Evidence Mounts That the Federal Reserve is Warming to Calls for Extending Duration of Government-Backed Loans to Help Restart Frozen Securitization Market
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| Jeffrey DeBoer, president and chairman of Real Estate Roundtable, said recent glimmers of hope by CRE executives could be short-lived if the government doesn't support longer terms for commercial mortgage bailout loans. |
The government’s new loan program aimed at helping restore liquidity to clogged credit markets, the Term Asset-Backed Securities Loan Facility (TALF), hasn't exactly roared out of the starting gate in its first two months. Officials believe it will eventually generate up $1 trillion in lending.
But so far, subscriptions have totaled a paltry $6.4 billion in the first two months. One of the main problems commercial real estate investors appear to have with the facility is that the loans aren't long enough. TALF calls for three-year terms, while most commercial mortgages are for a minimum of five years.
Some investors and the intermediaries who will arrange the government loans and hold the asset-backed securities as collateral are worried about the potential for unpleasant surprises and random rule changes, such as restrictive executive compensation rules and retroactive taxes and other penalties imposed by Congress on TALF participation profits. The shorter loan length has been the real deal killer, however, discouraging investment firms from fully buying into TALF, which essentially aims for creation of a brand-new commercial mortgage-backed securities market, launched and supported by the Federal Reserve.
Details have come out slowly since the TALF program was announced in November. However, momentum started to build late last month when the Treasury Department unveiled the Public Private Investment Program (PPIP), a program modeled on TALF striving to help banks clear their balance sheets of troubled loans and securities -- or "legacy assets" as they are now dubbed by the government. Like TALF, the aim of the legacy securities portion of the PPIP is to help thaw the secondary loan market, including CMBS.
Meanwhile, market participants that have met with Fed officials tell CoStar that the central bank appears to be warming to the idea of five-year TALF loans. Fed officials want to ensure that any lengthening of the loans won't diminish liquidity needed by the bank in the future to regulate the credit system -- for example, to fight inflation. One proposed solution is for the bank to charge higher margins in the later stages of the loans and accept existing mortgage securities as well as new originations as collateral.
Rapid deployment of TALF to help finance new loans is at the top of Real Estate Roundtable’s five-point plan to restore credit market liquidity and reboot CMBS. Roundtable President/CEO Jeff DeBoer, using words like "ominous," and "dangerous" and "precarious" -- warns that government’s failure to act quickly to fill in the details and lengthen TALF loans could contribute to sweeping commercial mortgage defaults as billions of dollars in maturing loans come due over the next three years.
"It’s clear that the nation's frozen credit markets currently do not have the capacity to meet the looming wave of commercial real estate loan maturities," DeBoer said.
The lobbying group’s second-quarter survey of sentiment among commercial real estate executives, released this week, reports that unlike three months ago, the industry sees "glimmers of hope" about the future. But the tidal wave of maturing debt could quickly extinguish those hopes if the TALF program can't get under way quickly, preferably by the end of April, and begin to jump-start loan securitization and bail out troubled mortgage holders. DeBoer noted that the full program will take two to three months to deploy once details are announced.
TALF is the Fed’s emergency lending program providing non-recourse loans to holders of certain AAA-rated asset-backed securities backed by new or recently originated consumer and business loans. Since it was announced in November, the program has increased its potential allocation from up to $200 billion to as much as $1 trillion with the inclusion of CMBS and other securities.
The March 23 introduction of PPIP by Treasury Secretary Tim Geithner added another weapon in the arsenal for battling troubled assets. The TALF-like plan to use public funds to leverage private capital’s acquisition of troubled legacy loans and securities from financial institutions sparked a broad market rally in late March led by financial and real estate stocks. The Treasury this month released new guidance for investment in legacy securities under the program, which is backed by the Fed and the FDIC.
The Roundtable's DeBoer this week said that while the PPIP program is innovative and promising, investors need more details about how the process will actually work, along with an assurance that the government won't decide to retroactively go after any profits it deems excessive. Many in the market remain spooked by the memory of the 90% retroactive tax imposed by Congress after the huge public outcry over hefty bonuses earned by employees of American International Group (AIG), which accepted TARP funds.
