Fed Extends TALF to Include Legacy CMBS

More details of the Fed’s broadened Term Asset-Backed Securities Loan Facility program, or TALF, are coming to light. Yesterday afternoon, the Federal Reserve Board announced that in addition to making loans to investors to purchase newly issued AAA-rated commercial mortgage-backed securities, the TALF would be extended to include CMBS issued before Jan. 1, 2009, known as legacy CMBS.

“Notwithstanding the variety of challenges to the program’s success, the TALF’s expansion to new and legacy CMBS is a positive step in addressing the imbalance between pending maturities and lenders’ extant capacity in extending credit,” wrote Sam Chandan, chief economist for New York-based Real Estate Econometrics in a research note this morning.

The TALF program, which was first authorized in November, will provide up to $100 billion in non-recourse loans to borrowers to buy eligible CMBS and asset-backed securities. The first round of TALF loans in March was extended to securities backed by auto and student loans, credit card debt and small business administration loans, among other asset types.

But the response from investors so far has been tepid. The Federal Reserve Bank of New York issued only $4.7 billion in loans in March, $1.7 billion in April and $10.6 billion in May.

New CMBS round set for June

The first round of loans to purchase newly issued CMBS is now set for June 16, while the first round of loans to purchase legacy CMBS is slated for late July. Investors will be permitted to take out loans at a minimum of $10 million with a 5% haircut, or equity stake. The New York Fed will offer three- and five-year non-recourse fixed-rate mortgages. Interest rates will correspond with the three- and five-year LIBOR swap rate plus 100 basis points.

In order to qualify for the program, CMBS pools will be required to receive AAA ratings from two of the four TALF CMBS-eligible rating agencies, which include DBRS Inc., Fitch Ratings, Moody’s Investors Service, Realpoint LLC and Standard & Poor’s.

There are now four federal programs in the works to thaw the frozen commercial mortgage market. In addition to the two TALF programs, the Federal Reserve, the Treasury Department and the FDIC are working to clear legacy loans and securities off the balance sheets of banks and other financial institutions through the Public-Private Investment Program, or PIPP.

The two major components of PIPP are the Legacy Loans Program and the Legacy Securities Program.

In short, the way the Legacy Loan Program works is that a bank in conjunction with the FDIC decides which loans it wants to remove from its balance sheet. The approved loans are then auctioned off by the FDIC, which guarantees 85% of the loan taken out to purchase the asset. The Treasury Department then funds 50% of the required equity, about 15%, leaving the borrower to contribute 7.5% of the total value of the asset.

So far, says Chandan, the actual source of the loans to purchase the auctioned assets is unclear.

The Legacy Securities Program has two parts. The first is the expansion of the TALF to include legacy CMBS, announced yesterday. Details for the second piece, the creation of dedicated funds to deal with CMBS and other asset-backed securities have not yet been announced.

Goal: unfreezing the market

In essence, as the TALF works to attack the frozen CMBS market, the PIPP program will serve to clear legacy commercial mortgage loans and securities from the balance sheets of banks and other financial institutions, thereby freeing up capital to refinance or modify existing loans as well as make new commitments.

“Banks are clearly constrained in their capacity to meet the credit needs of the market independently,” Chandan observes. “Most bank lenders are focused on modifying and extending their maturing and problem credits. Many are actively diversifying away from real estate.”

But it is not just the $264 billion maturing commercial mortgages in 2009 that is keeping bankers up late at night. Real Estate Econometrics forecasts that the national delinquency rate on commercial loans will rise to 3.9% by year-end 2009, and to 4.7% by year-end 2010.

Through March this year, banks refinanced some $36.8 billion in commercial mortgages. New commercial mortgage commitments totaled just $18.2 billion over the same period.

“To date, the modification and extension activity has just kept pace with maturity schedules,” says Chandan. “Banks will be much more constrained in terms of their ability to meet the demand for refinancings, extensions, modifications later in the year. By the end of this year, without some support, they’re going to be stuck.”

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