With Developers Diversified Realty making official its plans to raise up to $700 million in CMBS financing through the government-sponsored Term Asset-Backed Securities Loan Facility (TALF) program, it seems the Obama administration's efforts to help the commercial real estate industry might be beginning to pay off.
While a month ago TALF's initial deadline passed without any investors signing up for government loans to buy new CMBS bonds, today there are about a dozenin the works, according to participants in a July 21 webcast produced by the Commercial Mortgage Securities Associations (CMSA), a global trade association focused on the commercial real estate capital markets. Most of those deals reportedly involve retail REITs, including mall owners Westfield and the Macerich Company. What's more, the U.S. Treasury has already appointed nine fund managers for the Public-Private Investment Partnership (PPIP) program for legacy securities, with acquisitions expected to start approximately three months from now.
All this spells goodfor the commercial real estate industry as both TALF and PPIP will help jumpstart lending, the CMSA panelists said. But before the programs can make a real impact, the government would have to extend the amount of time they are expected to remain active.
"It's going to take time for people to get everything in order and actually participate," said Lisa Pendergast, managing director with Jeffries & Co., a New York City-based global investment bank.
When the TALF and PPIP programs first began to take shape this spring, many in the commercial real estate industry remained uncertain about how helpful they would prove to be. But recent changes in the CMBS market, in particular following the expansion of TALF to include CMBS loans, prove the programs have the potential to help spur lending, according to Pendergast.
For the week ending July 22, five-year AAA-rated CMBS bonds, the only bonds eligible for TAFL funding, featured spreads of 475 basis points, 360 basis points below the 52-week average, according to Commercial Mortgage Alert, an industry newsletter. Ten-year AAA-rated CMBS bonds featured spreads of 525 basis points, 204 basis points below the 52-week average. During the same time, spreads on AA-rated bonds, which are not eligible for TALF, featured spreads of 3,500 basis points-- 522 basis points above the 52-week average of 2,978 basis points.
In addition, after 11 months of zero CBMS issuance, the U.S. CMBS market finally saw $600 million in issuance in June and $300 million in issuance in July. The figures are way off the all-time monthly high of $38.5 billion in CMBS issuance reached in March 2007, but they represent some welcome movement in a sector that has remained moribund for close to a year. "The tightening [in spreads] that we've seen recently has caused a significant amount of selling in the market," said Pendergast. "The issue of supply and liquidity is addressed to some extent."
But even though there is increasing interest in taking advantage of TALF for CMBS, the program still has some kinks that haven't been worked out, according to Richard D. Jones, partner in the finance and real estate group of Dechert LLP, an international law firm. One of the issues facing companies interested in taking advantage of new TALF-backed loans is that until they put a deal together, they have no way of knowing the CMBS bonds used to back the loans will be approved by the government.
"Participants have to essentially buy the bond and pray it [gets funding]," Jones noted.
Another issue is that because of the requirement that any CMBS bonds passing through the program be AAA-rated, the pool of companies able to take advantage of TALF-sponsored loans will be limited to safe sponsors such as publicly traded REITs. Moreover, there are disagreements over which bonds deserve the AAA rating. For example, Standard & Poor's (S&P), one of the three rating agencies appointed to aid the government in administering TALF, has been going back and forth on downgrading three CMBS bonds issued in 2007. On Jul. 14, S&P lowered the bonds' rating to BBB-, the lowest possible, from AAA, the highest possible. A week later, the agency reverted to the original rating, reportedly because of adjustments on the timing of projected losses on the mortgages backing the bonds. Meanwhile, S&P's unexpected change of heart did little to restore investor confidence in the safety of government sponsored securities.
At the moment, it appears companies interested in securing CMBS financing through TALF would have to jump through pretty high hurdles. For example, to qualify for the AAA rating, the Developers Diversified financing will reportedly feature a loan-to-value ratio of 40 percent, below the current standard of 50 percent to 60 percent, and will be backed primarily by shopping centers focused on discount retailers, which are widely considered recession-resistant. During Developers Diversified's second quarter earnings call on Jul. 24, company chairman and CEO Scott Wolstein indicated the deal is currently being evaluated by the rating agencies and is expected to close in the fall.
But the need for refinancing dollars in the commercial real estate arena is much greater, participants noted. John D'Amico, senior managing director with Centerline Capital Group, a New York City-based asset management firm that also serves as a special servicer, estimates that approximately 20 percent of the properties in Centerline's special servicing portfolio went into default because the owners were not able to refinance maturing loans. The vast majority of those loans are on performing properties, but refinancing remains a challenge, especially on loans over $10 million that can't be funded by local and regional banks, D'Amico said.
If the situation in the credit markets doesn't improve in the near future, the CMBS delinquency rate might rise to as high as 9 percent by year-end, according to Pendergast. A delinquency rate of 6 percent by December of 2009 is already virtually guaranteed, she added. In June, the delinquency rate for all CMBS loans reached 3.5 percent, encompassing a total of $28.65 billion, according to Realpoint, LLC, a Horsham, Pa.-based credit rating agency. The delinquency rate for retail hit 5.2 percent, or $11.8 billion. Retail assets also made up the largest portion of the $40.53 billion in loans in special servicing, at 41.3 percent.
Meanwhile, many of the firms that should, in theory, be able to take advantage of TALF-funded CMBS won't be able to do so because of what Jones calls a "ludicrous" timeline for completing deals—eligible CMBS bonds have to be issued before Jan. 1, 2009. Developers Diversified officials have noted that their transaction was fast-tracked as a result of extensive media coverage, which alerted potential investors that a new CMBS issue was in the works. But under normal circumstances, investors would not be aware of the deal until it was approved by the Federal Reserve. Plus, both Pendergast and Jones pointed out that it normally takes months just to get all the documentation in order, which is why they feel it's essential the government extends TALF until at least 2010.
"If we don't get an extension, we'll look back and say 'Never have so many people worked so hard to accomplish so little,'" Jones noted.