05/08/2009

Banks, Borrowers Start Mulling TALF Deals

A handful of lenders and REITs have started exploring the possibility of using the Federal Reserve's Term Asset-Backed Securities Loan Facility to foster new commercial MBS transactions, but no one expects a rush of deals to result.

The buzz in the market is that Developers Diversified Realty and Simon Property are among the REITs interested in exploring how the TALF program might help them raise financing. Deutsche Bank, Goldman Sachs and J.P. Morgan have held preliminary discussions with officials at the Federal Reserve Bank of New York about possible TALF-eligible transactions.

The Fed formally announced last Friday that the TALF program, which was originally set up to finance buyers of bonds backed by newly originated consumer and small-business loans, will be extended to new commercial mortgages in June.

The hope is that the move, by creating relatively low-cost financing for bondbuyers, will encourage lenders to begin originating commercial mortgages for securitization again. The initial reaction, however, is that the terms of the program will limit participation.

Some market players were disappointed because the Fed said it "expects collateral pools to be diversified." Most observers believe initial transactions will involve single borrowers, both because lenders are still wary of the risk of amassing loans from multiple borrowers and because investors are likely to prefer them as easier to analyze.

But the announcement added that the Fed would consider "nondiversified" deals on a case-by-case basis. Christopher Hoeffel, president of the Commercial Mortgage Securities Association and a managing director of Investcorp, said Fed officials had indicated they were indeed open to financing transactions backed by collateral properties owned by one company. "They told us that TALF will be available for single-borrower deals, since they recognize that these transactions may be the first ones to get done," he said.

CMBS players expressed great disappointment that the Fed didn't expand the program to include the financing of seasoned CMBS. Most observers believe that spreads in the CMBS secondary market must tighten significantly before origination can resume to any significant degree and the primary market can revive. CMBS investors have been counting on the availability of TALF financing to help jumpstart secondary-market trading.

Hoeffel, who as head of the industry's trade group is in close contact with federal officials, offered hope on that score as well. "Most notably, they did confirm that a TALF program for legacy CMBS is forthcoming, but we do not know the timing," he said. Still, while there was some behind-the-scenes activity about possible transactions, industry players emphasized that it was preliminary. There were no signs, for example, that any transactions have been presented to the rating agencies.

There was a broad split in industry reaction, with players generally lining up as either cautiously optimistic that the program would spur activity or as extremely gloomy about the prospects of a lending revival.

The pessimists pointed out that only the senior 70% of transactions would be eligible for TALF financing, leaving dealers with a hefty amount of bonds to sell in the open market, presumably at quite high yields. That will drive up the borrower's cost, making the financing very expensive at the margin, said one veteran CMBS lender, who noted that a larger proportion of consumer-loan securitizations are eligible for TALF. "While this is a step in the right direction, this should not be viewed as overly positive," he said. "It can affect a fraction of CMBS. TALF's effect on consumer-based loans and lending will be far, far, far better."

Since TALF was introduced to the consumer segment of the market in March, it has sparked $23.5 billion of bond deals.

Many observers think the key to breaking the lending logjam is reducing CMBS spreads in the secondary market. As long as those spreads remain high, investors will likely feel entitled to similar returns from new-issue bonds. But those spreads currently are far too high to justify mortgage rates that would be acceptable to borrowers.

"Assuming that TALF investors will require at least a mid-teens return on equity on their investments, the minimum coupon at which commercial mortgage loans would have to be originated is sufficiently high that, in our view, there would be limited appetite on the part of borrowers," Deutsche Bank analyst Richard Parkus wrote in a report this week.

On the other hand, in the consumer-loan market, the TALF program has caused secondary-market yields to tighten considerably.

The terms of the program include a number of provisions that have been advocated by bondholders since the CMBS collapse. For example, interest-only loans are ineligible, and loans must be underwritten on the basis of in-place income, not projected income. Also, the holder of the junior class will lose control of the special-servicing rights once the principal balance of that class falls below 25% of the original balance.

Only super-senior, fixed-rate bonds are eligible for TALF loans, and the bonds must be collateralized by fixed-rate loans. Mortgages must have been originated since July 1, 2008.

The New York Fed, which is administering the TALF program, will hire a "collateral monitor" and will reserve the right to reject any collateral loans before securitization.

TALF loans can have a maturity of three or five years. The rate on 3-year loans will be set annually, pegged to 100 bp over the 3-year Libor swap rate. Likewise, 5-year loans will be pegged to 100 bp over the 5-year Libor swap rate.

The Fed will lend up to 85% of the face amount of bonds with an average life of five years or less - referred to as a 15% haircut. The haircut will increase by one percentage point for each additional year in the average life, up to a maximum 20% haircut for 10-year bonds. By contrast, the haircuts on consumer-related bonds, which generally have much shorter average lives than CMBS, range from 5% to 16%.

To reduce the risk of amassing loans and to facilitate pooled securitizations, the Fed said it might let lenders "reserve" funding for TALF loans in advance for a fee.

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