Term Asset-Backed Securities Loan Facility Expanded to Include Legacy Commercial Mortgage-Backed Securities

January 1, 0001


In its latest move to jump-start the illiquid market for commercial mortgage-backed securities (“CMBS”) and spur commercial real estate lending, the Federal Reserve Board of Governors (“Federal Reserve”) announced on Tuesday the anticipated expansion of the Term Asset-Backed Securities Loan Facility (“TALF”) to include certain highly rated “legacy CMBS” issued before January 1, 2009 as eligible collateral. This most recent expansion of TALF marks the first addition of a “legacy” asset class to the list of TALF-eligible collateral and follows the Federal Reserve’s announcement earlier this month that newly issued, highly rated CMBS would become TALF-eligible collateral beginning in June. The initial TALF subscription for legacy CMBS is expected to occur in late July. On Tuesday, the Federal Reserve also expanded the number of credit-rating firms qualified to rate TALF-eligible collateral and released details regarding the pre-certification process for eligible borrowers who seek pre-clearance to qualify for a TALF loan.

As part of the multi-pronged Financial Stability Plan, the Federal Reserve announced in November 2008 the creation of TALF, a consumer and business lending initiative administered by the Federal Reserve Bank of New York (“FRBNY”) that would leverage $100 billion of funding from the U.S. Department of the Treasury (“Treasury”) and up to $1 trillion in Federal Reserve lending to provide non-recourse loans to purchasers of new consumer loan, small business loan asset-backed securities (“ABS”) and CMBS. For the initial TALF subscriptions beginning in March 2009, TALF-eligible collateral was limited to newly issued (i.e., issued after January 1, 2009), AAA-rated ABS backed by credit card receivables, student loans and Small Business Administration-guaranteed loans, and was expanded in recent TALF subscriptions to include newly issued, AAA-rated ABS backed by floorplan loans, vehicle fleet leases, loans and leases for business equipment and mortgage servicing advances. Earlier this month, the Federal Reserve announced an expansion of TALF to include newly issued, AAA-rated CMBS and insurance premium finance loans, with the initial subscription date for TALF loans secured by newly issued CMBS now set for June 16, 2009. Click to view an overview of the TALF program and our May 4, 2009 client alert.

By expanding TALF eligibility to encompass legacy CMBS, the Federal Reserve intends to promote price discovery and liquidity for legacy CMBS, with the expectation that a reinvigorated legacy CMBS market will stimulate the extension of new credit by helping to ease balance sheet pressures on banks and other financial institutions. This extension of credit, in turn, would facilitate the refinancing of maturing loans on otherwise economically viable commercial properties, borrowing to finance new purchases of commercial properties, and the issuance of newly issued CMBS. So far, TALF has not been expanded to include residential mortgage-backed securities as eligible collateral, an expansion which the Federal Reserve indicated in February 2009 that it was considering.

Below is an outline of key aspects of the expanded TALF program:

Overview of TALF-Eligible Legacy CMBS

Eligible legacy CMBS includes U.S. dollar-denominated, cash (i.e., non-synthetic) CMBS issued before January 1, 2009 and that otherwise meet the following requirements:

  • Qualifying Assets: Eligible CMBS must evidence interest in a trust fund consisting of fully-funded, first-priority, mortgage loans (and not other CMBS, other securities or interest rate swap or cap instruments or other hedging instruments). A participation or other ownership interest in such a loan will be considered a mortgage loan 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. The properties underlying the eligible CMBS must be a fee or leasehold interest in income-generating commercial properties, at least 95% (by related loan principal balance) of which must be, as of the TALF loan subscription date, located in the United States or its territories. In addition, at least 95% of the dollar amount of the credit exposure underlying the CMBS must be exposures originated by U.S.-organized entities or institutions or U.S. branches or agencies of foreign banks.

  • Credit Rating: As of the TALF loan closing date, eligible CMBS must have a credit rating in the highest long-term investment-grade rating category from at least two TALF CMBS-eligible rating agencies designated by FRBNY (namely DBRS, Inc., Fitch Ratings, Moody’s Investors Service, Realpoint LLC, and Standard & Poor’s), with no CMBS-eligible rating agency rating the CMBS below such level. CMBS that uses third-party guarantees as a credit enhancement to obtain such a rating, or which has a rating on review for possible downgrade, is ineligible.

