Starved for good news, the lending community earned a major victory this week in the effort to revive the commercial mortgage-backed securities market and restore investor confidence.
On Tuesday, the Treasury Department unveiled its Financial Stability Plan to unlock the credit markets and strengthen the financial system. A major component of the financial rescue package calls for an expansion to $1 trillion of the government’s Term Asset-Backed Securities Loan Facility (TALF), and allocates part of the program to purchase AAA-rated commercial mortgage-backed securities.
“The intent here is not to have the federal government become the CMBS buyer of last resort or to even bail out the commercial mortgages,” explains David Cardwell, vice president of capital markets and technology for the National Multi Housing Council. “It’s an attempt to try and provide some liquidity to the loans that are maturing in the commercial mortgage-backed securities market. That is the single focus.”
Of the $806 billion of commercial and multifamily mortgages held in or related to CMBS, collateralized debt obligations or other asset-backed securities, $90.5 billion will mature in 2009, followed by $61.9 billion in 2010, according to the Mortgage Bankers Association (MBA).
The fed’s move will mean that high-quality loans with reasonable debt-service coverage and loan-to-value ratios can be issued without a significant level of tranches because there is a AAA buyer, according to Cardwell.
“If a AAA buyer is in the market, that will bring the interest rates down because there will be a confidence level that these loans are secure and that someone wants to invest in them, and so the other investors will come in,” he says.
The move couldn’t come soon enough for a CMBS industry that is in total hibernation after being a major driver of commercial real estate finance for several years. After a record-setting $230 billion in domestic CMBS issuance in 2007, total U.S. issuance in 2008 plummeted to $12.1 billion with no issuance in the second half of the year. Bond investors’ lack of appetite for risk has caused spreads to widen dramatically and forced borrowers to look elsewhere for more favorable financing terms.
TALF was initially launched in November 2008 as a $200 billion government loan facility designed to stimulate investment in car loans, student loans, credit cards and small business loans. The inclusion of commercial real estate in the “son of TALF”, as some industry experts refer to the facility, comes on the heels of intensive lobbying efforts for federal assistance by the MBA, the Commercial Mortgage Securities Association and 10 other trade groups.
"We commend President Obama, Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke for recognizing the importance of including commercial real estate in the Financial Stability Plan," commented Doug Bibby, president of the NMHC, in a written statement. "Most of the attention paid to the mortgage crisis has been on the single-family finance system, but the apartment sector and other commercial real estate sectors, like so many other industries, have become collateral victims of the global financial meltdown."
The importance of the expansion of TALF can’t be overstated, said Jan Sternin, senior vice president of the commercial/multifamily division at the MBA, during the association’s 20th annual convention in San Diego this week. With so much focus over the past year on government steps needed to stabilize the faltering housing market, the commercial real estate sector was in the shadows.
“Unlike the residential sector, we had performing loans and the property fundamentals were sound. We had an unprecedentedly low delinquency rate,” says Sternin. At one point, loan delinquencies on CMBS were less than 1%.
But the economy started to deteriorate rapidly during the second half of 2008. “Property fundamentals went down, and loan delinquencies started to rise. We knew we had to do something,” says Sternin. “The trade associations came together, they sent joint letters, they had joint meetings.”
While Treasury has expressed its support for the commercial real estate industry, details of the implementation of TALF have yet to be rolled out. “This is not easy stuff and you’ve got folks coming in that are new to the [Obama] administration, and new to Capitol Hill,” Sternin says. “Part of what the MBA continues to do is to educate. Unless you understand how structured finance works, it’s going to be hard to understand, or hard to manage this in a rollout process.”
TALF is not the silver bullet for commercial real estate, emphasizes Sternin. Also top of mind is the need to modify the legal structure of real estate mortgage investment conduits (REMICs) to grant special servicers more latitude in the event that a CMBS loan becomes troubled. The MBA has been working on REMIC reform for three years. “REMIC reform is all about allowing special servicers to have more tools in their tool belts,” says Sternin.
Sam Chandan, president and chief economist at Real Estate Economics, agrees that the expansion of the TALF will not, in and of itself, breathe life back into the CMBS market.
“Another area of significant conflict that needs to be addressed is resolving investor concerns around the role of the rating agency in terms of its compensation by the issuer and a greater transparency around the rating agency’s processes for measuring and disseminating information about the risk of the underlying collateral,” he says.
In addition, Chandan maintains that the misalignment of risk and incentives between mortgage originators and CMBS issuers will also need to be addressed to get the CMBS market up and running again.
“There’s a fundamentally different risk profile associated with being an originator of one type of loan versus another,” he says. “In one case, you’re holding the full extent of the risk on your balance sheet through maturity. In another case, you’re largely transferring that risk over to another party.”