Newsletter

Aug 26, 2009

SERT Alert: August 2009

Update on the TALF Program

As part of its efforts to combat the economic downturn, the Federal government developed, among other programs,¹ the Term Asset-Backed Securities Loan Facility program (TALF Program).²

The TALF Program has evolved substantially since its creation in December, 2008. In fact, on May 1, 2009, and again on May 19, 2009, the Federal Reserve significantly expanded the TALF Program.

Specifically, on May 1, 2009, the Federal Reserve announced that “U.S. dollar-denominated, cash (that is, not synthetic) commercial mortgage-backed pass-though securities (CMBS) issued on or after January 1, 2009”³ (emphasis added) meeting certain conditions can qualify as “eligible collateral” for loans to be made by the Federal Reserve Bank of New York (FRBNY) under the TALF Program. For purposes of this article, CMBS issued on or after January 1, 2009 shall be referred to herein as “New Issue CMBS.”

On May 19, 2009, the Federal Reserve further expanded the TALF Program by announcing that “U.S. dollar-denominated, cash (that is, not synthetic) commercial mortgage-backed pass-though securities issued before January 1, 2009”⁴ (emphasis added) meeting certain conditions also can qualify as “eligible collateral” for loans to be made by the FRBNY under the TALF Program. For purposes of this article, CMBS issued before January 1, 2009 shall be referred to herein as “Legacy CMBS.”

The newly expanded TALF CMBS Program is underway. $669 million in Legacy CMBS TALF Loans were requested in July and over $2.2 billion in Legacy CMBS TALF Loans were requested in August. No New Issue CMBS TALF Loans have been requested to date. The next subscription date for CMBS TALF Loans is scheduled for September 17, 2009.

For your convenience, set forth below are certain details regarding the expansion and development of the TALF Program to include New Issue CMBS and Legacy CMBS as eligible collateral.

Brief Overview of TALF Program ⁵

General Overview of TALF Program (CMBS and Non-CMBS Eligible Collateral)

Under the TALF Program, the FRBNY will make up to $200 billion of loans (TALF Loans) available to United States companies⁶ that own certain eligible collateral. The United States Department of the Treasury (Treasury) was to provide up to $20 billion of credit protection to the Federal Reserve in connection with the TALF Program.

Under the TALF Program, the FRBNY offers a fixed amount of non-recourse loans each month. Such loans are awarded to borrowers through a competitive, sealed bid auction process. The minimum amount of each TALF Loan is $10 million and each TALF Loan must be fully secured by eligible collateral. TALF Loan borrowers will be required to enter into a Master Loan and Security Agreement which will set forth the precise terms of the applicable loan.

Unless extended, TALF Loans secured by New Issue CMBS will be made available to eligible borrowers under the TALF Program until June 30, 2010 and all other TALF Loans will be made available under the TALF Program until March 31, 2010.

General Overview of TALF Program (Non-CMBS Eligible Collateral)

Currently, non-CMBS eligible collateral is defined under the TALF Program to include United States dollar-denominated cash asset backed securities (ABS) that have the highest long-term or short-term investment-grade rating category from two or more nationally recognized statistical rating organizations (i.e., Fitch Ratings, Moody’s Investors Service and Standard & Poor’s) and that do not have a credit rating of below the highest investment-grate rating category from a major nationally recognized statistical rating organization. Permitted underlying credit exposures for the ABS include, among others, auto loans, student loans, credit card loans or small business loans guaranteed by the United States Small Business Administration.

The amount of each TALF Loan is equal to the lesser of par or market value of the ABS less a haircut (presently, minimum haircuts for non-CMBS eligible collateral are 5%) established by the FRBNY for each class of eligible collateral. Haircuts are determined based on the price volatility of each class of eligible collateral.

Certain Details Regarding Expansion, on May 1, 2009 and May 19, 2009, of TALF to Include New Issue CMBS and Legacy CMBS as Eligible Collateral⁷

Details Common to the New Issue CMBS and Legacy CMBS Programs

Each TALF Loan, whether secured by New Issue CMBS or by Legacy CMBS, will, at the borrower’s option, have a three year maturity or a five year maturity. A three year TALF Loan will bear interest at a fixed rate per annum equal to 100 basis points over the three year LIBOR swap rate and a five year TALF Loan will bear interest at a fixed rate per annum equal to 100 basis points over the five year LIBOR swap rate.

To qualify as eligible collateral, the CMBS must have, as of the TALF Loan subscription date, a “credit rating in the highest long-term investment grade rating category from at least two TALF CMBS-eligible rating agencies (i.e., DBRS, Inc., Fitch Ratings, Moody’s Investors Service, Realpoint LLC and Standard & Poor’s) and must not have a credit rating below the highest-investment-grade rating category from any TALF CMBS-eligible rating agency.” CMBS that meets the credit ratings requirements because of a third party guaranty will not qualify as eligible collateral.

