WASHINGTON — The Federal Reserve's decision to expand, yet again, the terms of its securities lending facility with the aim to stabilize the commercial real estate market may be too little, too late.
The Fed is now letting top-rated commercial mortgage-backed securities packaged before 2009 to qualify as collateral for loans in its Term Asset-backed Securities Loan Facility, or Talf.
Officials are hoping that including older CMBS in Talf will help increase liquidity and encourage price discovery in the commercial real estate loan secondary market. This would let banks gain access to more capital that they could then use to let borrowers refinance the commercial loans that are beginning to come due. But it is unclear how many banks will take the bait.
"Banks aren't very interested in refinancing high-risk commercial real estate loans right now because investors won't necessarily sanction writedowns in principal," said a retired banking executive who doubted the program's potential to fix the market.
And Fed officials might have trouble persuading those same investors that now is the right time to buy more CMBS, even with government assistance.
"Whether leveraged or not, you will not enter a contract or purchase a security [for which] you have a high estimate of potential loss," said Anthony Clemente, the chief executive of Canaras Capital Management LLC. "With credit cards or auto loans," he explained, "you have groups that believe with more subordination and unbelievable diversity in a pool, you will potentially not lose money. This is not the case with CMBS."
Mark Zandi, the chief economist and co-founder of Moody's economy.com, predicted that investors would remain cautious until the broader economy begins to show signs of revival.
"At the end of the day you're not going to get a lot of interest until it becomes clear that the downdraft in the job market is over," he said. "As long as they're still losing thousands of jobs a month, investors will be nervous about signing on to the commercial real estate market."
Another problem relates to the Fed's requirement that Talf securities carry a AAA rating, but the ratings on CMBS notes are falling as problems in the commercial real estate sector grow. Standard & Poor's recently announced it would probably downgrade many CMBS notes. If this happens, fewer notes would qualify for Talf without some restructuring. Investors and banks hoping to foist their risky CMBS onto the Fed have already begun reshuffling the slices of securitized loan pools.
"The collateral will have to be scrubbed appropriately," said Douglas Landy, a partner at Allen & Overy. "They will need to do what it takes in organizing the CMBS to get the AAA rating that's required."
In some cases, existing securities may have to be broken up and reworked to create new assets, which can then be divided into tranches, some of which can then earn the highest rating.
Despite its troubles, the program could offer a good deal for investors because it lets them increase their leverage in investments related to asset-backed securities without taking on much additional risk.
"If it's good enough for the Fed, I think it ought to be good enough for the buy side," said Ernest Patrikis, a former general counsel at the Federal Reserve Bank of New York and a partner in White & Case LLP.
And overall investor interest in Talf has begun to gain momentum, despite the slow start it saw through March and April. Companies put up more than $5 billion worth of debt for sale in the fourth round of Talf subscriptions, according to Bloomberg, with bids due today.
Analysts say that, if the CMBS market does not perk up, liquidity will be insufficient for banks to help roll over the commercial mortgage loans as they come due.
"There is a lot of mortgage debt that is going to start rolling over over the next several years," said Zandi. "If by this time next year, it's not apparent that the market is coming to life, then hopefully there's a plan B for what to do."
The authorities, he added, "are nervous that no capital is flowing into commercial real estate and, if it doesn't return, the problems with the financial system are going to get noticeably worse."