On May 19th, the Federal Reserve Bank of New York (the “New York Fed”) announced preliminary revised terms and conditions (the “Legacy CMBS Terms and Conditions”) to provide the framework for the expansion of eligible collateral in the Term Asset-Backed Securities Loan Facility (“TALF”) to include legacy (i.e., pre-2009 issued) non-agency commercial mortgagebacked pass-through securities (“CMBS”).

The New York Fed announced that it may limit the volume of TALF loans secured by legacy CMBS and may allocate loans by auction or other process.

Subscriptions for TALF loans secured by legacy CMBS are expected to begin in late July 2009 and will run on a different subscription and closing cycle than other non-CMBS TALF loans.

Although the basic elements are the same, the Legacy CMBS Term and Conditions differ from the non-CMBS and newly issued CMBS term and conditions in a number of ways that may be interesting to investors. We have highlighted below some key differences as well as several aspects of the legacy CMBS framework that are still under development by the New York Fed:

  • Availability of five-year maturities: As is the case for newly issued CMBS and certain other asset classes (i.e., certain SBA certificates and asset backed securities (“ABS”) backed by student loans), TALF loans secured by legacy CMBS may have, at the election of the borrower, three- or five-year terms. A three-year loan will bear interest at 100 basis points over the 3-year LIBOR swap rate and a five-year loan will have an interest rate equal to 100 basis points over the 5-year LIBOR swap rate. If a borrower chooses a five-year TALF loan, however, the excess in any TALF loan year of the interest distributions on the pledged CMBS over the TALF interest payable to the New York Fed will be remitted to the borrower only until such excess equals 25% (10% in the fourth loan year and 5% in the fifth loan year) of the haircut amount, and the remainder of such excess will be applied to TALF loan principal. In addition, for a three-year TALF loan backed by legacy CMBS, such excess interest will be remitted to the borrower in each year until it equals 30% per annum of the haircut amount, with the remainder applied to loan principal.
  • Legacy CMBS purchased at a discount to par will have higher effective haircuts than assets purchased at par: The maximum amount the New York Fed will lend to a borrower is equal to the current market value of the pledged legacy CMBS minus a set, par-based haircut (the “Base Haircut”). The Base Haircut begins at 15% of par for all legacy CMBS with an average life of five years or less and increases 1% for each additional year of average life of the collateral beyond five years. Because the maximum TALF loan amount is based on current market value and not par, the effective haircut will exceed the Base Haircut if legacy CMBS is purchased at a discount to par. For example, assuming par equals $100, if a borrower applies for a TALF loan to finance legacy CMBS with a five year average life, the Base Haircut would equal $15. If the legacy CMBS was purchased for $80, the maximum loan amount would be $65, an effective haircut of $18.75. The New York Fed noted in its frequently asked questions related to legacy CMBS that “the size of the haircut increases with the size of the price’s discount from par, reflecting a recognition that large discounts from par generally indicate credit concerns.”
  • Fixed rate non-IO/PO CMBS collateral only: Similar to the terms and conditions related to newly issued CMBS, the Legacy CMBS Terms and Conditions provide that the legacy CMBS pledged to secure a TALF loan must entitle its holders to payments of principal and interest and cannot be interest-only or principal-only securities. In addition, the pledged CMBS must bear a fixed rate of interest or an interest rate based upon the weighted average of the underlying fixed mortgage rates. The underlying mortgage loans must be fixed rate.
  • Fully-funded U.S. commercial mortgage loans only: Eligible collateral will include U.S. dollar-denominated, cash (i.e., not synthetic) senior CMBS. The collateral backing the qualifying CMBS must evidence an interest in a trust fund consisting of fully-funded mortgage loans and not other CMBS, other securities or interest rate swap or cap instruments or other hedging instruments. The Legacy CMBS Terms and Conditions also provide that a participation or other interest in a mortgage loan is not a CMBS or other security if, following a loan default, the ownership interest is senior to or pari passu with all other interests in the same loan in right of payment of principal and interest. As of the TALF loan closing date, at least 95 percent of the properties (by loan balance) securing the pledged legacy CMBS must be located in the United States or one of its territories and the security for each loan must include a mortgage or similar instrument on a fee or leasehold interest in one or more income-generating commercial properties.
  • New York Fed to engage collateral monitor: As is the case for newly issued CMBS loans but unlike other ABS asset classes eligible for TALF loans, for legacy CMBSbacked TALF loans the New York Fed will engage a collateral monitor to review pools of pledged collateral to asses risk. The New York Fed also retains the right to reject any CMBS based on the New York Fed’s risk assessment. The New York Fed expects to pay particular attention to CMBS mortgage pools with large financial losses, concentrations of loans that are delinquent, in special servicing or on servicer watch lists or concentrations of subordinate priority mortgage loans and undiversified pools.
  • New York Fed to retain consent over voting rights: Similar to newly issued CMBS loans but unlike other ABS asset classes eligible for TALF loans, a borrower who pledges legacy CMBS as collateral for a TALF loan must agree not to exercise, or refrain from exercising, any voting, consent or waiver rights under the pledged CMBS without the consent of the New York Fed.
  • Current AAA collateral only: Each TALF loan secured by legacy CMBS must have a current credit rating in the highest long-term investment grade category from two TALF CMBS-eligible credit rating agencies and must not (i) have a credit rating below the highest investment-grade category, (ii) obtain its credit rating based on the benefit of a third-party guarantee or (iii) have been placed on review or watch for a downgrade. The CMBS-eligible credit rating agencies are currently DBRS, Inc., Fitch Ratings, Moody’s Investors Service, Realpoint LLC and Standard & Poor’s. It was reported that at least one credit rating agency is considering downgrading a number of AAA rated 2007 vintage CMBS tranches which may impact the amount of transactions eligible for TALF.
  • Additional guidance to be forthcoming: The Legacy CMBS Terms and Conditions indicate that additional guidance will be issued, including the possibility that defaultrelated circumstances may be considered in determining the weighted average life of legacy CMBS and adding a requirement that TALF loans for legacy CMBS be used to fund recent arm’s length secondary market transactions between unaffiliated parties.

For the New York Fed TALF website, please see http://www.newyorkfed.org/markets/talf.html.