Fed program for new CMBS' impact may be limited

A Federal Reserve program to spur commercial real estate lending may provide a bit of a jolt, but the amount of financing will likely be limited because the infrastructure needed to produce commercial mortgage-backed securities in bulk is still broken.

The Fed threw a lifeline to the battered commercial real estate sector in June by opening up its consumer and business lending program, the Term Asset-Backed Securities Loan Facility (TALF), to commercial mortgage backed securities (CMBS).

Through the TALF program, investors who buy newly issued CMBS can borrow directly from the Fed. Investors in existing CMBS can also borrow under the program.

While there has been some participation for existing CMBS, there have been no new commercial mortgage bonds available for the program as it takes months to structure new CMBS.

The first new CMBS to be issued as part of the TALF effort is not expected until the later this year. But even once the deals start, there may not be many, and they may be limited to a few real estate investment trusts using their best properties as collateral, such as Developer Diversified Realty (DDR - news).

Banks are uneasy about creating the investment vehicles that helped produce CMBS en masse before the global financial crisis, creating a major stumbling block for the Fed's plan.

The stakes are high. San Francisco Federal Reserve Bank President Janet Yellen said on July 28 that the fate of the $6 trillion market presented a "particular danger zone" for the fragile financial system.

The investment vehicles, known as conduits, were created by the banks to buy and hold loans until they could be packaged into securities. In 2007, the conduits and a hot market allowed dealers to compete for loans for their CMBS issues, which grew as large as $7 billion.

But with credit still strained, banks can't get inexpensive funding for conduits and see a high risk in holding loans at a time the outlook for commercial real estate remains shaky.

Another reason is that the Wall Street investment banks that were the most active in creating conduits have now collapsed or become more risk-averse bank holding companies.

"Goldman Sachs, Morgan Stanley and Lehman, these were all highly leveraged investment banks that had conduits. You just can't do that in the current market," said Walt Schmidt, head of FTN Financial's mortgage strategy group in Chicago.

The Fed extended its facility for commercial real estate financing until June 31, which Schmidt thinks was partly to give the market time to create conduits.

Darrell Wheeler, head of securitized asset strategy at Citigroup in New York says that even with the longer time frame, banks will be wary of warehousing loans in case they can't be packaged into CMBS by June's deadline.

"We see several barriers, but the key issue is timing as any loan originated today has to be securitized by June 31 and nobody feels confident enough that they can do that," Wheeler said.

"Getting a deal aggregated and sold by June 31 is like asking a bunch of bankers to herd cats blindfolded near a cliff," he added. "The cliff being the risk that the market sells off. We need somebody to put a fence by the cliff at least."