The continued disruption in the commercial real estate space may be about to claim a new victim. An email from Fitch Ratings today warns that iStar Financial — a real estate investment trust with $11 billion of undepreciated assets and $2.2 billion of undepreciated book equity — is facing imminent default.

"Absent a significant improvement in commercial real estate fundamentals which would result in iStar receiving a substantial amount of loan repayments from its borrowers, it is inevitable that the company will need to effect a coercive debt exchange (CDE) with its second lien noteholders to avoid bankruptcy," according to the email from Fitch Ratings.

In an email from iStar, Andrew Backman, the senior vice president of investor relations downplayed the significance of the Fitch declaration. "Fitch stated that if the company effected a coercive debt exchange (CDE) with its second lien note holders, Fitch would consider it a default as outlined in Fitch's global criteria report Coercive Debt Exchange Criteria," he said. "A Fitch default is not a default under any of our loan agreements.  iStar continues to operate its business as usual.  We have ample near-term liquidity and we continue to assess all of our various options to re-align our asset and liability maturities."

Fitch has now downgraded iStar’s Issuer Default Rating (IDR) as follows:

–IDR to 'C' from 'CC';
–First priority credit agreement to ‘B-/RR1’ from ‘B/RR1’;
–Second priority credit agreement to ‘CCC/RR2’ from ‘B-/RR2’;
–2011 second lien notes to ‘CCC/RR2’ from ‘B-/RR2’;
–2014 second lien notes to ‘CCC/RR2’ from ‘B-/RR2’.

Fitch has affirmed the following security ratings at their current level, as ‘C’ is the lowest assigned financial obligation rating:

–Unsecured revolving credit facilities at 'C/RR5';
–Senior unsecured notes at 'C/RR5';
–Convertible senior floating-rate notes at 'C/RR5';
–Preferred stock at 'C/RR6'.

Fitch’s estimates of iStar's liquidity to currently be in a substantial cash shortfall.

The rating actions are also driven by continued weakening of the quality of iStar's loan portfolio. For the quarter ended June 30, 2010, iStar recognized $109 million of loan loss provisions, and iStar has recognized over $750 million of loan loss provisions over the last 12 months. As of June 30, 2010, non-performing and watch list loans collectively represented nearly 54% of iStar's total gross loan portfolio, compared with 50% as of June 30, 2009.

"Challenging property-level fundamentals, combined with the decline in commercial real estate values over the past several years, have decreased the ability of iStar's borrowers to repay loans," Fitch states. The rating agency predicts iStar will have trouble monetizing its portfolio in the current environment. And facing a liquidity deficit of over $2 billion may lead to an inability to fund obligations from upcoming debt maturities over the next 24 months.

58% of iStar's unencumbered loans and other lending investments are non-performing, Fitch added.

Write to Jacob Gaffney.

In an attempt to ignite the sedated secondary market, Bank of America (BAC: 7.29 -0.14%) and privately held United Midwest Savings Bank have bundled first-mortgage loans into pools for securitization.

Bank of America pooled about $32.1 million of loans purchased from other lenders and United Midwest assembled a pool of nearly $8 million, according to the Small Business Administration.

This marks the initial attempt to provide some liquidity to lenders through MBS or fixed-asset financing under the First Mortgage Loan Pooling program that is part of the American Recovery and Reinvestment Act passed last year.

The SBA will back about $25.7 million of the loans in the BofA pools and $6.4 million of the United Midwest pools. The federal agency provides a government guarantee on pools of eligible 504 first-mortgage loans assembled by approved originators who sell them to third-party investors. Lenders retain at least 15% of each loan, pool originators assume 5% of the risk, and the SBA guarantees the remaining 80%.

"The 504 loan pool guarantee program is one more tool we've added to SBA's toolbox to expand access to capital for America's small businesses," SBA administrator Karen Mills said. "By jump starting the 504 secondary market, more banks will have greater opportunity to strengthen their liquidity and in turn increase their lending to small businesses and entrepreneurs."

Write to Jason Philyaw.

The U.S. Department of the Treasury announced today intentions to sell trust preferred securities (TRUPS) it acquired from Citigroup (C: 30.87 +1.61%) during the bailout in 2009. The sale will constitute a complete net profit gain under the Asset Guarantee Program. Citi will not receive any of the proceeds.

The Asset Guarantee Program is part of the Emergency Economic Stabilization Act and allows the Treasury to hold assets for financial institutions critical to the function of the nation's financial system for a premium. In January 2009, the Treasury alongside the Federal Deposit Insurance Corporation, the Federal Reserve and the Office of the Comptroller of the Currency, signed a shared-loss agreement with Citi to absorb potential losses of $301 billion.

Citi agreed to pay a dividend payment of 8% on the government preferred stock.

The TRUPS the Treasury is now trying to sell were part of that agreement. The agreement also included 7.7 billion shares of Citi's common stock.

Citi terminated the shared-loss agreement in December 2009 following the completion of a $20 billion securities offering and repayment to the Troubled Asset Relief Fund, which canceled $1.8 billion worth of TRUPS originally allocated to the government. The Treasury kept $2.2 billion of the premium which was originally $4 billion in securities.

It said that, because the Treasury was "never required to make any payment under the arrangement and has no further obligation to do so, all proceeds from the sale will constitute a net gain to the taxpayer under the [AGP] program."

The offering does not include $800 million in TRUPS held by the FDIC. Those assets are required to be turned over to the Treasury unless they incur any losses on debt of Citigroup guaranteed by the FDIC under the Temporary Liquidity Guarantee Program. It also doesn't include the warrants for Citigroup's common stock issued under the AGP or the 7.7 billion shares of government common stock, which the Treasury has been disposing of separately.

The Treasury currently owns about 18% of Citigroup's shares.

BofA Merrill Lynch, JPMorgan, Morgan Stanley, UBS Investment Bank, and Wells Fargo Securities will act as joint lead managers for the offering.  Citigroup Global Markets Inc. will act as global coordinator but not as an underwriter or a sales agent.

Write to Christine Ricciardi.

While Fannie Mae issuance declined in August, the government-sponsored enterprise's gross mortgage portfolio increased 3.8% from a year ago.

The Fannie Mae gross mortgage portfolio reached $809.1 billion in August, up 3.8% from $779.4 billion a year ago. It did drop at a compound annualized rate of 4.1% in August.

Fannie Mae reported $47.9 billion of total issuance of mortgage-backed securities in August, down 22.7% from a year ago but a 12.2% increase from the previous month. Its MBS issuance peaked in June 2009 at more than $130 billion.

The serious delinquency rate in the Fannie Mae portfolio dropped for the fifth month in a row to 4.82% in July, the latest month of available data, from 4.99% in June. It’s still 65 basis points above the rate last year.

Today, the House Committee on Financial Services is holding a hearing on the future of the GSEs.

Michael Bodaken, president of the National Housing Trust will say in written testimony released yesterday that the serious delinquency rate on Fannie and Freddie Mac single-family mortgages rose from 3% in 2005 to 11.5% in 2009.

Write to Jon Prior.