TALF: A Looming Deficit

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Last week I published a blog post that outlined the credit facilities introduced by the Federal Reserve to address the impact Coronavirus has had on the financial markets and real economy. My introduction to that post did not shy away from the fact that I had some reservations and misgivings about the decisions made by the Fed. I stated that I would expand on these misgivings in more detail in future posts, so this week I will follow through on that statement. I am going to discuss issues I have with three credit facilities in particular in separate posts: Term Asset-Backed Securities Loan Facility, Primary Market Corporate Credit Facility, and Secondary Market Corporate Credit Facility. I will begin with TALF.

The Missing Market

I’d like to start off by stating that I understand the impetus for TALF and believe it will provide stability to lenders and allow them to support borrowers through the crisis. The rationale is essentially that this will allow lenders to continue extending credit since the Fed will step in and maintain the market for asset backed securities. However, as American Banker has pointed out, the 2020 version is ill equipped to fully address the existing market for these loans. This credit facility neglects a significant aspect of the contemporary market – the prominence of unsecured consumer loans.

According to Kroll Bond Rating Agency (KBRA), approximately $10 billion of consumer loan backed ABS was originated in 2019. These loans were primarily originated by nonbank lenders, also known as “fintechs” (financial technology companies). These loans are typically considered investment-grade (i.e. they have a higher interest rate associated with them in lieu of collateral and therefore provide a higher yield to investors willing to purchase them). The problem here is that these tranches of ABS loans are not eligible under the existing TALF provisions, hence excluding a significant portion of originators from relief. It is likely that this will in turn lead to restricted credit access for millions of consumers.

Demand for unsecured consumer installment loans has expanded rapidly over the last 10 years, with volume more than doubling. The St. Louis Fed published an article stating that approximately 78% of consumers have utilized these loans in one form or another, most often for the purpose of refinancing existing debt. These loans also play a significant role in small business lending – which I can speak to anecdotally. Small business owners will often front initial start-up costs with personal loans from companies such as Prosper or Kabbage. Once they become “bankable” (i.e. they have a more stable track record operating as a business) they will seek to refinance these installment loans with a commercial loan at a lower rate.

Many fintechs fund their lending operations through the capital markets. They originate the aforementioned installment loans and then package them as investment-grade ABS products for sale to investors. As a result of the uncertainty stemming from the pandemic, the market for these riskier, higher yield ABS products has started to dry up. Since many of these fintech companies rely on the capital markets to fund their operations, the absence of prospective buyers for these tranches will force them to rely on their balance sheets to originate new loans, or halt lending for an undetermined period. Given the business model associated with most fintechs, the latter appears to be the more likely outcome. This will of course lead to a large swath of consumers being cut off from much needed credit.

Conclusion

Without access to reasonably priced credit, many consumers will be left without viable credit options. The alternative for many will be to accept credit on more expensive terms at a time when they will likely be unable to afford it. Unfortunately, given the dynamics of the pandemic, it is difficult to think of a viable solution to the aforementioned that wouldn’t have to come from TALF. This is especially true, in my opinion, given the issues we’ve seen with the roll out of PPP lending and individual stimulus checks.

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