The Federal Reserve Bank of New York (New York Federal Reserve) announced on Friday, May 1 that the Term Asset-Backed Securities Loan Facility (TALF) will be expanded to include commercial mortgage-backed pass-through securities (each a CMBS). The initial CMBS subscription and funding dates have not yet been announced, but are expected to be sometime in late June.  

The TALF program was initially rolled out in March to stimulate the securitization markets by providing low interest government financing of purchases by qualified investors of AAA-rated assetbacked securities backed by auto, credit card, student, and SBA-guaranteed loans. Shortly after the initial subscription in March, the New York Federal Reserve expanded the program to also provide financing for purchases of eligible AAA-rated asset-backed securities backed by (i) mortgage servicing advances; (ii) loans or leases relating to business equipment; (iii) leases of vehicle fleets; and (iv) floorplan loans. The TALF program opened in March with loan requests for approximately $4.7 billion in TALF loans and, thereafter, the program seemed to lose ground with the April subscription bringing in requests for approximately $1.7 billion in TALF loans to finance the purchase of AAA-rated asset-backed securities backed by auto and credit card loans. However, the May subscription picked up some steam with approximately $10.6 billion requested in TALF loans to finance the purchase of AAA-rated asset-backed securities backed by auto, credit card, student, equipment, and SBA-guaranteed loans. It appears that even though the TALF program stumbled in only its second month, the program got a kick start in May with a large increase in activity as the New York Federal Reserve continued to expand the TALF program to include additional categories of eligible collateral, like the CMBS category. The New York Federal Reserve’s expansion of the TALF program to include the CMBS category as eligible collateral is expected to encourage investment in the commercial real estate market by enhancing liquidity and easing the lending crisis currently facing commercial real estate.  

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

  • The CMBS must be issued on or after January 1, 2009.
    • The CMBS must evidence an interest in a trust fund consisting of fully-funded, first priority mortgage loans that:
    • Are secured by a fee or leasehold interest in income-generating commercial properties that are located in the United States or one of its territories;  
    • 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;  
    • Are current in payment at the time of securitization;  
    • Were originated on or after July 1, 2008; and  
    • Are underwritten or re-underwritten recently prior to the issuance of the CMBS on the basis of then-current net operating income and property appraisals.  
  • The pooling and servicing agreement and other agreements governing the issuance of the CMBS and servicing of the assets must satisfy the following conditions:  
    • If the class of the CMBS is one of two or more time-tranched classes of the same distribution priority, distributions of principal must be made on a pro-rata basis to all such classes once credit support is reduced to zero;  

    • Control over the servicing is never held by investors in a subordinate class of CMBS once the principal balance of that subordinate class is reduced to less than 25 percent of the initial principal balance of that class;  

    • No recognition of post-securitization property appraisals obtained by someone other than servicer; and  

    • Representations by each seller of a mortgage loan that is included in the collateral pool that the improvements were in material compliance with law.  

  • The CMBS must have a credit rating in the highest long-term investment-grade rating category from the required number of TALF CMBS-eligible rating agencies without the benefit of a third-party guarantee.1  

  • The issuer of the CMBS cannot be an agency of the United States or a government sponsored enterprise.  
  • Each CMBS must be cleared through the Depository Trust Company.  

TALF loans that are secured by a CMBS must comply with the general terms and conditions of the  

TALF program, as modified by the following terms and conditions.  

  • The pools underlying each CMBS should be diversified with respect to loan size, geography, property type, borrower, and other characteristics, but the New York Federal Reserve will consider non-diversified asset pools on a case-by-case basis.
  • The New York Federal Reserve: (i) will hire a collateral monitor; (ii) will retain the right to reject any CMBS as collateral for a TALF loan based on its risk assessment; and (iii) until the issuance of each CMBS that has not yet been issued, reserves the right to exclude specific loans from each pool.  
  • The pooling and servicing agreement and other agreements governing the issuance of the CMBS and servicing of the assets, and the terms and conditions of its underlying loans, should provide for adequate reporting that would allow evaluation of the TALF loan collateral by the New York Federal Reserve.  
  • 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.  
  • The collateral haircuts for each CMBS with an average life of five years or less will be 15 percent and will increase by one percent for each additional year of average life beyond five years.2  
  • 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 CMBS without the consent of the New York Federal Reserve.  

This latest announcement by the New York Federal Reserve as to the terms and conditions of TALF loans secured by a CMBS raises a number of issues and questions that we hope are resolved by the New York Federal Reserve in the upcoming weeks. The New York Federal Reserve will need to provide further guidance on who the rating agencies will be and what methods will be employed to rate the CMBS for eligibility under the TALF program. As announced, it is not clear how an issuer can determine the appropriate diversification of the CMBS collateral pools required to be TALF eligible or how an issuer can ever get comfortable that a CMBS is eligible when the New York Federal Reserve has reserved the right to reject any CMBS as collateral for a TALF loan. In addition, it is unclear what role the collateral monitors will play, whether the New York Federal Reserve intends to review each loan that is part of a securitization pool, and the extent of such review. Finally, the inability of the borrower to exercise any voting, consent, or waiver rights without the consent of the New York Federal Reserve may have a chilling effect on the success of the TALF program as expanded to include the CMBS category.  

In the coming weeks, we anticipate that the New York Federal Reserve will release the specific subscription and funding dates for TALF loans secured by a CMBS, the list of rating agencies and rating qualifications, and additional details as to the modified terms and conditions which we expect will answer some of the questions discussed above. In addition, the New York Federal Reserve is currently considering a process which would enable issuers to reserve prospective TALF funding to be secured in the future by new issue CMBS. We also hope to see additional announcements from the New York Federal Reserve with respect to expansion of the TALF program to provide financing for the purchase of Legacy Securities under the Public-Private Investment Program which we discussed in the Financial Services Regulation Update dated March 25, 2009.4