Federal Reserve Announces Changes in Ratings and Risk Assessment for TALF ABS

Yesterday, the Federal Reserve announced two significant changes to its “procedures for evaluating asset-backed securities (ABS) pledged to the Term Asset-Backed Securities Loan Facility (TALF).”  The first is a proposed rule that would establish criteria for the Federal Reserve Bank of New York (FRBNY) to choose additional Nationally Recognized Statistical Rating Organizations (NRSROs) for newly issued ABS (not backed by commercial real estate) other than the three largest rating firms, Standard & Poor’s Ratings Services, Moody’s Investors Service and Fitch Ratings. The second is a change in the Federal Reserve’s collateral review process that is intended to enhance the credit quality of the ABS that is pledged, by subjecting all collateral to a risk assessment to be conducted by the FRBNY.

The Federal Reserve’s proposed rulemaking would establish guidance for the FRBNY "to determine the NRSRO whose ratings are accepted for determining the eligibility of ABS to be pledged as collateral at the TALF.”  The proposed rule, if adopted,  would likely result in an expansion of TALF-eligible NRSROs for newly issued ABS by permitting rating agencies with a certain minimum level of experience in rating ABS deals to participate. The FRBNY presently accepts ratings for CMBS collateral from DBRS, Inc., Fitch Ratings, Moody’s Investors Service, Realpoint LLC and Standard & Poor’s.

In the second part of its release, the Federal Reserve announced that, beginning with the November subscription, the FRBNY will conduct a formal risk assessment of all pledged ABS collateral. Currently, the FRBNY only formally assesses the risk of newly issued and legacy CMBS. The risk assessment will be in addition to the present requirement  that collateral pledged for TALF loans receive AAA ratings from two TALF-eligible NRSROs. In order “[t]o facilitate the risk assessment, each issuer wishing to bring a TALF-eligible ABS transaction to market will be required to provide, at least three weeks prior to the subscription date, information including, but not limited to, all data on the transaction the issuer has provided to any NRSRO.” The Federal Reserve has issued an outline describing the standards guiding its risk assessment principles for non-mortgaged-backed ABS and an update of the TALF program's Terms and Conditions and list of  Frequently Asked Questions. Under the new collateral review process, ABS issuers “may reasonably expect an indication of acceptability based on the Federal Reserve Bank of New York's risk assessment at least one week before the applicable subscription date.”

The TALF is a $200 U.S. billion non-recourse credit facility funded by the FRBNY that was originally scheduled  to terminate December 31, 2009. In August, the Federal Reserve and the U.S. Treasury jointly issued releases announcing the extension of the TALF through March 31, 2010, for TALF loans against newly issued ABS backed by consumer and business loans and legacy commercial mortgage-backed securities (CMBS), and through June 30, 2010, for TALF loans against newly issued CMBS. The facility was originally scheduled.