  • Original Seniority: Upon issuance, the CMBS must not have been junior to other securities with claims on the same pool of loans. Such exclusion is intended, however, as a reference to subordination for credit support; CMBS that is entitled to receive principal later than the other most senior CMBS classes (i.e., has a later position in the time tranche sequence) is not excluded as TALF-eligible collateral.

  • Payment Terms: Eligible CMBS must entitle its holders to both principal and interest payments (i.e., is neither interest-only nor principal-only) and bear interest at a pass-through rate that is fixed or based on the weighted average underlying fixed mortgage rates.

  • Issuer: Eligible CMBS may not be issued by an agency or instrumentality of the United States (including government-sponsored enterprises).

  • TALF Loan Maturity: TALF loans supported by CMBS may have a three- or five-year maturity, at the borrower’s election, with loans bearing interest at a fixed annual rate of 100 basis points (“bps”) over either the 3-year Libor swap rate (for loans with three-year maturities) or the 5-year Libor swap rate (for loans with five-year maturities).

  • Collateral Haircut: The maximum TALF loan amount secured by a legacy CMBS would be the current market price of the CMBS minus the base dollar haircut, such that the collateral haircut for a CMBS is effectively the base dollar haircut divided by the current market price. FRBNY’s methodology is such that the size of the collateral haircut increases with the magnitude of the market price discount from par, reflecting the assumption that more substantial market discounts are generally indicative of credit concerns.

    • The base dollar haircut for CMBS with an average life of five years or less will be 15% of par, increasing by one percentage point of par for each additional year of average life beyond five years.

    • The average life of a CMBS will be the remainder of the original weighted average life as set by its issuer, using industry-standard assumptions, but subject to certain adjustments under consideration by FRBNY. FRBNY has indicated that it is considering requiring that default-related circumstances be considered in calculating weighted average CMBS life.

  • Principal Payment: As a general rule, principal payment on the CMBS must be applied to the principal of the TALF loan in proportion to the haircut. For a three-year TALF loan, the excess of CMBS interest distributions over TALF loan interest payable will be remitted to the TALF borrower only until such excess equals 30% per annum of the haircut amount, with the remainder applied to principal. For a five-year TALF loan, such excess interest distributions will be remitted to the TALF borrower only until such excess equals 25% per annum of the haircut amount in the first three loan years, 10% in the fourth loan year, and 5% in the fifth loan year, with the remainder applied to reduce the outstanding principal amount of the TALF loan.

  • Collateral Matters: FRBNY expects to engage a collateral monitor and will have the right to reject any CMBS based on its risk assessment. FRBNY will subject to higher scrutiny (i) those asset pools that contain loans from a single borrower or limited to a single asset class, with the expectation that such pools will need to have higher creditworthiness of the pool collateral or higher levels of credit support to justify such concentrations, (ii) those asset pools, whether on a stand-alone basis or when considered together with other loan pools backing other TALF-financed CMBS, that are not otherwise generally diversified with respect to loan size, geography, property type, borrower sponsorship and other characteristics, and (iii) those asset pools that have high cumulative historical losses or concentrations of subordinate-priority mortgage loans, loans that are in default, in special servicing or on servicer watch lists. FRBNY indicated that it may consider in its decisions forecasts of pool level losses under various stress scenarios.

  • FRBNY Consent Rights: The TALF borrower must agree not to exercise or refrain from exercising its voting, consent and waiver rights without FRBNY’s consent.

  • Subscription and Settlement: Whereas the cycle for non-CMBS ABS TALF subscriptions will remain at the beginning of each month while the TALF program is in effect, the subscription and settlement cycle for CMBS will occur in the latter part of the month. Each CMBS must be cleared through the Depository Trust Company.

There are a number of open issues relating to the implementation of legacy CMBS TALF, with respect to which FRBNY has indicated that further guidance is forthcoming:

  • Limit on Legacy CMBS Share of TALF Loans: FRBNY noted that it may limit the volume of TALF loans secured by legacy CMBS, and is considering whether to allocate such volume via an auction or other procedure.

  • Credit Rating Methodology: Earlier this month, FRBNY indicated that it was assessing rating methodologies to be employed in rating TALF-financed CMBS, as well as identifying ratings agencies for such eligible collateral. While FRBNY has announced that DBRS, Inc. and Realpoint LLC will, in addition to Fitch Ratings, Moody’s Investors Service, and Standard & Poor’s, be qualified to rate TALF-eligible CMBS, no further guidance was provided on the rating methodologies to be employed.

