End Of TALF Signals Stability

Federal Reserve sees enough evidence to reach for the brake pedal.

Three components for a sustained commercial real estate recovery went into motion in recent weeks, giving rise to optimism. More debt financing, further loan sales and CMBS stability all appear to finally be on the horizon.

First, Freddie Mac recently launched a new program that partners with mezzanine lenders to expand its multifamily loan originations, bringing positive usage of the word “leverage” back into vogue for commercial real estate finance.

In the program, mezzanine partners provide leverage of up to 85% loan-to-value (LTV) on top of the safe 60% LTV senior notes that Freddie funds or holds as investments.

Then, the Federal Reserve's recent move to reverse course on its nearly zero percent federal funds rate for member banks also is a sign that both the economy and real estate market may be turning around quicker than anticipated.

Meanwhile, capital continues to flood the financial markets, giving sufficient evidence for the Fed to bring TALF, the Term Asset-Backed Securities Loan Facility, to an uneventful close. TALF is a program that supports the CMBS and asset-backed securities market by purchasing some legacy and new real estate-backed bonds. TALF for legacy loans ended on March 31, and the program ends on June 30 for new loans.

The FDIC effect

The manner in which the Federal Deposit Insurance Corp. plans to auction more than $1 billion in assets that it seized from failed banks is another connecting dot for winding down TALF.

The FDIC is simply selling partnerships in its portfolio of mostly sub-performing and non-performing assets, and the agency is retaining a 60% stake to share in the anticipated upside when prices begin to rise again.

The FDIC also is considering loan sales in the form of a CMBS offering. And because competitive bids are in ample supply for its whole loans, the agency is on the verge of joining the CMBS issuance space, a significant vote of confidence in the capital markets.

The next FDIC auctions are expected to have a greater impact on real estate finance. They may trigger some banks to write down their real estate finance holdings. Some 63% of the loans set to be auctioned were not issued exclusively by the seized banks. Other banks are co-lenders in these loans, with sealed bids due April 6 and April 9.

If the assets are auctioned at a deep enough discount, the co-lenders can be forced to recognize such write-downs on their already vulnerable balance sheets.

Consequently, some banks, faced with the possibility of seeing their participation value diminished as a result of the sales, may bid for the assets themselves as a strategy to protect their balance sheets.

CMBS recovery

According to CMBS trading data from Barclays Capital, returns are rising because depressed high-quality bonds and loans continue to stage an impressive comeback. The trend gives the Fed confidence to end TALF on schedule.

Already the Barclays CMBS Trading Index shows a total return of 7.41% from January through mid-March 2010, compared with 2.55% from October through December of 2009.

Similar data from Morgan Stanley shows the highest-rated CMBS tranches now yielding just over three percentage points (3.03%) above U.S. Treasuries. This is the lowest spread since August 2008, when the credit markets went into meltdown, and these spreads followed corporate bonds, reaching record highs.

Finally, even though CMBS delinquencies have spiked and only about $20 billion worth of new issuance is projected for 2010, Moody's Investors Service notes that the delinquency rate on CMBS loans it tracks rose 31 basis points to 5.73% in February. This is below the average of 44 basis points during the previous five months.

So TALF quietly ends, and even the largest outstanding troubled CMBS loan today — a $3 billion mortgage on the Stuyvesant Town-Peter Cooper Village apartment complex in Manhattan — has yet to be officially classified as in default. Instead, the loan has been in special servicing since January, awaiting resolution. All eyes are on the outcome of this resolution to gauge evidence of a commercial real estate recovery.

Joe Caton is a South Florida journalist who provides training and development services to real estate finance professionals.

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