Fed Struggling to Win Over Investors Wary of ‘Sharks’ in TALF

By Scott Lanman and Craig Torres

April 3 (Bloomberg) -- The Federal Reserve’s $1 trillion effort to restart the market for securities backed by loans is encountering resistance from investors, undermining Chairman Ben S. Bernanke’s attempt to further drive down borrowing costs.

The Term Asset-Backed Securities Loan Facility may next week fail to see a big rise from its $8.3 billion first round of investor commitments in March, said Reed Auerbach, co-chief executive officer of law firm McKee Nelson LLP in New York. Hedge funds and other investors are balking because of visa restrictions on workers and possible efforts to tax earnings.

Investors are concerned that Congress, while responding to taxpayer anger over bank bailouts, hasn’t described how the most sweeping regulatory overhaul since the Great Depression will change the ways financial companies turn a profit. The government needs Wall Street to help revive credit yet can’t ignore the outcry over aid to firms that took excessive risks.

“I can do very well for my clients without venturing into federal waters which are inhabited by sharks,” said David Kotok, the chairman of Cumberland Advisors Inc. in Vineland, New Jersey, who manages about $1 billion. “We are leery of doing anything with the federal government.”

Bernanke has had some success in pushing down rates through lending and credit programs introduced since December 2007. The Commercial Paper Funding Facility, begun in October to purchase short-term corporate debt, has “significantly” reduced interest rates on the paper, Bernanke said in a speech last month.

Average Rate

Also, the average U.S. rate on a 30-year fixed mortgage dropped to 4.78 percent this week, the lowest in Freddie Mac data going back to 1971, in response to the Fed’s commitment to buy $1.25 trillion in bonds backed by home loans.

Financial companies have faced criticism from lawmakers and taxpayers after bonus payments were provided to executives at American International Group Inc., the insurer receiving a $182.5 billion government rescue.

The U.S. House of Representatives this week passed legislation to ban bonuses at companies getting aid if the payments are deemed “unreasonable or excessive” by the Treasury Department or not performance-based. A separate bill last month, also approved by the House, would set a 90 percent tax on bonuses at companies that got at least $5 billion from the Treasury’s Troubled Asset Relief Program.

The $787 billion fiscal-stimulus law enacted in February contains a provision that makes it tougher for recipients of federal bailout funds or Fed emergency loans to hire skilled workers from abroad. TALF investors would be among those subject to the restrictions.

First Round

The Fed extended $4.7 billion of TALF loans in March for the first monthly round, or less than 1 percent of $1 trillion. Investors have until 3 p.m. New York time on April 7 to apply for TALF loans to buy newly issued securities this month. For the first round, the Fed provided a two-day extension on the deadline for loan applications.

This month’s deal volume “might be marginally more, but I would be surprised if it was overwhelmingly more than March,” said Auerbach, who is working with issuers and underwriters on the program. “There’s a lot of concern about the populist revolt against Wall Street.”

The TALF is being funded partly by $100 billion from the $700 billion TARP formed by Congress in October. The Fed effectively prints money to provide the loans, with the TARP funds giving the central bank protection from losses.

Even without a surge of applications for TALF loans, extra yield relative to benchmark interest rates that investors demand to own debt backed by some types of consumer loans has declined in recent weeks.

Auto Loans

Top-rated bonds backed by auto loans traded at about 250 basis points more than the benchmark rate, a drop of 75 basis points from four weeks earlier, according to a Citigroup Inc. report. A basis point is 0.01 percentage point.

The TALF will initially lend as much as $200 billion to finance the purchase of AAA rated securities containing loans for autos, education, credit cards and small businesses. A later phase will expand the TALF to $1 trillion and include commercial mortgage-backed securities, while the Treasury will also use the TALF to remove older mortgage debt from banks’ balance sheets.

A few obstacles to greater investor involvement aren’t within the Fed’s control.

Some investors are declining to sign private contracts with brokers because of concern about allocation of risk between the dealer and the investor, Auerbach said. Also, there are concerns the deepening recession may result in defaults on loans contained in TALF securities.

Too Risky

Richard Schlanger, who helps invest $13 billion in fixed- income securities as vice president at Pioneer Investment Management in Boston, said it may be too risky to invest in consumer loans, even with the TALF limited to AAA rated securities. “The consumer sector is going to continue to come under scrutiny and have a difficult time,” he said.

Keith Hembre, a former Fed researcher who is now chief economist at FAF Advisors Inc. in Minneapolis, helping oversee $109 billion, said the TALF program “ignores” the level of demand from consumers for new loans. Also, with weak investor demand, “you’re not injecting as much credit easing into the system” as possible, Hembre said.

Investors may gain significant returns through the TALF. Citigroup sold $3 billion of securities linked with credit-card loans last month in the TALF’s first round.

Notes Unscathed

An investor putting up $6 million to buy $100 million of one three-year class of the securities under the TALF could make about $840,000 a year, based on current Libor rates, if defaults on the underlying credit card loans are small enough to leave his notes unscathed, according to Bloomberg calculations.

That’s an annual return of roughly 14 percent, before considering a Fed administrative fee of $47,000.

Attorney V. Gerard Comizio, senior partner in the banking practice at Paul, Hastings, Janofsky & Walker LLP in Washington, said his firm recently held a conference call with representatives from about 300 companies who were “wildly concerned” about the restrictions on hiring foreign workers.

“Businesses like certainty,” and it’s important that the government not alter any terms or rules after investors sign on to the TALF and other government aid programs, Comizio said.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net; Craig Torres in Washington at ctorres3@bloomberg.net.