By Jody Shenn on Bloomberg.com
Aug. 20 (Bloomberg) — Investors asked the Federal Reserve for $2.3 billion of loans against commercial-mortgage-backed securities created before this year, an expansion from $668.9 million in its financing program’s first round a month earlier.
The central bank got no requests for newly issued bonds backed by loans on skyscrapers, shopping malls, apartments or hotels, the New York Fed said today on its Web site. That part of the Term Asset-Backed Securities Loan Facility, or TALF, hasn’t been used since its start three months ago.
BLOGGER COMMENT: The biggest problem facing commercial real estate is the capital markets’ lack of liquidity. CMBS issuance went from $230 billion in 2007 to $12 billion in 2008 to less than a billion dollars YTD in 2009 (send an e-mail to moc.laicnanifnosibnull@evad and I will supply you with my research source materials). Higher vacancies and higher reserves can be built into financial models to determine an underwritten cash flow (UCF). We can apply a stressed interest rate and a higher than normal debt coverage ratio to the UCF to determine very conservative maximum loan proceeds. As delightful a math exercise that might be… when there is no functioning capital market to provide liquidity, there are no transactions in some market segments. What used to get easily financed with a non-recourse loan at 80% of cost now will only justify 40-60% LTC/LTV (lesser of) financing from long term investors such as insurance companies and pension funds based on the new ultra conservative underwriting standards. This makes commercial real estate a “rich man’s game” once again and will knock all the amateurs out of the business. For those with massive amounts of cash and a long time horizon this is the greatest buying opportunity of our lifetimes. The only thing that can change this inevitability is government involvement in the capital markets through a program like TALF where at least the lowest risk AAA piece has liquidity once again.
“I would not call this a blow-out number by any stretch of the imagination, but certainly relative to what we saw in July it was positive and definitely within the range of what people were thinking,” said James Grady, managing director in New York for Deutsche Asset Management, a unit of Deutsche Bank AG that oversees $240 billion of investments.
Wall Street profits and the $700 billion CMBS market, which rallied amid the opening of TALF to the debt and start of Treasury Secretary Timothy Geithner’s Public-Private Investment Program, may depend on the programs’ results.
While the average price of top-rated commercial-mortgage securities is up 8 percent since June to almost 90 cents on the dollar, last week values began weakening as buying in anticipation of investor demand tied to the programs eased, according to Merrill Lynch & Co. index data.
“With dealer inventories now fairly bloated across the Street, we will need to see not only a sizable subscription next Thursday, but will also need the Fed to remain accommodative with respect to the bonds it accepts as TALF-eligible collateral,” Alan Todd, a JPMorgan Chase & Co. analyst in New York, wrote in Aug. 14 report.
TALF loan requests of less than $1 billion would be a “disappointment” to the market, while requests of more than $2 billion would probably be “well received,” he said in a telephone interview today before the announcement.
Investment banks have been recently buying commercial- mortgage securities being offering for sale “pretty aggressively in the expectation that TALF buyers would materialize,” Grady said in a telephone interview. The investors typically will seek to acquire the bonds a few days before, or the same day that, the Fed accepts requests, he said.
Fed Chairman Ben S. Bernanke this week extended the TALF for commercial-mortgage bonds into next year as he seeks to stabilize a market where property values have fallen 36 percent from their October 2007 peak, according to Moody’s Investors Service data. Banks and insurers own more than $2 trillion of U.S. commercial real-estate debt not packaged into bonds.
Top Rating Required
Last month, the Fed refused to accept only one commercial- mortgage bond as TALF collateral, announcing the decision about a week after disclosing the loan requests without saying why it found the debt too risky. At a minimum, the securities must carry top credit ratings, not be under review for downgrades and rank among the senior-most classes of a securitization.
The central bank is receiving advice on the decisions from Trepp LLC, a New York-based research firm, and Pacific Investment Management Co., the Newport Beach, California-based firm that manages the world’s largest bond fund.
The PPIP, which the government announced July 8 would begin with nine asset managers raising as much as $10 billion and receiving as much as $30 billion in taxpayer capital and loans, accepts a broader range of commercial- and residential-mortgage bonds originally rated AAA.
The Fed is seeking to revive commercial-mortgage bond sales after issuance halted as the cost to sell the debt became too high to originate new real-estate loans. That choked off financing to borrowers including those seeking to refinance $165 billion of debt this year. In 2007, a record $237 billion of commercial-mortgage bonds were sold, before sales fell to $12.2 billion last year and none this year, according to JPMorgan.
The Fed extended the commercial-mortgage TALF to June 30, 2010, from Dec. 31. The Aug. 17 announcement followed a letter to Bernanke from 41 House members — including Financial Services Committee Chairman Barney Frank, a Massachusetts Democrat, and Carolyn Maloney, a New York Democrat who heads the Joint Economic Committee — asking for a one-year extension after property owners stepped up lobbying for a later deadline.
Spreads Over Benchmarks
Yields over benchmark interest-rate swaps on so-called super senior commercial-mortgage securities issued in 2006 that are likely TALF-eligible were about 4 percentage points earlier today, according to JPMorgan data. Spreads on similar bonds that aren’t eligible were 5.5 percentage points.
Since Aug. 7, spreads have widened between about 0.50 percentage point and 1 percentage point, with prices for ineligible debt weakening the most, Todd said. In November, the spreads topped out at record highs between about 13 percentage points and 15 percentage points, he said.
The average price of top-rated CMBS securities has eased from a high this year of 91.2 cents on the dollar on Aug. 13, after climbing from a 2009 low of 72 cents in February, according to Merrill Lynch index data.