority  to oversee TARP, including the joint Federal Reserve-Treasury Term  Asset-Backed Securities Loan Facility (TALF) . . ..” As noted, however, the  Federal Reserve was only partially correct: section 601 provided GAO  authority to access records of the Treasury-funded TALF LLC in order to  audit Treasury, but not authority to audit and evaluate the Federal  Reserve’s TALF actions.
Citigroup, Bank of America, and Bear Stearns. This language was enacted  as a new subsection (e) to 31 U.S.C. § 714.
Finally, the Federal Reserve commented that because of TALF’s unique  “hybrid” nature—it serves objectives of both monetary policy and TARP— GAO has “ample authority” to audit TALF operations, Treasury’s  participation in them, and the Federal Reserve’s administration of TALF  “on behalf of” Treasury, all from the perspective of TARP. In this regard,  the Federal Reserve noted that in practice, it obtains Treasury’s input and  agreement on many aspects of TALF. However, the view that GAO can  separately audit the Federal Reserve’s TALF performance as long as the  audit is limited to TARP objectives, without violating the statutory  prohibition against GAO auditing Federal Reserve monetary policy  actions, is not supported by either the language of 31 U.S.C. § 714, its  original legislative history, or the amendments Congress enacted to it in  May 2009. “inextricably bound up in monetary policy” and is intended to be covered  by the prohibition. Under this reading, GAO is prohibited from auditing  the Federal Reserve’s TALF discount window lending activities even from  the perspective of TARP.
The Federal Reserve’s position also conflicts with Congress’ enactment of  § 714(e) in May 2009, noted above, authorizing GAO to audit Federal  Reserve section 13(3) actions with respect to a single and specific  partnership or corporation. If GAO already could audit TARP aspects of  “hybrid” Treasury and Federal Reserve activity, such additional authority  would have been unnecessary regarding AIG, for example, because both  Treasury and the Federal Reserve already were providing assistance to  AIG. Yet GAO was required, as the Federal Reserve then agreed, to await  enactment of additional authority in order to audit this joint assistance.
In light of these statutory restrictions on GAO’s authority to audit the  Federal Reserve’s TALF activities, we continue to believe that Congress  should provide GAO with authority to audit the Federal Reserve’s  operation and administration of the TALF program.
section_title: Appendix XI: GAO Contact and Staff Acknowledgments
subsections: section_title: Staff Acknowledgments
paragraphs: In addition to the contacts named above, Karen Tremba (Assistant  Director), Angela Burriesci, Emily Chalmers, Rudy Chatlos, Joe Cisewski,  Rachel DeMarcus, Mike Hoffman, Robert Lee, Sarah McGrath, Marc  Molino, Tim Mooney, Omyra Ramsingh, Susan Sawtelle, and Cynthia  Taylor made important contributions to this report.