Fed to Allow Longer Loans for Commercial Real Estate

By Scott Lanman

May 1 (Bloomberg) — The Federal Reserve authorized longer- term loans for investors buying securities backed by commercial mortgages in a $1 trillion emergency credit program, taking a step the industry said was needed to avert defaults.

Beginning in June, the Fed will offer five-year loans at higher interest rates than the three-year loans previously approved for the Term Asset-Backed Securities Loan Facility, the central bank said today in a statement from Washington. The Fed will also accept securities backed by loans designed to help small businesses buy insurance.

While policy makers had been wary of financing longer-term loans out of concern it would be harder to raise interest rates when the economy recovers, leaving TALF unchanged may have resulted in tighter credit. Sales of commercial mortgage-backed securities slumped to $12.2 billion last year from a record $237 billion in 2007, according to JPMorgan Chase & Co. estimates.

Adding CMBS to the TALF “will help prevent defaults on economically viable commercial properties, increase the capacity of current holders of maturing mortgages to make additional loans and facilitate the sale of distressed properties,” the Fed said today.

$100 Billion

The Fed set an initial limit on the total amount of five- year TALF loans at $100 billion and “will continue to evaluate that limit.” Terms apply to CMBS issued in 2009, backed by loans originated since July 1, 2008, and carrying the highest credit rating. The Fed is separately still developing terms of a so-called legacy TALF to finance purchases of older securities.

Yield premiums on commercial-mortgage bonds compared with benchmark securities rose after the announcement, as some investors were expecting the Fed to also detail plans for older securities, according to Lisa Pendergast, an analyst at RBS Securities Inc. in Greenwich, Connecticut.

“There’s no one on the Street doing new loans,” limiting the impact of the Fed’s initiative until the legacy assets are addressed, she said.

The extra yield over benchmark rates on the most-senior class of a 2007 Goldman Sachs Group Inc. commercial-mortgage bond climbed about 1 percentage point to about 8.5 percentage points today, according to RBS. The yield gap had fallen from 12.6 percentage points when regulators in late March detailed plans to finance purchases of older, distressed assets.

‘Step at a Time’

“While it’s a great step in the right direction, it doesn’t have the impact on older securities that we would like,” said Christopher Hoeffel, president of the Commercial Mortgage Securities Association, a trade group, in New York. “They have not shut the door on a five-year term for legacy assets, but they are taking this one step at a time.”

New loans for CMBS will be more expensive based on today’s interest rates. If the Fed set TALF rates today, an investor could borrow for five years at 3.63 percent or three years at 2.97 percent, according to calculations by Bloomberg.

Five-year loans will be available for purchases of CMBS as well as securities backed by education and small-business debt, the Fed said. Investors haven’t requested loans for those securities through the TALF yet.

“Three-year funding wasn’t long enough” to aid the market, said John Ryding, chief economist at RDQ Economics LLC in New York, who formerly worked at the Fed. “It’s another piece of the Fed’s balance sheet that’s going to be locked in place for a really long time,” he also said.

TALF loans are backed by Treasury Department funds from the Troubled Asset Relief Program, helping protect the Fed against the first 10 percent of losses.

Bigger ‘Haircuts’

Investors, such as hedge funds, will need to put up $15 of their own capital for every $100 in CMBS that will be posted as collateral to the Fed. That’s one of the steepest “haircuts” in the TALF, indicating Fed officials see CMBS among the riskiest assets. For subprime credit-card ABS with a five-year “average life,” investors put up $10 for every $100 in securities.

The first investor subscription date for CMBS loans through the TALF will be in late June, followed by the “latter part of each month,” the Fed said. The subscription date for other assets, such as auto-loan and credit-card securities, will remain at the beginning of each month. The Fed authorized the TALF through December.

May 5 is the deadline for the third monthly round of applications for other TALF loans. General Electric Co., Harley- Davidson Inc., Volkswagen AG and Honda Motor Co. lead companies selling debt for next week’s round, according to people familiar with the sales.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net.