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Will TALF Expansion Jumpstart CMBS Lending?

The Federal Reserve announced that it will expand the Term Asset-Backed Security Loan Facility, or TALF, to include AAA-rated securities backed by new and recently originated commercial mortgage loans. The move is intended to grease the wheels of borrowing for commercial mortgage-backed securities (CMBS).

The TALF program allows investors to secure low-cost loans from the Fed to purchase securities backed by consumer debt, such as credit card debt and car debt. The expanded program will include commercial mortgage securities debt.

“The inclusion of CMBS as eligible collateral for TALF loans will help prevent defaults on economically viable commercial properties, increase the capacity of current holders of maturing mortgages to make additional loans, and facilitate the sale of distressed properties,” announced the Fed in a press release Friday. The new loans, expected in late June, will be extended through the Federal Reserve Bank of New York.

The Fed estimates that up to $100 billion of TALF loans could have five-year maturities. “The move to five-year loans is a necessary condition for the success of the program, in spite of its impinging on the Fed’s flexibility in managing its balance sheet,” wrote Real Estate Economics chief economist Dr. Sam Chandan in a special report over the weekend.

“If implemented successfully, the program will relieve some part of the credit imbalance. But left in isolation, it will not significantly improve the delinquency and default outlook.”

Real Estate Economics estimates that $264 billion in commercial mortgages, excluding construction and land development loans, will mature in 2009 with an additional $274 billion maturing in 2010. The New York-based real estate research firm forecasts that the default rate on commercial mortgages will increase to 4.7% by year-end 2010.

“Together these conditions limit the scope of the program to new issues,” according to Chandan. In short, only CMBS issued after Jan. 1 this year, which includes commercial mortgages originated on or after July 1, 2008, are eligible for the June round of loans.

However, Chandan adds, while only new CMBS will be eligible for the June round of loans, the TALF is expected to increase in scope to include older issues under Legacy TALF.

The first rounds of TALF have received a tepid response from investors, and the new expansion to include CMBS is not foolproof. “Amongst the program’s challenges,” notes Chandan, “the underwriting of loans to current in-place property cash flow may fail to capture the potential for further deterioration.”

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