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Investors Eye Fed Emergency Lending Program That Brought Rich Returns in 2009

By Dave Michaels 

Investors are preparing for the return of a stimulus program that produced big returns during the last financial crisis -- and could reignite a debate over how much Wall Street benefits from Washington's emergency lending efforts.

The $100 billion Term Asset-Backed Loan Facility is a reprise of a program launched in 2009 that enabled investors to buy bonds linked to consumer and business debt using money borrowed from the Federal Reserve. The central bank and other supporters say the program, known as TALF, helped unfreeze credit markets vital to the workings of the economy.

If it works as intended, TALF will jolt the market into reviving the issuance of new bonds, which spreads risk to investors and allows lenders to continue making loans. On the other hand, the Fed could face criticism for helping to super-charge returns for some of the biggest investors at a time when millions of Americans are losing their jobs as a result of the coronavirus pandemic.

"They are trying to ensure there is money available to continue purchasing important sources of liquidity for consumer and business lending," said Tim Clark, a former deputy director of supervision at the Federal Reserve who is now a senior banking adviser at Better Markets, an advocacy group for stricter financial regulation. "The fact that on the back side there may be some money to be made by participants in those markets has to be a secondary consideration for the Fed during a time of crisis."

The Fed hasn't said when TALF will open for business, but many investors expect it will begin operations in May. Investors hope to profit by buying bonds at a time of market distress, when prices are low, and selling them once prices recover. They will be able to borrow up to 95% of the cost of the securities from the Fed, depending on the type of debt.

The newest version offers many of the features that made the program enticing to Wall Street in 2009, including cheap loans and a low probability of losses on AAA-minus-rated debt. But the new program may also be harder to capitalize on, since lending conditions have already improved somewhat -- lowering the ceiling on bond returns -- and the earliest entrants may soak up the best opportunities.

"TALF is going to reward the fund managers who are able to move quickly into this," said Timothy Spangler, a partner in the financial services practice at law firm Dechert LLP.

Some of the world's biggest money managers, including BlackRock Inc. and Pacific Investment Management Co., along with a slew of hedge funds, bought assets during the first version of TALF. Some participants earned as much as 48% at the height of the 2009 panic, though returns were more commonly in the range of 20% to 40%.

Then and now, TALF targeted newly issued bonds backed by student, auto and credit-card loans and other assets. It also includes bonds linked to business liabilities, such as loans made to car dealers to finance their inventories, known as "auto dealer floorplan," and to heavily indebted companies with below-investment-grade credit ratings, as well as securities backed by mortgages on U.S. commercial properties such as hotels, office buildings and shopping centers.

Analysts at JPMorgan Chase & Co. said April 15 that investors could earn 21% on AAA-rated bonds backed by subprime auto loans and 16% on debt tied to privately issued student loans. Bonds backed by auto loans, auto-dealer floorplan and private student credit also look attractive, according to hedge fund manager BlueMountain Capital Management, which is considering whether to participate.

Other experts say there are limits this time to the potential for profits.

Borrowing costs, which soared in March even for the most heavily traded asset-backed securities, have continued to fall since the Fed announced the program in March. That shows how just the Fed's promise to support markets helps to limit the damage from the coronavirus even before the program has started making loans.

The extra yield over benchmark Treasury bonds that investors demand to purchase triple-A commercial-mortgage-backed bonds has dropped by about one-third since late March to 1.50 percentage points, according to research by Citigroup Inc.

Investors who participate in TALF 2.0 can probably expect percentage returns in the "mid-to-high single digits on the low end to the low teens on the high end," said Greg Leonberger, director of research and managing partner at consulting firm Marquette Associates Inc.

"Investors may think twice about making an investment given the illiquid nature of the funds," Mr. Leonberger said.

At the same time, a shortage of newly created loans during the economic slump will make it difficult for banks and investment managers to find enough loans to package into bonds and sell to investors.

"There just may not be as many TALF-eligible assets the longer it takes to get the economy up and running," said Jeff Phlegar, chairman and chief executive officer of MacKay Shields LLC, a New York Life Investments company that is weighing participation in TALF 2.0.

--Matt Wirz contributed to this article.

Write to Dave Michaels at dave.michaels@wsj.com

 

(END) Dow Jones Newswires

April 25, 2020 05:44 ET (09:44 GMT)

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