The CMBS must “bear interest at a pass-through rate that is fixed or based on the weighted average of the underlying fixed mortgage rates.” Furthermore, the CMBS cannot be interest-only or principal-only pay securities—the securities must entitle their holders to payments of principal and interest. CMBS issuers cannot be an agency or instrumentality of the United States or a government sponsored entity.

Payments of principal received on the CMBS collateral must be used to reduce the principal balance of the TALF Loan in proportion to the haircut. Based on a FRBNY formula, when the amount of interest paid on the CMBS collateral exceeds the interest due on the TALF Loan, a portion of such excess may, under certain circumstances, be paid to the TALF Loan borrower, with the balance to be used to repay the TALF Loan.

The FRBNY has reserved the right to reject CMBS as eligible collateral based on its risk assessment. In conducting a risk assessment the FRBNY will consider, among other factors, whether there is an unacceptable concentration in the pool (such as borrower sponsorship, property type or geographic region). The FRBNY’s right to reject CMBS as eligible collateral could become important in the Legacy CMBS context because a “TALF [Loan] borrower may purchase a [L]egacy CMBS at any time following the prior month’s [L]egacy CMBS subscription date, but in any event, the borrower must enter into a transaction [to purchase the Legacy CMBS] with a settlement date on or before the [then-]current subscription date for [L]egacy CMBS.” Accordingly, a situation could arise where a potential TALF Loan borrower purchases Legacy CMBS, only to have such Legacy CMBS rejected as eligible collateral for a TALF Loan. Although not necessarily an indicator as to how the FRBNY may act in the future, it is nevertheless important to note that the FRBNY approved 35 of the 36 Legacy CMBS TALF Loan applications in July.

CMBS will not be Eligible Collateral if the TALF Loan borrower is, or is an affiliate of, a borrower under a mortgage loan backing the CMBS unless “that loan, and each other mortgage loan in the CMBS mortgage pool made to an affiliate of the TALF borrower, together constitute no more than 5% of the aggregate principal balance of the mortgage loans in the pool as of the [TALF Loan] subscription date.”

The FRBNY has engaged Trepp, LLC to serve as a “collateral monitor” and may engage other firms to serve as collateral monitors. Collateral monitors will not “establish policies or make decisions” for the FRBNY but will assist the FRBNY by providing valuation, modeling, analytics and reporting.

Characteristics Unique to the New Issue CMBS Program

Haircuts

The haircut for each New Issue CMBS with an average life⁸ of five years or less will be 15% and collateral haircuts will increase by one percentage point for each additional year (or portion thereof) of average life beyond five years, with a maximum permitted average life of 10 years.

CMBS Requirements

To qualify as eligible collateral, each New Issue CMBS must “evidence an interest in a trust fund consisting of fully-funded, first-priority mortgage loans that are current in payment at the time of securitization, and not other CMBS, other securities or interest rate swap or cap instruments or other hedging instruments.”⁹ The New Issue CMBS must not be “junior to securities with claims on the same pool of loans.”

Underlying Mortgage Loan Requirements

The underlying mortgage loans must have been originated on or after July 1, 2008 and must be fixed rate loans. Furthermore, the underlying mortgage loans cannot provide for payments of interest only during any part of their remaining terms.

Each of the underlying mortgages must encumber a fee or leasehold interest in one or more income generating properties located in the United States or one of its territories. Furthermore, the mortgage loans must have been recently underwritten or re-underwritten prior to the issuance of the New Issue CMBS based upon “then-current in-place, stabilized and recurring net operating income and then-current property appraisals.”

Pooling and Servicing Agreement Requirements

The Pooling and Servicing Agreements must meet several requirements. Specifically, the following requirements appear in the FRBNY New Issue Terms and Conditions Sheet:

If a class of the CMBS is one of two or more time-tranched classes of the same distribution priority, distributions of principal must be made on a pro rata basis to all such classes once the credit support is reduced to zero as a result of both actual realized losses and “appraisal reduction amounts.”
Control over the servicing of the assets, whether through approval, consultation or servicer appointment rights, must not be held by investors in a subordinate class of CMBS once the principal balance of that class is reduced to less than 25% of its initial principal balance as a result of both actual realized losses and “appraisal reduction amounts.”
A post-securitization property appraisal may not be recognized for any purpose under such agreements if the appraisal was obtained at the demand or request of any person other than the servicer for the related mortgage loan or the trustee.

The mortgage loan seller must represent that, upon the origination of each mortgage loan, the improvements at each related property were in material compliance with applicable law.

Miscellaneous

The FRBNY anticipates that collateral pools will be diversified in terms of property type, geography, loan size and borrower sponsorship; however, the FRBNY will consider nondiversified collateral on a case-by case basis.