As for TALF, Moody's Investors Service concluded in a recent report that it will have an "uneven and modest" impact on credit markets at first, but will gain "significant momentum" as it unfolds and its terms are adjusted to cover more securities and vintages.
"TALF is structured to provide stop-loss protection to investors via non-recourse loans, while requiring participants to have 'skin in the game,' with haircuts that force borrowers to retain a share of the risk," noted Moody's Vice President Jean-Francois Tremblay, report author. "Once future expansions are phased in and the program gains momentum, TALF could help stimulate a market-based price-discovery process for less liquid securities, and through arbitrage, the yields on other instruments should fall -- which would gradually help all forms of debt."
However, investor response to the TALF program so far has been lukewarm. Investors applied for $4.7 billion in TALF-backed automobile and credit card securitization loans at the first auction in March, and a smattering of applicants lined up for only $1.7 billion in the second auction brought to market a couple weeks ago.
Echoing the Roundtable's concerns, a report published by Barclays Capital this week warned that the investor rally for senior AAA legacy CMBS over the last month, sparked by PPIP and the expansion of TALF to include commercial real estate securities, may be cut short if the government doesn’t act soon to lengthen the TALF loans. Tighter spreads and lower yields in the $700 billion market for existing CMBS -- which is as large as the combined markets for securitized student loans, consumer credit cards and auto loans -- has led some analysts to cautiously predict the re-emergence of the new commercial real estate securities originations market by year’s end.
However, Barclays said in its report "the biggest risk we see to this forecast is regarding the tenor of the [TALF] facility; in our view, anything less than a five-year TALF loan horizon would lead to an evaporation of recent gains."
An extension of TALF loans to five years should bring more investors to the table, Michael Singh, managing director with Jones Lang LaSalle’s Real Estate Investment Banking team, tells CoStar.
"I think there is a good chance it will happen," Singh said. "Any improvement to the terms on which investors will be able to borrow will help the program. Just the news that the Fed is considering extending support for TALF has been met with an enthusiastic market response and spread tightening.
"Most investors today acknowledge that the market will not clear in three years and that the road to recovery will take longer. A five-year loan facility helps address this concern and undoubtedly will ease the investor reluctance," Singh said.
One compromise being explored by the Fed and market participants is that the central bank could charge higher margins for loan terms higher than three years -- for example, increasing the spread over Libor to 200 basis points after the third year and 300 bp after the fourth year. That would encourage private investors to eventually sell the TALF securities and reimburse the Treasury so it can buy cheaper debt, presumably when the private financing market recovers.
Over the short and medium term, however, investment firms are high on government-guaranteed commercial real estate debt, at the higher loan duration of course, because it’s backed by hard commercial property assets such as apartment buildings, shopping centers and office tower rather than riskier credit-card debt. A major signal that a change is forthcoming in the Fed’s policy on TALF loan length is statements by executives for investment firms such as BlackRock Inc., who say they’re positioned to raise billions of dollars to buy TALF-backed CMBS once the program is modified.
JLL's Singh said that although he knows of no specific funds yet being raised, "my general sense is that the level of interest is definitely growing."
A major buy-in by investors into TALF would help new and existing commercial real estate borrowers by unclogging mortgage securities from bank balance sheets and freeing up the CMBS market, which plunged from a record $237 billion in 2007 to just over $12 billion last year. With borrowers unable to refinance maturing debt on rapidly contracting commercial property prices, the disappearance of CMBS has led to increasing defaults, delinquencies and foreclosures.
A rebirth of the securities market "would introduce a source of capital that we had counted out completely" to refinance the $400 billion of real estate debt maturing this year alone, UBS Investment Research said in a note to clients.
In related news this week, the Fed said it would offer two new interest rates on shorter-term TALF loans secured by asset-backed securities to better match interest rates with underlying collateral. The Fed said its TALF loan auction in May would offer loans against one- and two-year ABS at rates of 100 basis points over corresponding one- and two-year London interbank-offered (LIBOR) swap rates. Previously, the Fed had offered only two rates for TALF loans against ABS collateral without a government guarantee.