You know that feeling you get when you eat ice cream and it gives you that pain in the side of your head? Try making sense out of the government program: TALF – Legacy CMBS and you’ll get the same pain: brain-freeze.
I understand the need to jump-start the securitization markets. That process is vital to ensuring that banks meet their fundamental obligation to support the credit needs of individuals and businesses, which in turn is vital to our economic recovery.
However, the Legacy CMBS program has absolutely nothing to do with helping market participants meet the credit needs of households and small business. I’ve looked at this program from several different angles. I’ve spoken to folks “in the know” about the processes and procedures in the CMBS market. I’ve learned a lot and I admit, I still don’t understand it all. But of one thing I’m certain: it ain’t helping to get the banks to lend to the small business community.
My question, and the basis for this writing, is to figure out how the Legacy CMBS program meets the fundamental goal of TALF. It begs to be asked, and answered, in light of the fact that there have been ZERO newly issued CMBS processed through the TALF, while there have been over $6 Billion in Legacy CMBS processed.
Let’s start with the easy stuff: The initial premise of WHY the TALF program was created in the words of the Federal Reserve:
The Federal Reserve created the Term Asset-Backed Securities Loan Facility (TALF), to help market participants meet the credit needs of households and small businesses by supporting the issuance of asset-backed securities (ABS) collateralized by auto loans, student loans, credit card loans, equipment loans, floorplan loans, insurance premium finance loans, loans guaranteed by the Small Business Administration, residential mortgage servicing advances or commercial mortgage loans.
The premise makes sense. Years ago, banks held loans on their books. They retained the credit risk and therefore were diligent in applying safe and sound lending practices to all the forms of credit described above. As the need for more credit expanded through our society, the banking industry’s lending functions were limited by the amount of capital they carried. The securitization process was born. Banks made the loans, bundled them together and sold them off to Wall Street. They got their money back (and a nice profit to boot) and began the process anew. Credit flowed.
Wall Street, in turn, purchased these pools of loans (commercial mortgages, residential mortgages, credit cards, auto loans, SBA loans, student loans, etc), divided them up into segments called tranches that had different ratings: investment grade and non-investment grade. Each of these tranches were converted into what the layperson might know as a bond issue, which is really the same as an “asset backed security”. The bonds were then sold in large and small pieces to lots of different investors: some individuals, mutual funds, banks, pension plans and other institutional investors. Through this step, the funds returned back into the hands of the Wall Street firm, who, in turn, purchased more loans from the banks. Credit flowed.
The tranches or classes, defined by CUSIP numbers, are paid to the bond-holders in a particular order. The highest rated classes are paid first, both from the monthly loan payments that the “original borrower” makes and from those loans that are perhaps refinanced and paid off in full. Those tranches at the bottom of the list have the highest risk, since they are the last to be paid out.
Okay, I’ve over-simplified, but hopefully you’ve gotten the gist of things without the brain-freeze.
As the demand for new loans increased, banks started to make loans without any consideration to the rules governing safety and soundness in lending. We all know where that led us: right here in the middle of our nation’s economic collapse.
As our economy deteriorates, loan default rates by the original borrowers increases. That, in turn, lowers the value of the bonds. First problem: many of these bonds are held in the capital accounts of banks, insurance companies and investment firms. When the bond values decline, so does the financial industry’s capital. The second problem is that as the bond market’s performance deteriorates, there are less investors willing to buy the bonds and the market dries up. Basically, no one wants to buy this crap. If there isn’t a buyer, then you can’t sell. Bond prices plummet some more, and therefore financial industry’s core capital plummets.
Additionally, if no one will buy the bonds, Wall Street stops buying the loans from the banks, and the banks stop making the loans. Financing becomes virtually impossible to find and the credit market is frozen.
TALF… to the rescue. We need to get the securitization market flowing. Through the TALF program the government virtually guarantees payment to the bond holders. Under TALF, Wall Street, conceptually, will start to buy new loans and put out new bond issues through securitization. The banks know they have a market in which to sell the loans they make, and so they begin to lend again. If only that was actually happening!!! If there were newly issued CMBS being processed through TALF, then I’d see some hope in the success of this TALF scheme. But alas, it’s not to be.
What value, then, does the TALF Legacy CMBS program have in fostering lending activity? Legacy CMBS’s represent loans that were ALREADY made, ALREADY sold to Wall Street, ALREADY packaged up and divvied up and sold to individuals and institutional investors. When the FRBNY takes a piece of an OLD securitization as collateral and makes a loan, using those bonds as collateral, NO NEW MONEY goes to the banks. The bank already got that money years ago. No new money means no new lending. The Legacy CMBS TALF program is one big act of smoke and mirrors.