Characteristics Unique to the Legacy CMBS Program

Loan Amounts/Base Dollar Haircuts

Each TALF Loan secured by Legacy CMBS will in an amount equal to the lesser of the dollar purchase price on the trade date or the market price as of subscription date of the Legacy CMBS (the “applicable price”) less, in either case, a base dollar haircut (from par)¹⁰ determined as follows:

For Legacy CMBS with an average life¹¹of five years or less, 15% of par; and
For Legacy CMBS with an average life of beyond five years, 15% of par plus one percentage point of par for each additional year (or portion thereof) of average life beyond five years, with a maximum permitted average life of 10 years.¹²

The following example set forth in the FRBNY’s Term Asset-Backed Securities Loan Facility (Legacy CMBS): Frequently Asked Questions sheet provides useful details as to how a Legacy Loan amount would be determined:

Assuming a [L]egacy CMBS with a par value of 100 and seven year weighted average life, with a base dollar haircut of 17% of par:

If the applicable price is 75% of par, the loan amount is [$]58 (75-17) and the collateral haircut is 23% (17/75) of the applicable price; and
If the applicable price is 50% of par, the loan amount is [$]33 (50-17) and the collateral haircut is 34% (17/50) of the applicable price.

The FRBNY’s Term Asset-Backed Securities Loan Facility (Legacy CMBS): Frequently Asked Questions sheet provides that the FRBNY will validate the reasonableness of the price of secondary market transactions by comparing the price reflected on the sales confirmation to various market data with respect to the existing market price on the date of such transaction. If the FRBNY determines that the TALF Loan requested does not reflect then-prevailing market prices, the TALF Loan request will be rejected.

Additionally, the FRBNY also “will utilize the services of one or more of its agents to perform a valuation of each [L]egacy CMBS under various stress scenarios” and the FRBNY may reject a TALF Loan request if the requested TALF Loan amount is greater than the stress valuation.

The FRBNY and its agents will determine the market price of the Legacy CMBS as of the subscription date on the basis of information provided by pricing services, unless that information is determined by the FRBNY and its agents not be representative of market conditions prevailing at that time. If the pricing information is not available or is not determined to be representative, the FRBNY and its agents will use reasonable efforts to secure price quotations from at least three broker-dealers and the market price will be the arithmetic average of the broker quotations. If the FRBNY and its agents are unable to obtain such quotations or if it is determined that one or more of such quotations may not accurately reflect the market price of the Legacy CMBS, then the market price will be determined by the FRBNY and its agents.

Legacy CMBS Requirements

To qualify as eligible collateral, each Legacy CMBS must “evidence an interest in a trust fund consisting of fully-funded, mortgage loans and not other CMBS, other securities or interest rate swap or cap instruments or other hedging instruments.”¹³ The Legacy CMBS, upon issuance “must not have been junior to securities with claims on the same pool of loans.”

Underlying Mortgage Requirements

Each of the underlying mortgages must encumber a fee or leasehold interest in one or more income generating commercial properties, at least 95% of which (based upon related loan principal balance) are located in the United States or one of its territories.

Miscellaneous

The Federal Reserve may limit the volume of TALF Loans secured by Legacy TALF.

If a Legacy CMBS relating to a TALF Loan request has been downgraded or placed on review or watch for downgrade after the subscription date for a loan with respect to such Legacy CMBS, the Legacy CMBS “will not lose its status as eligible collateral for such loan request solely for that reason.”

Conclusion

Since its creation in December, 2008, the TALF program has became a crucial source of billions of dollars in credit in an otherwise near-frozen credit market. Continuing to expand, the TALF Program has become an important piece of the Federal government’s plan to turn around an ailing economy.

¹ Other programs created by the government include the Public-Private Investment Program (PPIP Program) which consists primarily of the Legacy Loans Program and the Legacy Securities Program. Further details of the Legacy Loan Program and the Legacy Securities Program may be found in the publication, dated March 25, 2009, entitled “United States Treasury Department Releases Details of the Public-Private Investment Program.” A copy of this publication can be found on our website, www.seyfarth.com/sertalert. For a SERT Alert regarding the PPIP Program, see below.

² Further details of the TALF Program may be found in the publication, dated December 9, 2008, entitled “The Creation of the TALF Program, the Citigroup Bailout and Other Recent Developments Related to the Emergency Economic Stabilization Act of 2008.” A copy of this publication can be found on our website, www.seyfarth.com/sertalert.

³ The quoted language is from the FRBNY’s Term Asset-Backed Securities Loan Facility (CMBS): Terms and Conditions sheet (FRBNY New Issue Terms and Conditions Sheet), last revised August 4, 2009.

