Monday, June 8, 2009

TALF is giving ABS a nice ride

Asset-backed securities (ABS) have experienced an unprecedented rally recently. Here we are going to look at ABS as bonds collateralized by receivables from credit cards, auto loans, auto leases, equipment leases, and student loans (as opposed to any real estate linked collateral.) The recent rally (collapse in spreads) is getting us back to the pre-Lehman levels. Effectively the "Lehman premium" in credit has been taken out.

This is indeed a positive development for the consumer. To the extent the US consumer is willing to maintain or add leverage, it's going to cost less (assuming the lenders can pass on their savings to the consumer). Such a rally must indicate a new source of demand for paper. Well, it's coming from the tax payer via TALF. The chart below shows ABS issuance via private funds, vs. TALF transactions. TALF-based financing is driving the new demand.

For more info on TALF, please see our post on the issue. So the taxpayer is financing this stuff and the question remains whether there will be a home for this paper in the post-TALF world. The good news is that the taxpayer holds the most senior claim and has much more subordination (down payment from investors) than senior lenders did in the past. Below is a chart prepared by Morgan Stanley that compares Harley-Davidson motorcycle loan receivables securitization pre-crisis and post-crisis with TALF.

The green portion is the AAA tranche that in the past would have been bought by investors/banks who used commercial paper conduits (topic for a later discussion) to fund these. Now the government lends against the AAA tranche that has a far bigger cushion (the gray section) than in the past (yellow and blue). This is to a large extent due to rating agencies trying to correct for their past mistakes, making much more conservative assumptions about defaults. Now that the tax payer (via the Fed) is loaded with this debt (in addition to all the other debt the Fed is buying), let's hope we can -forgive us- ride it out.

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