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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   June 2010

Sowing the Seeds for Recovery

Recent actions from the Fed and FDIC could spur commercial mortgage-market growth. Are you ready for it?

Sowing the Seeds for Recovery

After dealing with the fallout of the residential mortgage crisis, the government turned its attention to the declining commercial real estate and commercial mortgage-backed securities (CMBS) markets in the past year.

Most observers view the CMBS-origination decline, along with the large schedule of maturing commercial mortgage loans expected in the next three to four years, as a potential deterrent to economic recovery. In addition, as the Federal Deposit Insurance Corp. (FDIC) continues to close failing banks, it must deal with the significant volume of distressed commercial real estate debt on these institutions' books.

"Many CMBS borrowers are still saddled with overleveraged properties and are negotiating with special servicers to extend their loan-maturity dates."

The Federal Reserve Bank and the FDIC have implemented various programs in the past year to address the continuing crisis in commercial real estate lending in hopes of reviving the market. Because they cannot manage the process alone, the Fed and the FDIC will continue to look to the private sector for guidance and expertise.

This creates opportunities for commercial mortgage brokers, as well as for asset managers, due-diligence professionals and lenders.

Brokers who understand the Fed's and the FDIC's programs may not only be better able to predict the market's turnaround but also may find ways to help encourage green shoots to sprout.

The Fed solution

In 2009, total CMBS issuance was $3 billion. The total issuance was about $230 billion in 2007, according to the CRE Finance Council.

Although insurance-company lenders and banks occasionally originated new commercial mortgage loans for their longtime clients, most commercial real estate owners have found the debt markets to be tight for refinancing existing mortgages and virtually closed for new-acquisition loans. Further, many CMBS borrowers are still saddled with overleveraged properties and are negotiating with special servicers to extend their loan-maturity dates.

In an attempt to kick-start the debt markets, the Fed implemented the Term Asset-Backed Securities Loan Facility (TALF) program in 2009. This program was designed to provide liquidity for securitization programs covering a range of collateral classes. New and existing -- aka, legacy -- CMBS loans were included.

The reason for including legacy CMBSs was to provide liquidity and encourage lenders to make new loans. The program was set up to allow investors who owned existing CMBS bonds to apply to the Fed with their bond and investment details. Many investors found it difficult to predict which bonds the Fed would accept, however, which slowed down and often scuttled transactions.

The TALF program for legacy CMBSs ended this past March 31; the new-CMBS TALF program ends this month. Although the Fed accepted only about $12 billion in legacy-CMBS bonds for liquidity since the program started in July 2009, according to the Federal Reserve Bank of New York, industry participants believe the program broke the psychology of fear that has pervaded the market.

The Fed grew more selective each month about the quality of the loan collateral it would accept, however. In fact, several times, it refused collateral that it had previously accepted. For example, it rejected 19 of the 55 CMBS bonds offered as collateral at the last TALF funding round in March.

The good news is that industry observers believe the Fed views the CMBS markets as returning to some semblance of normalcy. First, although the TALF program covered only about 2 percent of total outstanding CMBS loans, spreads for existing bonds tightened significantly during the TALF program's tenure. According to an analysis by Citigroup, AAA-bond spreads reduced from about 1,000 basis points to 250 basis points over Treasurys from spring 2009 to this spring. This allowed institutional investors holding existing CMBSs to sell some of their holdings to raise capital for new CMBS loan investments.

Second, the improvement in spreads and the return of liquidity to the markets has stimulated some small-but-promising efforts to develop new CMBS-lending platforms -- an important fact for property-owners and their mortgage brokers. This could bring back investors.

A key development occurred in late 2009 when a large public real estate investment trust came to market with a $400 million new-issue CMBS loan backed by 28 retail properties. This was the first new-CMBS issue since June 2008, as well as the first use of TALF's new-issue-CMBS program. The issue succeeded with only about 20-percent TALF participation -- most investors were comfortable with the deal structure and pricing and did not need the Fed's assistance. Subsequently, two other large, single-borrower multiproperty deals came to market and were sold.

Banks are restarting several programs, as well. The first deal of this year was a recent $309 million diversified pool of commercial mortgages. This CMBS lender and others do not want to warehouse loans for any significant period of time.

What the commercial real estate investment market -- plus borrowers and brokers -- clearly need is a reliable, stable, CMBS-loan market that is available to small and medium-size single-property borrowers. This is essentially how the CMBS loan market started in the early 1990s.

The FDIC solution

While the Fed has worked to jump-start CMBS lending, the FDIC has been taking similar steps with the commercial real estate assets of the failed banks it is absorbing. Although securitizing these loans also is an option, the FDIC has been packaging these loans for a structured sale.

As more failed institutions hold significant commercial real estate positions, the FDIC is relying on the private market -- primarily, Wall Street firms and institutional investors -- to speed the process and generate higher returns than it would get from auctioning them off. The FDIC seeks investors who are experienced workout specialists and who can handle complex loan structures.

Because many of these portfolios are nonperforming, expertise in handling these types of situations is essential. In addition, investors experienced with construction and development loans are needed to determine if partially completed projects should be finished or shelved.

The FDIC is reaching out to private due-diligence firms to help with the loan-audit and site-inspection process to get a solid handle on the collateral. The FDIC also works with select Wall Street firms to put the pools together and target specific investors who meet their criteria. With the ultimate goal being to recover the most for taxpayers, the FDIC will partner with these investors by providing low-cost loans, equity and guarantees. As assets are worked out, the FDIC will participate in the upside and share in the income and expenses.

In addition to the structured-sale program, the FDIC is selling the assets of failed institutions by turning to the secondary market to package the loans as securities for sale.

Along with maximizing taxpayers' return, the FDIC hopes to create market liquidity and allow investors and other lenders to put their money to work and restart commercial real estate lending. This should increase the deal flow for mortgage brokers and lenders.

One sprout at a time

The Fed's TALF program has helped jump-start the CMBS market, but these are still only small steps. Although new-issue CMBS deals likely will range from $10 billion to $20 billion in the next year, the program does not address the looming $300 billion worth of maturities expected in the next three years.
In addition, the FDIC's strategy of unloading larger transactions assumes there will be continued investor appetite for deals that come with the federal government as a partner.

From a CMBS standpoint, there are several legislative and regulatory issues to address before the market thrives again. Among these is a proposal for issuer risk-retention. There also is discussion about the models that the nationally recognized rating agencies use.

There are some glimmers of hope from new-CMBS issuance and the FDIC's increased structured sales. But there is still a lot of wood to chop before this becomes a reality. The commercial real estate industry and the brokers within it need a thriving debt-finance market to survive and ride out this crisis.


 


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