Here Comes the Commercial Bailout

After months of watching from the sidelines, there are two newcomers to the Term Asset-Backed Securities Loan Facility (TALF) playground. The Federal Reserve on Friday announced commercial mortgage-backed securities (CMBS) and securities backed by insurance premium finance loans as of June are eligible collateral for TALF participation. The additions are aimed at stimulating lending in the commercial real estate and small business sector by allowing private investors to purchase securities with a matching government investment. “The CMBS market came to a standstill in mid-2008,” Fed officials said in a media statement. “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.” Although the Fed pointed out that CMBS accounted for nearly half of new commercial mortgage originations in 2007, the CMBS market itself seems to have grown less appealing in recent weeks, with Standard & Poor’s Ratings Services warning in early April of a coming slide in CMBS as the economic recession appears set to take a bite out of one of the few remaining real estate classes to survive much of the turmoil in financial markets worldwide. “Since September/October 2008, Standard & Poor’s has witnessed significant deterioration in the credit performance of the CMBS transactions it rates,” said credit analyst James Manzi. “The economic recession combined with the absence of readily accessible financing in the capital markets has, in our opinion, skewed the credit risks related to the performance of CMBS sharply to the downside, and in excess of what we expected at origination or in our prior scenario analysis.” Of course, the Fed’s announcement to include CMBS in the latest round of alphabet soup programs designed to provide liquidity and confidence to the financial markets means government regulators hope to stem further deterioration. The Fed also said the inclusion of ABS backed by insurance premium finance loans to small businesses should facilitate the flow and affordability of credit to small businesses. The Fed also authorized 5-year loans as of June to purchase CMBS, ABS backed by student loans and by loans guaranteed by the Small Business Administration. Up to $100bn of TALF loans could have 5-year maturities. The Fed said in February it planned to expand the program; Friday’s announcement moves TALF along toward that goal. The market in CMBS traditionally serves as a mirror to the residential mortgage-backed securitization space. In essence, RMBS must be doing really well for investors to feel confident in CMBS: when RMBS performance goes up, so does CMBS. However, recent times show a complete disenchantment with CMBS. RMBS activity dropped greatly during the credit crisis, but never stopped. Not so with CMBS, where the market sees weeks in a row without a single deal in the pipeline, retained or not. Predictably, the Commercial Mortgage Securities Association, an international trade body that supports the industry, is very pleased with the new bailout terms. “Extending TALF to CMBS with five-year terms is critical to providing liquidity and facilitating lending in the commercial mortgage market,” says CMSA president Christopher Hoeffel. “CMSA has strongly advocated for a term of five years to kickstart investor demand.” “A five-year term is more consistent with the longer-term nature of commercial lending and will provide more flexibility to borrowers as they navigate the current real estate cycle,” he adds. In a research note out today, analysts at Banc of America Securities are equally supportive. “This is a positive development as non agency RMBS would also benefit from such longer term TALF loans,” they write. For CMBS, the hair cut is higher for loans where the weighted average life of bonds is longer than the term of the loan, they explain. This may suggest haircuts in the RMBS space will be high as there is considerable uncertainty about the WAL and there is potential for dramatic extension especially under loan modification scenarios. Write to Diana Golobay at [email protected]. Jacob Gaffney contributed to this report.

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