⁴ The quoted language is from the FRBNY’s Term Asset-Backed Securities Loan Facility (Legacy CMBS): Terms and Conditions sheet (FRBNY Legacy Terms and Conditions Sheet), last revised July 2, 2009.

⁵ All material set forth in this Section I regarding the terms of the TALF Program is derived from the FRBNY’s Term Asset-Backed Securities Loan Facility Frequently Asked Questions sheet, last revised August 4, 2009, and from a FRBNY Press Release, dated August 17, 2009.

⁶ Defined as any entity that is “(1) a business entity or institution that is organized under the laws of the United States or a political subdivision or territory thereof (U.S.-organized) and conducts significant operations or activities in the United States, including any U.S.-organized subsidiary of such an entity; (2) a U.S. branch or agency of a foreign bank (other than a foreign central bank); (3) a U.S. insured depository institution; or (4) an investment fund that is U.S.-organized and managed by an investment manager that has its principal place of business in the United States.”

⁷ All material set forth in this Section II is derived from the FRBNY New Issue Terms and Conditions Sheet, the FRBNY Legacy Terms and Conditions Sheet or the FRBNY’s Term Asset-Backed Securities Loan Facility (CMBS): Frequently Asked Questions sheet, last revised August 4, 2009.

⁸ It is noted in the FRBNY New Issue Terms and Conditions Sheet that the “average life of a CMBS will be the remainder of the original weighted average life determined by its issuer employing industry-standard assumptions.”

⁹ The FRBNY has noted that, “A participation or other ownership interest in such a loan will be considered a mortgage loan and not a CMBS or other security if, following a loan default, the ownership interest is senior to or pari passu with all other interests in the same loan in right of payment of principal and interest.”

¹⁰ This formula represents the equivalent of a collateral haircut equal to the base dollar haircut divided by the applicable price.

¹¹ Weighted average life for Legacy CMBS will be calculated “on the basis of (1) the current composition of the mortgage pool, as reflected in recent servicer and trustee reports, (2) the entitlement of the [L]egacy CMBS to distributions (including, if applicable, its position in a time-tranched sequence of classes), (3) the assumption that ‘anticipated repayment dates’ are maturity dates, and (4) a 0% CPR [(conditional prepayment rate)] and the absence of future defaults.” When conducting such calculations, loans in default or in special servicing will be considered non-defaulted loans and previously modified loans will be considered in accordance with their modified terms rather than their original terms.

¹² Legacy CMBS cannot qualify as Eligible Collateral if its dollar purchase price or market price as of subscription date is less than its base dollar haircut.

¹³ The FRBNY has noted that, “A participation or other ownership interest in such a loan will be considered a mortgage loan and not a CMBS or other security if, following a loan default, the ownership interest is senior to or pari passu with all other interests in the same loan in right of payment of principal and interest.”

Brief Update on the Legacy Loans and Legacy Securities Programs

As detailed in this Firm’s publication, dated March 25, 2009 and entitled “United States Treasury Department Releases Details of the Public-Private Investment Program,” the Public-Private Investment Program (PPIP Program) created by the Federal Government consists primarily of the Legacy Loan Program and the Legacy Securities Program.¹

In a joint statement issued on July 8, 2009 (Joint Statement) by the Secretary of the United States Department of the Treasury (Treasury), Timothy Geithner, the Chairman of the Board of the Federal Reserve (Federal Reserve), Ben Bernanke, and the Chairman of the Federal Deposit Insurance Corporation (FDIC), Sheila Bair, it was announced that the Treasury would invest up to $30 billion in the Legacy Securities Program.² Furthermore, the Joint Statement contained a list of eight (8) firms that were pre-approved to serve as initial “fund managers” under the Legacy Securities Program. According to the Joint Statement, these firms have up to twelve weeks from July 8, 2009 to raise at least $500 million in capital from private investors for the Legacy Securities Program.
The Legacy Loans Program appears to be on hold. In the Joint Statement it was noted that, “The FDIC remains committed to building a successful Legacy Loans Program for open banks and will be prepared to offer it in the future as needed to cleanse bank balance sheets and bolster their ability to support the credit needs of the economy. In addition, the FDIC will continue to work on ways to increase the utilization of this program by open banks and investors.” Nevertheless, there have been no indications that the Legacy Loans Program will be launched any time soon.
For a copy of the Joint Statement, visit http://www.financialstability.gov/latest/tg_07082009.html

¹A copy of this publication can be found on the Firm’s website, www.seyfarth.com, by clicking the SERT Alert/Strategic Economic Response Team icon.

² It was originally contemplated that at least $75 billion to $100 billion would be invested in the Legacy Securities Program and the Legacy Loan Program.

Visit http://www.seyfarth.com/sertalert for past editions of SERT ALERT and a description of Seyfarth Shaw’s Strategic Economic Response Team (SERT).