CMBS included

But hung commercial real estate loan problem remains

The US Federal Reserve announced on Friday that, starting in June, qualifying new issue CMBS will be accepted under the TALF. However, the move has disappointed some in the market by failing to include details of future provisions for legacy CMBS assets. At the same time, there is concern that neither the new issue nor the legacy CMBS TALF requirements will address the problem of hung commercial real estate loans on banks' balance sheets.

"The Fed long ago telegraphed its intention to expand TALF 1.0 (new issue) to CMBS, but the more recent announcement that legacy assets would become eligible (TALF 2.0) raised expectations that details for legacy securities would be forthcoming," says Aaron Bryson, CMBS strategist at Barclays Capital. "The announcement makes no mention of legacy assets and is likely a disappointment to investors."

The TALF new issue CMBS criteria are designed to spur new direct lending in the first instance, while the TALF legacy CMBS criteria - which the government has announced will be released at a later date - are designed initially to unclog bank balance sheets in order to eventually lead to the same goal of new lending. Precilla Torres, md at NewOak Capital, suggests that the government's delay in providing details about legacy CMBS TALF terms vis-à-vis its Friday release of the provisions for the new issue CMBS programme was disappointing for the market because many investors had been 'fronting' secondary assets at discounts to garner enhanced returns when the legacy TALF programme came on line.

The new issue programme is targeted only at CMBS issued on or after 1 January 2009, collateralised by loans that were originated on or after 1 July 2008. The announced collateral haircut is 15% for bonds with average lives of five years or less. An additional percent will be added to the collateral haircut for each additional year of average life up to ten years.

The maximum annual excess carry for the first three years of five-year TALF loans will be 25% of the initial haircut, 10% for the fourth year and 5% for the fifth. Investors may instead choose a three-year loan, in which case there is no such cap on carry. There is also a restriction on the type of eligible CMBS: the bond must bear interest and principal and cannot be subordinated to other bonds on the same pool of loans.

TALF acceptance of new issue CMBS will nevertheless provide significant assistance for issuers in the short term, according to Torres. "I believe that issuers will take advantage of it, in spite of excess spread being capped at 25% and the penalties for maturities of CMBS with terms of over five years. The provisions attempt to balance the interests of issuers and the tax payers: there are limitations to the upside, while retaining reasonable economic incentives for issuers/lenders," she says.

Bryson indicates that, while the new issue terms should aid new origination, leveraging only the senior-most tranche could limit the benefit to deal creation. "The TALF 1.0 extension to CMBS is certainly meant to spur new lending," he notes. "The optimistic argument holds that new lending activity can feed back into underlying fundamentals in the form of lower debt costs and cap rates, enhancing the refinance-ability of recent vintages at the margin - leading from a 'vicious' to a 'virtuous' circle. We certainly place weight on this optimistic argument and the power of feedback loops; however, we would also prefer to see more details on legacy TALF loan terms."

Provisions for TALF legacy CMBS are expected to be released soon. These are likely to address the perceived credit issues of vintage deals (for example, the pro-forma underwriting common in 2007 transactions) by, for example, including potentially higher haircuts and interest rates than those stipulated for TALF new issue CMBS.

But Torres points out that there is a section of the commercial real estate market that has so far fallen through the gap between the qualifying criteria for the new issue CMBS TALF and the expanded TALF/legacy securities TALF programmes. Bank balance sheets remain clogged up with commercial loans made prior to 2008 that were slated for securitisation but didn't make it.

"This is an issue, representing billions of dollars, that still needs to be addressed," she explains. "The problem is that, while these loans qualify for the legacy loan programme, there is concern that banks won't sell the loans at current bid/ask spreads; however, securitising the loans and selling the resulting triple-As via TALF, with banks retaining the subordinated paper (either in loan or securities form), may result in economics that may be more palatable for banks to 'sell' a portion of such on-books assets. This could be achieved by amending the eligibility criteria for the TALF legacy securities or new issue CMBS programme even further."

In the same announcement, the Fed said that securities backed by insurance premium finance loans would also be eligible for the TALF from June and that up to US$100bn of TALF loans (to finance purchases of CMBS, as well as ABS backed by student loans and by loans guaranteed by the Small Business Administration) could have five-year maturities - though it will continue to evaluate that limit.

"Extending TALF to CMBS with five-year terms is critical to providing liquidity and facilitating lending in the commercial mortgage market," comments Christopher Hoeffel, president of the Commercial Mortgage Securities Association. A five-year term is more consistent with the longer-term nature of commercial lending and will provide more flexibility to borrowers as they navigate the current real estate cycle, he concludes.

CS