CMBS vs. TALF

Recent reports issued by Deutsche Bank, DBRS and Fitch Ratings find that commercial real estate fundamentals have dramatically weakened across most major property segments and markets, with some starting to reach the depressed levels of the last major recession in the early 1990s. Richard Parkus, head of CMBS Research at Deutsche Bank, projected in his firm's commercial real estate outlook last month that property prices are expected to decline 35% to 45% (or more) overall during this recession. If of course that happens, much of the $700 billion dollars worth of commercial real estate coming due between 2009-2011 will be extremely difficult to refinance, making default rates spike even further.

CMBS collateral performance are currently deteriorating at a historically fast pace and Parkus predicted the total delinquency rate could likely to exceed 3.5% by year-end. That is one of the highest estimates that have been projected by CMBS analysts. Worse still, Parkus added, it could go as high as 6% by 2010. By far the greatest risk facing CMBS loans right now is maturity default/extension risk, not term default risk, Parkus of Deutsch Bank said.

A large percentage of CMBS loans made in 2005-2008 may not qualify for refinancing without substantial equity injections due to much tighter underwriting standards, massive price declines and declining cash flow.

All of this, of course has led to increased pressure on the Obama administration to include commercial real estate on the list of vital industries that need help.

Longer-term debt is critical to saving the commercial real-estate business, which faces a record amount of debt coming due in the next three years. Industry observers are expecting the delinquency rate to double by the end of this year and go higher next year. Problems could be magnified if the credit drought continues and owners of even healthy properties are unable to refinance. This has sparked a lobbying effort to include CMBS in the TALF program.

Currently, TALF makes low-cost loans available to investors who buy securities backing everything from credit cards to auto loans. The first TALF-eligible deals, involving securitized car loans and credit-card cash flows, began in March, but investor response to the program has been anemic. Investors applied for just $1.71 billion in loans on Tuesday in the second round of TALF, according to the central bank. That follows applications for $4.71 billion last month.

Obama administration officials have been promising for weeks that the TALF would be expanded to include commercial real estate. But details have been sketchy and have been a subject of debate between policy makers and the private sector.

The big problem with expanding TALF to commercial real estate is the nature in which both entities naturally function. The government typically doesn't like to make loans, similar to those they are currently making under the TALF program, longer than a year or so. They do this because they like to control liquidity. However, they have already gone to three year loans, outside of their comfort zone, for existing TALF eligible loans. The CMBS loans, on the other hand, are typically five years or longer.


Industry executives hope that the TALF effort will resurrect the CMBS market. In 2007, about $230 billion of securities were sold. That number dropped to zero by last summer. The dearth of financing has frozen sales and sent values plummeting, setting the stage for another wave of defaults that could cripple some banks and other lenders.

Commercial-property debt is expected to be one of the most attractive TALF-eligible assets, because it is collateralized by office buildings, malls, warehouses and other income-producing real estate. It is perceived as less risky than consumer credit such as credit-card debt and car loans.

Anticipating that TALF will be modified, a number of investment firms, including BlackRock Inc., Prudential Financial Inc. and ING Groep NV unit ING Clarion Partners LLC, are positioning themselves to use the TALF program to buy high-quality commercial mortgage-backed securities, or CMBS. Some of them aim to raise billions of dollars for that purpose.

Let's hope, for all of our sake, that these guys are right, and that the government makes good on their promise. It's likely our livelihoods depend on it.