05/22/2009

Pru, MetLife Eye TALF Deals; Rally Broadens

The Federal Reserve's Term Asset-Backed Securities Loan Facility is spurring positive developments for commercial MBS issuance and secondary trading.

On the new-issue front, Prudential Mortgage Capital and MetLife are among a number of insurers exploring the possibility of originating loans for bond offerings.

Meanwhile, the formal announcement this week that TALF is being extended to seasoned fixed-rate CMBS buoyed market participants, further fueling the massive ongoing CMBS rally. Spreads on super-senior triple-A bonds tightened by another 115 bp, to 595 bp over swaps, as investors bet that the program, which provides low-cost financing to bondbuyers, will increase liquidity and drive up prices.

"This is a whole new world," said an executive at one of the biggest holders of CMBS. "It's like the sun came out."

While the initial market reaction to the expansion of TALF to legacy paper was overwhelmingly positive, some questions remain. It's unclear how much actual trading will be spurred by the program. Still up in the air is whether TALF will eventually be broadened to include subordinate triple-A CMBS. And, on a broader scale, while TALF could bolster liquidity, it doesn't address concerns about the underlying real estate risk, which has also been a major contributor to the plunge in CMBS prices.

Some investors are doubtful that the bullishness generated by TALF will hold up if the economy doesn't rebound. "What happens to the long-term investor when the marginal buyers go away and we face the headwinds of the next few years?" asked Brian Phillips of AllianceBernstein. "If unemployment stays at 9 or 10%, the exit price on these bonds is going to fall."

In the near term, TALF is likely to increase the tiering in prices of bonds from different deals. The Fed is reserving the right to exclude certain seasoned CMBS deals from TALF eligibility because of credit concerns. As word spreads about which deals are in or out of the program, pricing variances are likely to grow, with excluded deals incurring a price penalty.

Overall, CMBS pros are hoping that TALF will be the catalyst that clears the origination roadblock. The thinking is that low-cost government loans will induce credit-starved bondbuyers to pay up for bonds. That, in turn, should gradually cause CMBS spreads to tighten to the point that lenders would be able to originate loans at rates that are low enough to be acceptable to borrowers, but high enough to enable securitization at a profit. While the jury is still out on whether the idea will work, triple-A spreads have tightened dramatically from the peak of 1,350 bp in November, just before the Fed first announced its broad guidelines for TALF.

The program initially applied to triple-A bonds backed by newly originated consumer and small-business loans. On May 1, the Fed announced that the initiative would be expanded to include new commercial mortgages. This week, the program was expanded to include seasoned CMBS - that is, bonds issued before Jan. 1.

The program's expansion to new fixed-rate commercial mortgages has already caused some lenders to explore the possibility of resuming origination for securitization. As previously reported, Deutsche Bank has rolled out such a program. Some $500 million is said to be allocated for that effort.

Now comes word that Pru and MetLife are examining the feasibility of writing loans for securitization. Any resulting deals would likely be in the neighborhood of $500 million. The collateral pools could contain both refinancings for existing customers and mortgages to new clients. Buyers of the resulting super-senior triple-A bonds would be able to tap TALF financing. It's presumed the insurers would retain some of the subordinate bonds and seek to sell the others.

Mark Wilsmann, head of MetLife's commercial mortgage operation, confirmed the insurer is "considering the idea" of a TALF-eligible CMBS deal, but hadn't yet reached a decision. "Like many others, we're a little apprehensive about participating in government programs, and the strings that might come attached to them." A Pru spokeswoman declined to comment.

The TALF program has also prompted other lenders to consider securitization. The most likely initial candidates are originators that have balance-sheet capacity - that is, lenders that would be able to retain loans if securitization ends up being uneconomical. Additional insurers are considering the strategy. Also, GE Capital has begun internal discussions about whether to proceed, according to one market player. A GE spokesman didn't return a call seeking comment.

Even some fund operators are weighing whether securitization is now viable. One example: Mesa West Capital, which has already raised $425 million for its second origination fund. The company floated a $600 million CDO in January 2007.

Still, the interest so far is the equivalent of dipping a toe into the ocean, according to skeptics who doubt that widespread origination will resume anytime soon. "I think TALF is very good for driving up prices of legacy assets, but it will do zero for getting new money out," said one veteran lender. "The larger problem that needs to get addressed is the fact that properties are worth less, rents are going down and vacancies are going up. The only thing you can do is give it time, and eventually someone will have to take the losses on this real estate. That has to happen before the decks can be cleared and new loans can get written."

In the legacy program, TALF will provide 3- or 5-year loans to buyers of fixed-rate, super-senior bonds with triple-A ratings. The buyer would be required to pay 15% of the face amount for 3-year bonds and 20% for 5-year bonds, regardless of the purchase price. So the TALF loan would shrink as a percentage of the purchase price as the dollar price decreases. For example, for a 5-year bond sold at par, the Fed would finance 85% of the purchase price. But if the purchase price was half of the face amount, the Fed would finance only 70% of the purchase price, with the buyer's equity stake, or "haircut," representing 30% of the price. The haircut's larger percentage on lower-priced bonds reflects the higher perceived risk.

Analysts are projecting that the attractive TALF financing will enable CMBS buyers to garner hefty returns. "Under the terms of the program, investors might reasonably achieve [a return on equity] in the 20-30% range assuming that market prices at the maturity of the TALF loan do not erode severely," Deutsche Bank analyst Richard Parkus wrote in a report this week.

Barclays analyst Aaron Bryson estimates that $371 billion of CMBS would be eligible for financing under the program. That excludes the triple-A paper held by the mortgage agencies, which are likely to retain those bonds.

But while the program has already caused spreads to tighten dramatically, it's unclear whether it will spur a significant amount of trading over the long run. The reason: Dealers have already whittled down most of their inventories, and much of the triple-A universe is owned by long-term holders.

Citigroup analyst Darrell Wheeler thinks that there might be only an initial flurry of trading. "Once legacy TALF has been up and running for a few months, we expect bonds will be scarce, as most bonds are in the hands of stable investors that would likely prefer to hold the collateral pools they originally purchased," he said in an interview.

So far there are no indications that the Fed is thinking about expanding the legacy program to include mezzanine and junior triple-A bonds - the A-M and A-J classes. Analysts were divided on the likelihood. Wheeler, who thinks such a move is possible, said doing so would provide another catalyst for a resumption in lending. "The net effect would be better triple-A pricing that would provide a benchmark for new loan originations and potentially encourage a bank to originate, warehouse, and sell smaller-balance CMBS pools," he wrote in a report this week. "In today's market that may seem inconceivable, but we have found that given a potential need/profit, bankers usually find a way to fill it."

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