The CMBS TALF program is supposed to spur the lending functions of banks when the FRBNY finances the purchasing of NEW commercial loans. Consider this fact: To date TALF financing has not been used to purchase any NEW commercial mortgages. Conversely, it has been used to purchase over $6 Billion in Legacy CMBS.
How, then, has Legacy CMBS TALF helped promote lending? Simply put…. It hasn’t!!!! Which firms are utilizing the Legacy CMBS TALF program? Sorry, says the FRBNY: TALF rules say we don’t have to share that information with the public. So much for the new age of transparency. What, then, is the purpose of the Legacy CMBS program? I have my own theory, which I’ll share with you here.
For those of you who are willing to risk a little brain freeze, here is a great site to visit: http://www.cmbs.com/securitization.aspx?dealsecuritizationid=292
It’s a perfect picture of one of these securitizations. The loans were originated mostly by Bank of America and then to some extent by Barclays and Bear Sterns. The securitization’s name is BACM 2005-3. You’ll see here the list of all the properties that were financed, the interest rate charged, the maturity date of the loan, the type of property and where it’s located. It’s an interesting conglomeration of loans which include $250 Million in financing to the Woolworth Building, $74+ million in financing to the Queens Atrium, various hotels, Walgreens and CVS stores and sundry other multifamily, industrial, retail and office properties across the United States.
I thought it was fascinating to look at. I came upon this report when I searched the TALF site for CUSIP numbers that were approved for collateral in a Legacy CMBS transaction: namely CUSIP number 05947UR42. I’m not singling this issue out for any reason. They just happened to win my web-surfing lottery.
Here’s what I learned. A Wall Street firm (perhaps a bank or their investment firm counterpart) will go out buy a bulk of bonds, that carry the same CUSIP number, from the market. They need to put together a minimum of $10 Million in one bond issue to borrow against them from the FRBNY.
In step one, the Wall Street firm comes up with funds to buy the bonds in the secondary bond market….. not a terribly difficult task for them. Then, they take them to the FRBNY, pledge them as collateral, borrow money from the FRBNY and in doing so they get …… most of their money back (minus the haircut). Now, if , or maybe more accurately when, that bond portfolio, backed by commercial real estate, fails to perform, the investment firm or bank counterparty simply turns their bonds over to the FRBNY in full payment of their loan. Any future losses on those bonds from that portfolio will be funded by the taxpayers.
What does the investment firm or bank counterparty do with the cash they received from the loan they got from the FRBNY. They go out and buy MORE previously issued bonds. Then they take those bonds, bring them to the FRBNY, pledge them as collateral, and once again, get most of their money back. Each time they do this, they pass the risk of that Commercial Mortgage Backed Security (less the haircut) on to the taxpayer.
Furthermore, they are now holding an investment which they can value on their books without having to mark-the-value to market, thanks to the TALF program and our taxpayer guarantee. They have limited their losses and any depreciation in value of their bond holdings.
The Legacy TALF program only benefits the Wall Street firm that has the resources and means to buy up the bonds and bring them to the FRBNY’s window for a loan. It isn’t helping the smaller community banks that are sinking under the pressure of ever higher default rates on commercial mortgages they hold. And it isn’t getting the big banks to start lending again. If the government wants to argue that shoring up the capital positions of these few firms taking advantage of the Legacy CMBS TARP program is helping to stabilize these financial firms, I’d buy that argument. But then, they shouldn’t be promoting the program under TALF whose primary mission is : to help market participants meet the credit needs of households and small businesses through new securitizations.
Legacy CMBS TALF is not doing THAT!!! Churning previously issued commercial real estate bonds for a few savvy Wall Street financial companies does not promote lending to consumers and small business. It provides absolutely no incentive to promote new lending functions and it isn’t. A better acronym might be: SUC OFF which stands for “Shoring Up Capital by Overextending Federal Funding”.
By the end of the TALF program, which the government estimates will finance up to $2 Trillion dollars of Asset Backed Securities, these firms will have accumulated tens of billions of dollars in bonds guaranteed by our tax dollars which they will simply hold in their capital portfolios. I’ve been called cynical. Well so be it. Until I see the CMBS program under TALF used to finance NEW commercial loans, I will continue to call it like I see it: A government bailout in sheep’s clothing and an inappropriate use of our tax dollars.