Institutions see TALF as moneymaker

Money managers and investors are excited but a little wary about the return potential from investments in securitized products made with loans from the Federal Reserve Bank's new Term Asset-Backed Securities Loan Facility.

The lure of TALF 2.0 — the investment industry's popular moniker for the program — for investors is the possibility of achieving returns akin to those from funds associated with the Fed's circa-2008 TALF program.

Some investors, including the $52.3 billion Teachers' Retirement System of the State of Illinois, Springfield, saw internal rates of return between 30% and 40% or higher from investments in 2009 TALF-related asset-backed securities funds, sources said.

Investment consultants and managers report strong interest from asset owners in TALF-related funds, with most evaluating the opportunity now.

As for performance expectations from TALF 2.0 funds, based on current market conditions, estimates are for high-single-digit returns on the low end and mid-double-digit returns on the high end, said Elijah B. Reese, U.S. head of fixed income and portfolio management, Aon Investments USA Inc., Chicago.

Sources said while some aspects of the loan program remain to be determined by the Fed, TALF 2.0 primarily is modeled on the terms and conditions of the prior TALF program which opened in March 2009.

The Federal Reserve Bank of New York committed up to $100 billion to provide three-year loans through a special purpose vehicle, according to the Fed's April 9 term sheet. Eligible borrowers — which can include pension funds — must be U.S. companies with collateral consisting of AAA-rated asset-backed securities and collateralized loan obligations issued on or after March 23. Commercial mortgage-backed securities issued before March 23 also are eligible collateral. The TALF program will award loans equal to the market value of the securitized assets less an upfront fee. The Fed will stop making loans from TALF as of Sept. 30 unless the program is extended.

Although the Fed hasn't said when TALF 2.0 will begin, odds are on a June 1 rollout, industry observers said.

With the program's commencement date looming, managers with private credit expertise aren't wasting time prepping new funds to accommodate the assets they will acquire with their TALF loans, said Alice Lee, London-based director, investments and head of securitized credit manager research for investment consultant Willis Towers Watson PLC.

"After grinding to a halt, the (ABS) market is waiting for new issuance to pick up again," Ms. Lee said, adding that "spreads (relative to an ABS bond's corresponding swap rate) have continued to tighten since the TALF program was announced and a good portion of the AAA ABS bond market now trade below 200 basis points."

"Given the current trajectory, the return opportunity looks more like it will be in the high single-digits to low teens. Still, for assets that have a low risk of credit impairment, it could still be a good trade," she said, noting "managers are trying to get into this program fast because credit spreads may continue to tighten. It might be over before you know it."

Option-adjusted ABS spreads have narrowed from a recent peak of 325 basis points on March 26 to 180 basis points on April 16 for the Bloomberg Barclays U.S. Aggregate Corporate Average OAS measurement. On Dec. 31, the spread was 44 basis points.

Among the money managers known by sources to be readying funds are Angelo Gordon & Co. LP and Hildene Capital Management LLC. Spokesmen for the firms declined to comment.

Industry observers said many larger firms that participated in the initial TALF program are thought likely to reup for the new program, including BlackRock Inc., Morgan Stanley Investment Management, Invesco Ltd., Pacific Investment Management Co. and T. Rowe Price Associates Inc. Spokesmen for these firms declined to comment or did not respond to requests for information about their TALF 2.0 intentions.

ArrowMark Partners, a subsidiary of ArrowMark Colorado Holdings LLC, Denver, was the fourth-largest borrower in the first TALF program with a total $4 billion in loans and does "intend to participate in the TALF auctions, assuming investment conditions remain attractive," said spokeswoman Robin C. Beery in an email.

ArrowMark Partners managed $19.6 billion as of Feb. 29, its most recent SEC investment adviser disclosure filing showed.

Manulife Investment Management, Toronto, participated in the CMBS portion of TALF 1.0 and is assessing the opportunity represented by the new TALF program, said Peter Farley, a Boston-based managing director and senior portfolio manager, in an email. "Spread levels, sentiment for credit and available supply for eligible TALF sectors will eventually dictate its attractiveness, and timing is always important," he said.

Manulife does not disclose the size of the loans the firm received under TALF 1.0, said company spokeswoman Elizabeth Bartlett.

Manulife Investment Management had C$879 billion ($673 billion) in assets under management and advisement as of Dec. 31.

Shifting spread levels, particularly if they tighten significantly, are one of the perils facing managers as they set up their TALF investment portfolios or prepare to add TALF assets into existing multicredit portfolios, said Aon's Mr. Reese.

"The best returns in TALF 1.0 were in the earlier part of the program" before securitized-product markets began to materially improve, Mr. Reese said. "Managers who already have existing funds they can put the TALF assets into have an advantage over managers that don't. Those managers may miss out on near-term opportunities if their fund structures aren't ready."

In fact, the success TALF 1.0 had in normalizing the ABS market led to narrower spreads, reducing the incentives to borrow through the program, according to the New York Fed's evaluation of the program in its November 2012 Economic Policy Review.

The improvement in market conditions and liquidity in the ABS and CMBS markets was strong enough in 2009 that it led to a lower-than-expected volume of lending with a total of just $71.1 billion in TALF loan requests from the $1 trillion pool the Fed had pledged for the program, the report showed.

Among institutional investors taking a close look at the return prospects for investment in TALF 2.0 opportunities is the Illinois Teachers' Retirement System.

The pension fund committed $100 million in 2009 to a dedicated TALF strategy managed by Pacific Investment Management Co.

The system's investment in "TALF 1.0 did help our portfolio in 2011," said CIO R. Stanley Rupnik in an email. "TRS earned between 30%-40% net (internal rate of return) under the program, so a review of TALF 2.0 is warranted once we know more."

"We have heard that interest in the program (from institutional investors) is high. Like other investment opportunities, TRS will evaluate the particulars of TALF 2.0 in the context of our existing portfolio and asset allocation once the specifics are released," Mr. Rupnik said.

The South Carolina Retirement System Investment Commission, Columbia, also was an investor in the first TALF program, although details were not available about the previous investment, said Kara Brurok, a fund spokeswoman.

"Regarding TALF 2.0, we are evaluating the opportunity set, but do not have an opinion (about an investment) at this time," Ms. Brurok said.

The RSIC manages the portfolio of the $33.5 billion South Carolina Retirement Systems, Columbia.

The Minnesota State Board of Investment, St. Paul, did not invest in TALF 1.0 investment strategies from the state's $74.2 billion combined defined benefit fund, which is managed by the board.However, Mansco Perry III, executive director and CIO, said this time around, it's worth evaluating.

"It's interesting, but the devil is in the details. And of course, fees and hurdle rates will be important," Mr. Perry said.

As of Dec. 31, the board managed a total of $104.3 billion, including the combined defined benefit fund.