CMBS Talf Launches – Nobody Cares

A few days ago the Fed said most eligible CMBS OK for TALF:

Most commercial mortgage-backed securities eligible under published guidelines for the Term Asset-Backed Securities Loan Facility will also meet other Federal Reserve criteria, the Fed told investors on Friday, according one investor and a dealer.

Uncertainty over which CMBS could still be rejected from the TALF program next week has created confusion and capped gains in the $700 billion market, which the Fed wants to help unlock with the lending program.

The assurance by the Fed “will help, but we expect the market will be cautious,” Citigroup analysts said in a research note obtained by Reuters.

CMBS derivative index prices rose after the Fed conference call, according to one investor.

Today the program launched, and Investors request $669 mln in TALF loans for legacy CMBS:

Investors requested $668.9 million in loans for legacy commercial mortgage-backed securities on Thursday in a slow start for a key government program aimed at reviving the commercial real estate market.

The Fed is offering loans to investors for commercial mortgage-backed securities under its Term Asset-Backed Securities Loan Facility, or TALF, in an attempt to revive markets both for new and existing commercial bonds.

Lowering lending costs in commercial real estate could help ease refinancings by borrowers, who are increasingly defaulting on loans for a lack of credit.

Thursday was the first time the Fed accepted existing bonds under the TALF and the second round for its newly issued CMBS TALF program.

Investors did not request loans for newly issued CMBS in June or July.

It seems like CMBS TALF is off to a slow start. $668 million out of $700 billion is a drop in the bucket. Don’t expect it to pick up significantly. Commercial property lenders are loaded with non performing loans, precisely because lessees are going out of business or are unable to make their full payments. Demand for new loans is dried up. As I explained before, what the initiators of this program are missing…

(…)is the fact that the consumption credit expansion has brought about an abundance of retail space in malls, shopping centers and elsewhere. On top of that, a lot of businesses from the lending business were utilizing a significant portion of prime office space.

Now those businesses that were utilizing these spaces are going out of business. The recession is trying to send a signal that the resources are needed elsewhere. They are unable to make their rent payments. The owners of the properties start defaulting on the loans made during the credit expansion. The lenders notice that way too much space was built. There is no demand for any more retail space. In fact, there is a significant surplus. Nobody wants any more retail space. People are sick and tired of debt and over consumption.

Now, what are those very lenders going to do when they receive additional loans from the Fed, at around 2.9% to 3.7%, maybe even more for higher maturities. So they would have to earn at least an additional 100 basis points, probably more, in rental yield in order to make this investment worth their while, and that over the next 3-5 years.

Is this going to happen in an environment of falling prices for commercial properties, falling rents, and record vacancies? No, absolutely not. When people have had enough of something, they’ve had enough. If this is still not clear, I would recommend reading Robert Prechter’s example on Jaguar Inflation which I posted in Inflation and Deflation Revisited.

CMBS TALF will be a miserable failure, just as all other lending facilities launched by the Fed. It is possible that this failure will actually expose the dire situation of commercial lenders and accalerate the downward spiral. Thus, look out for the aftermath of first CMBS TALF auction on July 16th. Rather than it being a cure, it is likely that it will usher in a significant acceleration of commercial property loan defaults.

Related Posts:

Commercial Mortgage Backed Securities Downgraded by S&P

Commercial property crunchtime continues to unravel as Downgrades Hit Commercial Mtge-Backed Securities Market:

Bonds backed by commercial mortgages were hit Tuesday after Standard & Poor’s downgraded several CMBS issues amid continued signs of strains in the market for loans to build office malls and shopping centers.

The CMBX Series 5, the most recent derivatives index based on bonds backed by commercial mortgages, fell three points to 72 cents on the dollar on the downgrades, according to Derrick Wulf, a senior portfolio manager at Dwight Asset Management in Burlington, Vt.

S&P cut several of these securities because of a recent change in its rating methodology.

“They have put a lot of bonds on watch for downgrade after updating their methodology, and this is making the market nervous,” Wulf said.

The commercial real estate market is grappling with a worsening outlook. Delinquencies have risen to about 3%, with hotels seeing the greatest month-to- month increase at 3.26%, up from 2.02%, according to a note from Moody’s Investors Service. The aggregate delinquency rate is likely to go up further, to between 5% and 6% by the end of the year, according to Moody’s estimates.

Banks holding commercial mortgages on their balance sheets are expected to feel the pinch as borrowers default on their loans. On Tuesday, Goldman Sachs ( GS) reported stellar second-quarter results but took a $700 million hit on its holdings of commercial real estate mortgage loans. At the end of the quarter, Goldman had $6.4 billion of commercial real estate loans that were “marked really in the low 50s,” meaning reduced by almost half their original valuation, said David Viniar, Goldman’s CFO, Tuesday on the bank’s conference call.

More downgrades are expected, which means more volatility ahead for the CMBS market, as S&P is expected to “roll out the results of their new methodology over the next three to six months,” said Darrell Wheeler, head of securitization research at Citigroup, in a note to clients.

The downgrades mean these bonds are no longer eligible for cheap financing under the Federal Reserve’s Term Asset-Backed Securities Loan Facility, or TALF.

“We think that regardless of S&P’s lack of justification for their methodology changes, if they intend to downgrade bonds, then they should get on with it as it will provide investors with some clarity on which bonds they can buy and finance with TALF,” Wheeler noted.

At this point, the market is “getting bifurcated,” Wulf said, adding that TALF-eligible bonds are doing better than the ones that can no longer be bought using the Fed’s cheap loans.

The central bank will offer another installment of these loans on Thursday.

On Tuesday, the GG-10 A4, a benchmark commercial mortgage backed security, was trading about 100 basis points wider than its close of 675 basis points on Monday after it was downgraded multiple notches from the pristine triple-A to just a notch above junk status at triple-B minus, Wulf said.

Two other rating agencies, Moody’s and Fitch Ratings, haven’t cut their ratings on the bond so far.

It is indeed curious that these downgrades coincide with the beginning of CMBS TALF. As I pointed out 5 days ago:

CMBS TALF will be a miserable failure, just as all other lending facilities launched by the Fed. It is possible that this failure will actually expose the dire situation of commercial lenders and accalerate the downward spiral. Thus, look out for the aftermath of first CMBS TALF auction on July 16th. Rather than it being a cure, it is likely that it will usher in a significant acceleration of commercial property loan defaults.

These downgrades may be just one corollary of what I am expecting.

Related Posts: