A Cautious Thumbs-Up for TALF

NEW YORK CITY-Despite initial tepidity, experts and Commercial Real Estate Players still express guarded optimism that the Treasury Department’s February expansion of the $1-trillion TALF program into the CMBS market might meet with success. This past June, TALF was further expanded to include CMBS legacy securities, i.e. those issued before Jan. 1, 2009. The next round of issuance will be July 16.

Notwithstanding their initial enthusiasm, commercial real estate investors have thus far been slow to express interest. In its initial round on June 16, there were no loan requests.

Real Estate Econometrics says anticipation for loan requests in the July 16 round is equally low. The company says policy makers and private market participants should consider a range of explanations for the initial round’s not attracting investors. REEcon asserts that among possible explanations for the initial weak response include a failure by policy makers to anticipate the time it would take to restart the dormant CMBS market processes, and the time it takes to execute the steps in the securitization process, from loan origination through to issuance.

Further, a lot of different pieces have to fall into place, according to REEcon president Dr. Sam Chandan. He tells GlobeSt.com the pace of deal activity and the sheer size of deals, in terms of dollar volume, the number of loans, and the number of properties, have made it difficult for investors and other market participants to fully vet loan details.

Another factor, Chandan says, is that there have to be borrowers for whom the securitization channel is appropriate along with accessible conduit originators as well as ratings agencies. And, as he points out “this is a market that’s been dormant for quite some time now.”

In response to GlobeSt.com’s question on whether policy changes might be necessary to spur interest in the program, a spokesperson for the Federal Reserve Bank of New York refers to a June 4 speech by New York Fed president William Dudley. “We are not going to have a subscription mid-June but the process for CMBS securitization takes quite a while to ramp up so we would actually not expect anything in that mid-June subscription period,” Dudly said in June. “Don’t take that as a mark of CMBS effort, please.”

In that same speech, Dudley said he thought some parts of the securitization market would return and eventually be viable without government support. However, he added, “other parts of these [securitization] markets were fundamentally flawed, and they will not survive, nor should they.”

Spencer Levy, senior managing director with CB Richard Ellis, also says it is too early to judge the program’s success. “The reason no one applied for the first round is that there simply was no new product in the marketplace.” He adds, “the view I’ve gotten from the marketplace has been a bit warmer than what some suggest, particularly from some of the originators,” because “they see some purchasers of their CMBS securities are going to be able leverage it up using TALF capital.”

Levy says TALF had shown signs of progress in other asset backed securities like student loans and auto loans. He says in those asset types, spreads had come in. He adds that because of TALF capital, the cost of capital dropped from the standpoint of the buyer of those securities. “We would hope TALF capital would do the same thing in theory with CMBS.”

And he asserts that interest in the program might be keener than most people think. “What we’re waiting for now is to get some large consumers of capital to take it.” Levy adds that he knows “there are several large consumers of capital that are looking at the program now.”

If those large consumers do in fact make the move and begin raising new debt through TALF-supported CMBS, REEcon says that might pave the way for other investors to seek financing for the next round of TALF CMBS issuance in August.

Still, Chandan tells GlobeSt.com, “one of the concerns investors are going to have is whether the evaluation of the loans, the loan quality, fully captures the potential downside.” He refers to loans from 2006 or 2007 as being underwritten to perspective as opposed to current cash flows. In other words, “how might the property be doing next year,” says Chandan, who adds that now, it’s difficult to assess cash flows. “It’s reasonable that cash flows will deteriorate at a large number of properties,” says Chandan.

Chandan says the growth in the number of loans that reach maturity, including CMBS balances, present material risks, and are a contributor to the rise of delinquencies and default rates. He says for a broad class of investors that might not be as familiar with the nuances of commercial real estate, the perception of rising default rates and the further deterioration of fundamentals is something that gives investors pause as they evaluate whether it’s appropriate to invest in new deals coming to the market.

As the July issue of industry publication US Banker noted, more than $168 billion of the $204 billion in commercial mortgages coming due this year are held by banks and thrifts. That dwarfs the $19.1 billion of CMBS loans that also mature this year.

Data from Trepp, LLC shows a heady CMBS market in the years from 2004 to 2007. Over those few years, the US saw over $578 billion in CMBS issuance. At the CMBS market’s peak in ’07, $192.8 billion of CMBS was issued. But then when the sky fell in 2008, the amount dropped to $10.8 billion.

Eastern Consolidated CEO Peter Hauspurg tells GlobeSt.com that”part of the whole thing that’s keeping these banks glued up with the CMBS is the fact [that] no one has been able to unravel the loans they understood when they made them.” He says there are thousands of loans now jamming up the banks, taking the attention of top officials who are all trying to figure them out. And their complications cause new problems, he explains, “the market has the specter of commercial real state players actually throwing their own properties into default, just to get the attention of special servicers who they hope will modify their loans.”

Levy says most of the capital that’s going to come out in the first couple of rounds of lending for CMBS or LEEDS in TALF will be at either very high or relatively high coupon, or at very low leverage. He says that’s because only triple-A securities are eligible for TALF funding.

The Fed says that as of the TALF loan closing date, the CMBS must have a credit rating in the highest long term investment-grade rating category from at least two-TALF CMBS-eligible rating agencies and must not have a credit rating below the highest investment grade rating category from any TALF-CMBS rating agency. But last month, in what some see as a blow to the CMBS market, leading ratings agency Standard & Poors said it would begin tightening ratings requirements for CMBS. The downgrades include CMBS from 1995 to 2008.

Reportedly, the new models would lead to ratings downgrades on around 95% of top bonds issued during the peak of the last cycle in 2007. “The impact of that has already showed up in the market,” Levy says.

Chandan adds that among the agencies, its in the best interest of the marketplace that information about deals be distributed as widely as possible. “Irrespective of whether or not, there are two, three or five ratings agencies participating in a deal, the information in regards to the composition of that deal should be provided to each to them.” He says the broad dissemination of information around a deal, will help build investor confidence.

A Moody’s spokesman tells GlobeSt.com that structured finance like CMBS has operated in a limited information disclosure model relative to markets like those associated with corporate and municipal securities. He says the agencies are looking to securities based on credit and credit profile adding that as much information as possible “should be shared with the investing public.”In the end, 2009 may only see modest contributions of liquidity from TALF. Regardless, Chandan says it’s an important and beneficial step. He adds, “even a small number of deals will be helpful.”