In an effort to thaw the frozen commercial real estate markets, the Federal Reserve Bank of New York announced last week that it would be expanding the term of loans available under the Term Asset-Backed Loan Facility (“TALF”) from three years to up to five years. The Federal Reserve also announced that, starting in June 2009, investors can finance purchases of AAA-rated commercial mortgage-backed securities (“CMBS”) loans through the TALF credit facility.
TALF, initially launched in November 2008, is a government loan facility designed to address the credit crisis by encouraging private investment in a variety of securitized assets, including CMBS, through government financing at favorable rates. The Federal Reserve anticipates that the broadening of TALF to target a wider investor audience will help stimulate commercial lending. In a press release issued last Friday, the government stated, “The inclusion of CMBS as eligible collateral for TALF loans will help prevent defaults on economically viable commercial properties, increase the capacity of current holders of maturing mortgages to make additional loans, and facilitate the sale of distressed properties.”
The Federal Reserve’s announcement was generally expected and welcomed by members of the real estate industry, which itself had been aggressively lobbying the Federal Reserve to extend the term of the TALF loans to five years. In response to the government’s decision to provide longer, five-year loans, Christopher Hoeffel, president of the Commercial Mortgage Securities Association stated last Friday, “A five-year term is more consistent with the longer-term nature of commercial lending and will provide more flexibility to borrowers as they navigate the current real-estate cycle.”
Since the inception of TALF, the Federal Reserve has made significant changes to the program; these include pledging to increase the credit facility from $200 billion to $1 trillion, opening the category of eligible collateral to include CMBS, increasing the term of TALF loans, and removing executive compensation restrictions. TALF loans were first proposed to have a one year term (later extended to three years). Although the Federal Reserve initially preferred to keep the term of TALF loans short, it subsequently modified the program in response to industry pressure, showing a willingness to cooperate with investors to resolve the financial crisis.
By providing longer-term financing under TALF, the government will enable investors to hold the underlying assets securing the TALF loan for a longer period of time, thereby avoiding the need to liquidate those assets before the real estate market has had a chance to recover. The additional two years will also provide investors with greater opportunity to restructure or extend the term of the underlying loan, foreclose or otherwise try to realize value on the asset.
To qualify as eligible collateral for TALF funding, the CMBS must evidence an interest in a first-priority mortgage loan that was originated on or after July 1, 2008. The cut-off date poses a potential problem given that the majority of existing securitized loans were originated before July 2008. Consequently, a significant portion of CMBS loans will not be eligible for TALF financing. Although this issue has not yet been addressed, it is likely that the real estate industry will continue its lobbying efforts in order to further expand the criteria for eligible CMBS loans. Another potential problem is that the TALF program is set to expire on Dec. 31, 2009, which may not be enough time for lenders and investors to properly structure and close TALF transactions. Key elements of the expanded TALF program for CMBS include the following:
- Qualifying Securities: The CMBS being purchased must evidence an interest in a first-priority fixed-rate mortgage loan, secured by a fee or leasehold interest in commercial property located within the U.S. or a U.S. territory. The underlying loan must have been originated on or after July 1, 2008, and the security issued on or after Jan. 1, 2009.
- Eligible Borrowers: The borrower must be a U.S. company maintaining a relationship with a primary dealer that serves as the Federal Reserve’s trading counterparties.
- Loan Terms: The TALF borrower may elect to obtain government financing for a term of three or five years. Three-year TALF loans will bear interest at a fixed rate per annum equal to 100 basis points over the three-year Libor swap rate. Five-year TALF loans are expected to bear interest at a fixed rate per annum equal to 100 basis points over the five-year Libor swap rate (available TALF material is unclear as to the date of the applicable Libor swap rate, although one can assume it will be the rate on or about the closing date). The principal amount of the loan must be at least $10 million.
- Payment: If the term of a TALF loan matures before the term of the underlying loan or security, the TALF borrower must either repay the government loan, at which time the Federal Reserve would release the collateral, or arrange for the sale of the collateral and instruct the Federal Reserve to deliver the CMBS to the counterparty against payment. Any excess proceeds from the sale are paid to the borrower. TALF loans are generally non-recourse to the borrower, with a few exceptions, including breaches of various representations, warranties and covenants under the TALF loan documents.
- Haircut: The “haircut” (i.e., the capital that the borrower must invest to obtain TALF financing) will be 15% for CMBS with an average life of five years or less.
- Initial Subscription Date: The initial CMBS subscription date is expected to be in late June 2009. For investors that require additional time to assemble their loans for financing beyond the June subscription date, the Federal Reserve is considering a process that will permit borrowers to reserve funding by paying a monthly reservation fee until the CMBS is issued.
Although it is too early to determine if the TALF program will be attractive to investors and will accomplish its intended purposes, the addition of CMBS as eligible collateral and the extension of the TALF loan term to five years, enhanced by low interest rates and capped risk exposure, make the program a potentially attractive opportunity for commercial real estate investors.