The Federal Reserve Bank of New York announced on Tuesday, May 19 that the Term Asset- Backed Securities Loan Facility (TALF) will be expanded to include commercial mortgage-backed pass-through securities issued before January 1, 2009 (each a Legacy CMBS). This announcement closely follows the May 1 expansion of the TALF program to include newly issued commercial mortgage-backed pass-through securities issued on or after January 1, 2009 (each a Newly Issued CMBS) which we discussed in the Financial Services Regulation Update dated May 7, 2009.1 The initial subscription date for TALF loans collateralized by Newly Issued CMBSs will be June 16, 2009 and the initial subscription date for TALF loans collateralized by Legacy CMBSs is expected to be in late July. We expect the Federal Reserve Bank of New York to announce the exact subscription date for Legacy CMBSs when it sets the July subscription date for Newly Issued CMBSs.  

In order for a Legacy CMBS to be eligible collateral for a TALF loan, the following conditions must be satisfied.

  • The CMBS must have been issued before January 1, 2009.
  • The Legacy CMBS must evidence an interest in a trust fund consisting of fully-funded mortgage loans that:
    • Are secured by (or, if payments due under the loan have been defeased, the security for the loan or its predecessor must have previously included) a fee or leasehold interest in income-generating commercial properties, and where, as of the TALF loan subscription date, at least 95 percent of the properties, by related loan principal balance, are located in the United States or one of its territories; and
    • Are fixed rate loans that provide for payment of principal and interest and do not provide for interest-only payments during the loans’ remaining terms.  
  • As of the TALF loan closing date, the Legacy CMBS must have a credit rating in thehighest long-term investment-grade rating category from at least two TALF CMBS-eligible rating agencies without the benefit of a third-party guarantee.2  
  • Upon issuance, the Legacy CMBS must not have been junior to other securities with claims on the same pool of loans.  
  • The issuer of the Legacy CMBS cannot be an agency of the United States or a government sponsored enterprise.  
  • Each Legacy CMBS must be cleared through the Depository Trust Company.  

TALF loans that are secured by a Legacy CMBS must comply with the general terms and conditions of the TALF program, as modified by the following terms and conditions.  

  • The Federal Reserve Bank of New York (i) will hire a collateral monitor and (ii) will retain the right to reject any Legacy CMBS as collateral for a TALF loan based on its risk assessment. In assessing risk, the collateral monitor will pay particular attention to, and the Federal Reserve Bank of New York may reject a CMBS based on, CMBS mortgage pools with large cumulative losses, high percentages of mortgage loans that are delinquent, mortgage loans in special servicing or on servicer watch lists, or high concentrations of subordinate-priority mortgage loans. In addition to the above risk assessment factors, the Federal Reserve Bank of New York will take into account losses forecast for a mortgage loan pool under a stress scenario, and the diversification of the CMBS mortgage pools with respect to loan size, geography, property type, borrower, and other characteristics.  
  • At the option of the borrower, a TALF loan will have a (i) three-year maturity with a fixed interest rate equal to 100 basis points over a three-year Libor swap rate or (ii) five-year maturity with a fixed interest rate equal to 100 basis points over a five-year Libor swap rate.
  •  Any principal payment on the CMBS will go to reduce the TALF loan in proportion to the TALF advance rate.3
  • Eligible borrowers shall not exercise any voting, consent, or waiver rights under a Legacy CMBS without the consent of the Federal Reserve Bank of New York.  

The TALF loan amount for each Legacy CMBS will be the dollar purchase price of the CMBS less the base dollar haircut (from par) which means that the size of the haircut increases as the price discount from par increases (reflecting that the larger the price discount from par, the greater the credit concerns). The base dollar haircuts for each Legacy CMBS with an average life of five years or less will be 15 percent and will increase by 1 percent for each additional year of average life beyond five years.4 The Federal Reserve Bank of New York set forth the following example of how these par-based haircuts will be applied:  

  • Assume a CMBS with a par value of $100 and a seven-year weighted average life, with a base dollar haircut of 17 precent of par.  
  • If the market price is 75 percent of par, the TALF loan amount is $58 ($75-$17) and the collateral haircut is 23 percent ($17/$75).  
  • If the market price is 50 percent of par, then the TALF loan amount is $33 ($50-$17) and the collateral haircut is 34 percent ($17/$50).  

