Trouble With TALF?

NEW YORK CITY-Commercial real estate players got welcome news this past Friday as the Federal Reserve Board said that eligible collateral for the late June round of its term asset-backed securities loan facility will expand to include certain issuances of CMBS. The extension authorizes TALF loans with five-year maturities and in securities backed by small business insurance premium finance loans. The Fed has said the extension means the $200-billion program could grow to $1 trillion in size.

But despite some showers of encouragement labeling the Fed’s move as positive, there’s no guarantee that the program has the ability to jump-start the market, and no guarantee that TALF in its present form presents an appealing motivator for the investment community. “If you look at the initial two rounds of TALF, subscription levels have been very low, with $4.7 billion in the first round and $1.7 billion in the second,” Dr. Sam Chandan, president of Real Estate Economics, tells GlobeSt.com.

Chandan cautions that “we can’t assume the CMBS TALF will be a success.” He adds, “Expanding and allowing for the five-year terms on loans is absolutely necessary, but there may be other things policy makers need to do.”

According to analysis compiled by REEcon, the Fed anticipates an increase in securitization and a corresponding increase in loan origination activity, which in turn will enhance lenders’ capacity to refinance maturing mortgages, originate new mortgages and support the specific financing needs of investors seeking to acquire properties in distressed sales. More simply, “it’s drawing in private capital from a variety of sectors which theoretically bring in all this money that’s sitting on the sidelines to purchase these securities and start lending again,” Clifton Rodgers, SVP at industry group the Real Estate Roundtable, tells GlobeSt.com.

Pleas for increased liquidity have been coming in loud and clear from the commercial real estate community for several months now as banks, hard hit by the economic downturn, have virtually frozen lending. According to the Fed’s Senior Loan Officer Opinion Survey for April, 66% of domestic banks reported tightening commercial real estate lending standards in the first calendar quarter.

Dimming hopes of future relaxing of standards is a growing lack of faith by banks in the quality of commercial mortgage quality. Standard & Poor’s recently placed $100 billion of CMBS issued from 2004 to 2008 on negative watch. Fitch Ratings followed suit with $18 billion of CMBS issued between 2006 and 2008. “We have numbers showing that more than 90% of domestic banks think the commercial mortgage quality is going to deteriorate, with 26% of those saying it’s going to deteriorate substantially,” says Chandan.

Raising the cash flow alarm volume higher, the RER says that over the next few years, the commercial real estate industry faces a liquidity crisis of mammoth proportions. Of the $6.7 trillion of assets compromising the greater commercial real estate market, around $3.5 trillion is debt. Around $10.7 billion worth of CMBS loans are currently delinquent or have defaulted, according to data from the Commercial Mortgage Securities Assoc.

The RER says that because most real estate mortgages have maturities between five and 10 years, the average annual amount of maturing loans beginning in 2009 is most likely somewhere between $300 billion and $600 billion. Put another way, the maturing debt that the real estate sector will see between 2010 and 2012 will total around $1.4 trillion.

Of its “in house” assessment, RER says it’s highly concerned that a wave of new defaults will further exacerbate the current credit crisis and further weaken the banking system. The group says it would be impossible for government to accommodate all the debt that will be maturing.

RER says TALF adheres to a central banking principal. Like others siding with optimism, RER’s hope is that TALF will jump start a class of assets and securitization of newly originated high quality loans, which will in turn spark stabilization of the market and bring new sources of credit, thus softening the increasing dysfunction on the horizon.

“Despite comments by index traders who’ve perhaps skewed the impact of the program, ultimately, we think the TALF extension will narrow spreads and bring the market closer to where it needs to be in order to work properly,” says Rodgers.

Initially, there were concerns voiced by investors and other leery of government/public contractual agreements. “Investors often don’t want to be in contractual relationships with the governments,” says Chandan.

But even greater concerns and perceptions appear to be dogging the program’s potential success. “There were concerns about the executive compensation components and the potential retroactive actions by the government, based on what happened at AIG and other situations,” Rodgers says. “But, if you read the small print, I think the Fed is trying to stay out of that debate and trying to limit any kind of executive compensation caps that might be applicable here.”

In fact, that small print available at the Treasury Department’s website says “given the goals of the TALF and the desire to encourage market participants to stimulate credit formation and utilize the facility, the restrictions will not be applied to TALF sponsors, underwriters, and borrowers as a result of their participation in TALF.”

That said, while it’s certainly too soon to measure TALF effectiveness in any quantitative fashion, initial reaction to potential impact from some within the investment community has been positive, yet guarded. “The TALF program attempts to liquefy the market to some extent by specifically ‘incentivizing’ the creation of conservatively underwritten new loans, not loans that were underwritten with bad assumptions, as was the case in the past few years,” Tal Savariego, VP at Meridian Capital Group, tells GlobeSt.com.

He adds that he particularly likes the fact that the program limits its benefits to loans originated after July ’08, and that it provides safeguards to hopefully ensure the quality of the collateral, such as requiring the loans be underwritten based on in place cash flows only, and not pro forma cash flows. Savariego also reacted positively to the forbidding of any loans that are purely interest only loans, which he says offers an element of principal amortization over the long term.

While speaking to the general good offered by the TALF extension, Savariego did raise his own concerns, which he and others hope will be worked out through a meeting of private and public sector minds. “I obviously sympathize with investors who feel that rules are not as clearly defined as they should be under the contract law and also subject to ad hoc changes that create uncertainty,” Savariego tells Globest.com.

He goes on to compare these events to the Chrysler bankruptcy conversation. “While not directly related to TALF, it appears that the government is seeking to put the interests of secured lenders behind those of unsecured lenders,” he says. “I am sure that government has its own rationale for its actions, but well defined contract laws are not being subjected to reinterpretation and nullification. Over time, this creates legal risks that will increase transaction costs and risk premiums as investors are vulnerable to new uncertainties.”

Dan Fasulo, managing director at Real Capital Analytics, points out that “all the numbers floating around” on maturing commercial real estate debt are just estimates. “Best guesstimates are that therewill be 100s of billions worth of commercial real estate debt to refinance each year over the several years, approaching or surpassing $1 trillion in 2014/2015,” Fasulo tells GlobeSt.com. “The current debt markets do not have the capacity to refinance this debt. A functioning CMBS market is the only way to refinance the debt.”

He adds that the new TALF program will helps, as extending five-year loans for the acquisition of new CMBS issues “will encourage somenew issues to be released. The biggest complaint from industry is the new five-year loans available do not apply to vintage CMBS issues (pre-2009), which many consider to be the toxic assets that the Treasury claims they want to help clean up.