New CMBS Issues Ready To Be Weaned Off Federal Support

Two successive new commercial mortgage bonds issued with limited or no support from the Federal Reserve's program have suddenly raised the possibility that this corner of the debt market may be revived on its own.

While the market for bonds backed by commercial mortgages suffered more than a year of dormancy, there was palpable concern that the securitization of loans made for hotels, office buildings and stores would not return any time soon. Falling occupancy rates and rising delinquency rates made the picture even more dire.

The Federal Reserve extended its term asset-backed securities loan facility--initially intended for securities backed by consumer loans--to the commercial mortgage market in May, hoping to spur some activity.

For the first few months, investors tapped the facility, known by the acronym TALF, to buy existing commercial mortgage bonds, but no new issuance was in sight.

Things changed this week.

On Monday, Developers Diversified Realty Corp. (DDR) priced a $400 million deal, the first commercial-mortgage-backed security issue in more than a year. Its success proved two things: that investors were willing to buy well-structured, conservatively underwritten bonds, and that they were willing to make these purchases with little government support.

In the DDR deal, buyers sought only $72 million in cheap loans from TALF, while the rest of the $323 million triple-A portion was sold to unleveraged investors such as banks, pension funds and insurance companies.

"There is a growing consensus that the need for TALF is much dimnished today versus at the beginning of the year," said Lisa Pendergast, head of CMBS strategy and risk at Jefferies, and incoming president of the trade group Commercial Mortgage Securities Association.

"While legacy TALF is wildly successful, and helped orchestrate significant stability back to market and spreads tightened, TALF's role has diminished for new issuance," she said.

Further, there is so much money that has been sitting on the sidelines for such a long time that any deal that comes to the market is likely to be oversubscribed, said Frank Innaurato, managing director at Realpoint Research, a credit rating agency.

He said he expects at least two more CMBS deals to come to the market before year end, mostly with some TALF participation.

Already, a second deal is in the market. Bank of America Corp. (BAC) is set to announce a $460 million deal backed by office and industrial properties in Florida. This deal will be a real test of buyers' appetite for these CMBS because there is no government support. Further, this deal includes a $47 million triple-B class. The lowest tranche on the DDR offer was rated single A.

Investors are looking at whether the properties held as collateral on these loans are leased to good tenants, produce a steady flow of income with no looming lease terminations, and overall transparency on the deal, Innaurato said.

While true recovery is unlikely until commercial real estate hits bottom, liquidity is likely to return much sooner.

This also paves the way for the end of the TALF program in June, which many had said would have to be extended to give commercial real estate time to recover.

"The issue no longer is that you need TALF to bring new CMBS offer to the market, rather it's trying to get banks and lenders to originate new loans," Pendergast said.

-By Prabha Natarajan, Dow Jones Newswires; 212-416-2468; [e-mail]