Financial Markets in Crisis: TARP Covers Automakers; More TALF Details Announced

December 24, 2008

The Gibson, Dunn & Crutcher Financial Markets Crisis Group is tracking closely government responses to the turmoil that has catalyzed dramatic and rapid reshaping of our capital and credit markets.

We are providing updates on key regulatory and legislative issues, as well as information on legal issues that we believe could prove useful as firms and other entities navigate these challenging times.

This update focuses on the terms of the government’s agreement to provide financial assistance to the automobile industry, as well as recently released details of the Term Asset Backed Securities Loan Facility (TALF).

Auto Rescue Package

On Friday, December 19, Secretary Paulson announced that the Treasury would use its authority under the Troubled Asset Relief Program (TARP) to stabilize America’s automotive industry.[1]  Treasury agreed to loan the remaining $13.4 billion in the first $350 billion tranche of its TARP funds to assist Chrysler and General Motors while they undergo a significant restructuring.  The companies will receive $13.4 billion immediately and, if the second tranche of TARP funds is released, another $4 billion in February 2009.

Under the conditions of the loans, the federal government will take warrants for non-voting stock in the companies.  If the companies have not submitted a plan that, to the satisfaction of the “President’s Designee,” shows that they are financially viable by, at the latest, April 30, 2009, the loans will become due and payable within 30 days.

The companies also must accept limits on executive compensation and perks, such as corporate jets,  allow the government to inspect their books, and comply with federal emissions requirements.  They are further required to employ “best efforts” to, among other things, reduce debt, achieve wage and work rule parity with foreign-based automobile manufacturers’ U.S. workers, eliminate compensation other than severance pay for fired workers, and make payments to voluntary employees beneficiary associations primarily in stock.

In conjunction with this announcement, Secretary Paulson stated in his prepared remarks that, “It is clear . . . that Congress will need to release the remainder of the TARP to support financial market stability,” and that he would discuss that option with Congress and the President soon.  More recent reports, however, and our intelligence suggest that the Bush administration probably will not request the additional funds in its remaining days. [2]

Though President Bush claimed it would be “irresponsible” to allow the automobile companies to enter bankruptcy, he faced strong criticism from many congressional Republicans who recently helped defeat a similar legislative package.  Republicans with constituencies involved in the automobile industry, such as Senators Kit Bond (MO) and George Voinovich (OH), along with Democrats, including Senate Majority Leader Harry Reid and House Speaker Nancy Pelosi, praised the plan.[3]

TALF Details

Also on December 19, the Federal Reserve released new details about the TALF, a program under which the Federal Reserve Bank of New York will finance the purchase of up to $200 billion of newly issued, highly-rated asset-backed securities (ABS).  As originally announced, some of the details of the program are as follows:

• The loans will be one year [now three year], non-recourse loans, and will be fully securitized by ABS;
• Asset purchases will be made through Special Purpose Vehicles (SPVs), much as the Federal Reserve’s Commercial Paper Funding Facility is structured;
• Under the terms of the program, institutions can receive funding for securities collateralized by newly issued auto, student, and credit card loans, and loans guaranteed by the Small Business Administration;
• U.S. persons that own eligible ABS may participate in the program but must do so through a primary dealer;
• Originators of the credit exposures behind ABS must agree to abide by executive compensation standards established by the Emergency Economic Stabilization Act and implemented through Treasury guidelines;
• Awards will be made through a monthly sealed bid auction process [now allocated to all eligible borrowers]; and
• The $20 billion in TARP funds will serve as first loss protection for the NY Fed.  Cash from SPV assets will be used first to repay NY Fed loan principal and interest and second to cover the subordinated TARP loan.

The Fed revised the TALF’s terms after consulting with ABS issuers, investors, and dealers.  Under the revised terms, the Fed extended TALF’s loan maturity from one year to three years and now will provide funding to all eligible borrowers, rather than distributing the funds through an auction.[4]  Currently, the real estate industry is lobbying for the purchase of newly issued mortgage backed securities to be eligible for TALF assistance.[5]  The NY Fed indicated when it announced the program in November that the list of ABS eligible for purchase may be expanded  to include commercial mortgage-backed securities, non-Agency residential mortgage-backed securities, or other asset classes.  Hence, the terms of the program may continue to evolve.