In addition, the Federal Reserve Bank of New York (i) may limit the volume of TALF loans secured by Legacy CMBSs and (ii) may require such TALF loans to be used to fund recent secondary market transactions between unaffiliated parties that are executed on an arm’s length basis. In the coming weeks, the Federal Reserve Bank of New York must provide further details as to the procedures and requirements for Legacy CMBSs, including the process for the collateral monitor and the Federal Reserve Bank of New York’s right to reject CMBSs as collateral for a TALF loan, the process for allocating the TALF loan volume (i.e., via auction), the process for validation of price of the secondary market transactions, and the representations or other evidence required as to the eligibility of the securities for the TALF program and the impact it would have on the nonrecourse nature of the TALF loan.  

Over the first three months of the TALF program the Federal Reserve Bank of New York has deployed $17.2 billion in TALF loans to investors that have purchased $24.8 billion in new issuance AAA-rated asset-backed securities. As originally proposed the first phase of the TALF program was supposed to provide $200 billion of TALF loans. At the current rate, the TALF program will take a long time to accomplish that goal. However, the Federal Reserve Bank of New York expects that the recent expansion of the TALF program to include Newly Issued CMBSs and Legacy CMBSs will provide even a greater interest in the securitization market. There has been some questions raised in the market that in order for TALF to be more effective it might need to be expanded to include certain non-AAA rated securities.

In other developments, on May 20 Treasury Secretary Timothy Geithner stated that he expects the Public-Private Investment Program (PPIP) to begin operating over the next six weeks. As we discussed in the Financial Services Regulation Update dated March 25, 20095, the Treasury will form Public-Private Investment Funds (PPIFs) to purchase existing asset-backed securities backed by residential and commercial mortgage loans issued prior to 2009 that were AAA-rated when originally issued and meet other eligibility criteria (Legacy Securities). In addition to the equity capital provided by the Treasury and private investors, PPIFs will be able to obtain government debt financing from either non recourse loans from Treasury or the TALF program for eligible Legacy CMBSs.  

Treasury in conjunction with the FDIC and the Federal Reserve Bank of New York has plenty of work ahead if the PPIP is to begin operations within six weeks. The following are some of the more significant items that need to be focused on to enable the PPIP to begin operating within such six week timeframe.  

  • As to both the legacy loan and Legacy Securities components of the PPIP:
    • There need to be final forms of the fund documentation with clearly defined terms and conditions for the PPIFs, including whether the participants will be deemed passive-private investors for purposes of determining whether the restrictions on executive compensation apply; and  
    • There need to be clearly defined terms and conditions for the applicable warrants.  
  • As to the legacy loan component of the PPIP:
    • There need to be final forms of the required debt guaranties and acquisition loan documentation with clearly defined terms and conditions;  
    • The appropriate third party evaluators need to be engaged;  
    • Procedures for how the third party evaluators are to perform under the program must be developed and clearly defined; and  
    • Procedures for an auction process must be developed and clearly defined.  
  • As to the Legacy Securities component of the PPIP:
    • There need to be final forms of the loan documentation required for the government debt financing from Treasury with clearly defined terms and conditions;
    • There need to be appropriate modification to the existing TALF loan documentation required as a result of the expansion of the program to include Legacy CMBSs;
    • The prequalified private investment fund managers (Managers) to manage the PPIFs must be selected; and  
    • The Managers must raise equity required to co-invest with the Treasury.  

Most importantly, the PPIP’s success depends on participation in the program by the banks holding legacy loans and/or Legacy Securities.