Investment Management Alert
May 2009
Authors:
TALF Expanded to Include CMBS
Anthony R.G. Nolan
anthony.nolan@klgates.com
+1.212.536.4843
Daniel F. C. Crowley
dan.crowley@klgates.com
+1.202.778.9447
Gordon F. Peery
gordon.peery@klgates.com
On May 1, 2009, the Federal Reserve Board (the “FRB”) announced an expansion of
the Term Asset-Backed Securities Loan Facility (“TALF”) to include commercial
mortgage-backed securities (“CMBS”) and securities backed by insurance premium
finance loans as eligible collateral for loans under the TALF. We have previously
described the eligibility criteria for the TALF program in earlier alerts, entitled “The
Term Asset-Backed Securities Loan Facility Takes Form” and “The Term AssetBacked Securities Loan Facility in Sharper Focus.” Because the expansion to
include CMBS marks a departure from the TALF program as previously developed,
this Alert will focus on the new features of the TALF CMBS program.
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Drew A. Malakoff
drew.malakoff@klgates.com
+1.212.536.4034
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Background
The expansion of TALF to include newly issued CMBS was not unexpected, since
the FRB had indicated its intent to broaden the scope of TALF-eligible collateral to
encompass newly issued AAA-rated commercial mortgage-backed securities as early
as February 10, 2009. This in turn was a response to the fact that the CMBS market
came to a halt in mid-2008, after having provided liquidity for almost half of all new
commercial mortgage originations in 2007. The need to jump-start the CMBS
markets to provide liquidity and credit for the commercial real estate sector has
recently become increasingly urgent, as there is scarce capacity to refinance a
significant amount of commercial mortgages that are coming due in the next few
years.
The Treasury’s proposed public-private investment partnerships (“PPIPs”) program
for so-called legacy CMBS has also given impetus to developing the TALF CMBS
program, as it contemplates an expansion of TALF to provide financing for legacy
CMBS, i.e. that which was issued prior to 2009. The need to deal with these issues
before the implementation of the PPIP program became perhaps more important after
the issuance on April 21 of the first Quarterly Report to Congress of the Office of the
Special Inspector General for the TARP Program (“SIGTARP”). The report of the
SIGTARP identified certain diligence issues and potential conflicts of interest that
could arise from permitting PPIPs to borrow under TALF, and separately
implementing TALF for CMBS without the added complications of the overlay with
the PPIP program might well prove simpler than to introduce it in conjunction with
PPIP.
CMBS Eligibility Criteria
To qualify as eligible collateral for TALF loans, private-label CMBS must meet
criteria that significantly include the following. They must (1) have been issued on
or after January 1, 2009, (2) evidence an interest in a trust fund consisting of fully
funded, first-priority, fixed-rate mortgage loans that are current as of the time of
securitization, (3) entitle security holders to receive principal and interest payments,
(4) have an average life of less than 10 years, and (5) be backed by commercial
mortgages that meet the eligibility criteria described below. The CMBS must not be
subordinated to other securities with claims on the same pool of commercial
mortgages and must be rated in the highest long-term investment-grade
Investment Management Alert
rating category by a required number of TALF
CMBS-eligible rating agencies (to be announced by
the FRB) based on the asset pool and structure,
without giving effect to external credit
enhancements such as monoline guarantees.
The pooling and servicing agreement (“PSA”) and
other agreements governing the issuance of the
CMBS and the servicing of its assets will be
required to contain prescribed provisions that relate
to origination and servicing of assets, appraisals of
mortgaged property, and allocations of cash flow.
They will also require that the loan seller make
certain representations regarding the origination of
the mortgage loans. The PSA and the documents
governing the underlying loans are also expected to
provide the FRB with access to information
reporting and effective control over the exercise by
TALF borrowers of voting rights with respect to
pledged CMBS.
TALF-eligible CMBS must be backed by fixed-rate,
fully funded, first-priority mortgage loans that were
originated on or after July 1, 2008, that are current in
payment at the time of securitization, and that do not
provide for interest-only payments during any part
of the remaining term. The assets backing CMBS
may not include securities, interest rate derivatives
or other hedging instruments. A participation
interest or other ownership interest in a mortgage
loan is eligible as long as it is senior to or pari passu
with all other interests in the same loan in right of
payment of principal and interest following the
occurrence of a default on the underlying loan. The
FRB has expressed an expectation that pools will be
diverse and reserves the right to exclude individual
loans from any pool.
TALF Borrowing Terms
Although the borrowing terms for TALF secured by
CMBS are generally similar to those for TALF loans
secured by other categories of assets, the TALF
CMBS program departs from the general terms in
some respects, particularly regarding the maturity
terms, haircut rules, and the application of payments
received on TALF loan collateral to accelerate the
principal amortization of the TALF loan.
In order to address concerns about maturity
mismatch between the normal three-year term of a
TALF loan and the expected amortization date of
the collateral, considering the relatively long
average life of many CMBS, the FRB has
authorized TALF loans with maturities of five
years. (For similar reasons, the FRB has also
authorized a five-year term for TALF loans secured
by ABS backed by student loans and Small
Business Administration loans.) Borrowers may
elect to borrow with a three-year or a five-year
maturity, with a three-year TALF loan bearing
interest at a fixed annual rate equal to 100 basis
points over the three-year LIBOR swap rate, and a
five-year TALF loan bearing interest at a fixed
annual rate equal to 100 basis points over the fiveyear LIBOR swap rate. The haircut for a TALF
loan depends on the average life of the CMBS being
financed and ranges from 15% for tranches with a
life of 5 years or less to 25% for a tranche whose
average life is 10 years. The average life of a CMBS
will be the remainder of the original weighted
average life, determined by its issuer employing
industry-standard assumptions.
All principal distributions on a pledged CMBS must
be applied immediately to reduce the principal
amount of the TALF loan in proportion to the TALF
advance rate. In addition, TALF loans with a fiveyear term have an accelerating “turbo” feature,
pursuant to which the amount of CMBS interest
distributions in excess of the TALF loan interest
payable in any TALF loan year that may be remitted
to the TALF borrower is capped at an amount equal
to a set percentage of the haircut amount. The
excess interest above the amount remitted is
required to be applied to TALF loan principal
instead of being remitted to the borrower. The set
percentage is 25% during the first three loan years,
10% in the fourth loan year and 5% in the fifth loan
year. The need to true-up amounts over a loan year
will create an incentive to take shorter-term loans
and will probably require complex mechanical
provisions in the customer agreements that are not
required in TALF borrowings for asset-backed
securities backed by other asset classes.
May 2009
2
Investment Management Alert
Conclusion
rights over servicing and special servicing,
advancing and other matters can be quite
complex. The FRB’s approach to CMBS may not
satisfy all constituents, and significant questions
of implementation remain to be addressed before
the first subscription date this coming June.
Using TALF to finance CMBS raises
considerations that are not present with consumerdebt-backed assets. Individual assets are
relatively larger as a percentage of CMBS pools,
and the provisions of PSAs governing CMBS
certificateholders’ relations and their respective
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©2009 K&L Gates LLP. All Rights Reserved
May 2009
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