  • Adjustments to Collateral Haircut: FRBNY has indicated that, for purposes of calculating the weighted average life of CMBS, which is relevant to determining the collateral haircut for a CMBS, it is considering requiring that default-related circumstances be considered.

  • Funding Secondary Market Transactions: FRBNY noted that it is considering a requirement that TALF loans for legacy CMBS be used to fund recent secondary market transactions between unaffiliated parties that are executed on an arms’ length basis, as well as a process for price validation of such secondary transactions.

Eligible Borrower Pre-Certification Process

The Federal Reserve released on Tuesday details regarding the pre-certification process for eligible borrowers who seek pre-clearance to qualify for a TALF loan. Pre-certification requires that eligible borrowers and primary dealers meet certain criteria and follow certain procedures in order to become pre-approved to receive TALF funding.

  • Eligible Borrower Pre-Certification Criteria:

    • In addition to meeting the existing eligible borrower requirements required under applicable law and the TALF due diligence policy, in order to become pre-certified, eligible borrowers must (i) be a “top-tier” financial entity (i.e., among the industry leaders, and/or ranked among the largest entities and/or among the largest operators in its field), and (ii) have been subject to the primary dealer’s know your customer (“KYC”) process (including customer identification and due diligence). “Financial entities” is defined as U.S. depository institutions, U.S. branches or agencies of foreign banks, U.S. pension funds, U.S. university or college endowment funds, U.S.-based hedge funds, U.S.-based private equity firms, U.S.-based mutual funds, and U.S. insurance companies.

    • Further, the primary dealer must, after completing its KYC process, form a reasonable belief that it knows the potential borrower’s true identity and that such borrower is a reputable party acceptable to the primary dealer (i.e., the primary dealer would have provided its services to such borrower in non TALF-related circumstances).

    • If the primary dealer does not believe that the eligible borrower will satisfy the pre-certification criteria, the primary dealer may nonetheless submit the potential borrower to FRBNY for pre-certification, provided that the primary dealer submits the entire KYC file to the FRBNY. Such submissions must be made well in advance of (and no fewer than two business days prior to) the relevant TALF loan subscription date to allow FRBNY sufficient time to complete its review.

  • Pre-Certification Process: Primary dealers must complete and submit a pre-certification form on behalf of the potential borrower to FRBNY no fewer than two business days prior to the TALF loan subscription date. FRBNY will then determine whether the potential borrower satisfies its pre-certification criteria. Pre-certifications by FRBNY will remain valid through December 31, 2009. However, before requesting a new TALF loan on behalf of an eligible borrower, primary dealers are required to ascertain whether an eligible borrower has undergone a material change in its ownership or control structure or in the overall nature of its business, or has been the subject of regulatory action, civil or criminal investigation, or other negative information.

  • FRBNY Consent Right: FRBNY reserves the right to withhold TALF funding in exceptional circumstances, such as in the case where materially adverse information about the potential borrower is obtained prior to settlement.

Other TALF Developments

Finally, FRBNY released yesterday guidance for accounting firms in determining TALF collateral eligibility and the Form of Undertaking to be delivered by pool assemblers in connection with TALF-eligible Small Business Administration (“SBA”) 7(a) Pool Certificates.

  • Guidance for Accounting Firms in Determining TALF Collateral Eligibility: FRBNY clarified the following matters with respect to accounting firms charged with determining TALF collateral eligibility:

    • Auditor Attestation: ABS sponsors must provide an auditor attestation from a nationally recognized,[1] independent accounting firm registered with the Public Company Accounting Oversight Board (“PCAOB”), opining that the issuer and sponsor certification contained in the ABS prospectus is fairly stated in all material respects. Auditor attestations are not required for eligible small business loan ABS (CUSIPs of which will be provided by the SBA). The auditor attestation must be received electronically by FRBNY, and a hard copy must be postmarked, no later than 5pm on the fourth business day prior to settlement of the TALF loan. Only FRBNY, Treasury, and TALF LLC (the special purpose FRBNY vehicle formed to hold surrendered collateral on defaulted TALF loans) may rely on the auditor’s attestation.

    • Auditor Standards: FRBNY will not prescribe specific procedures that accounting firms must follow. However, accounting firms must conduct an engagement sufficient to provide a high level of assurance that TALF eligibility requirements are met. Examinations may be conducted in accordance with attestation standards set forth by the PCAOB or the American Institute of Certified Public Accountants and must be conducted in accordance with applicable law. FRBNY expects that accounting firms will conduct loan level testing that includes a review of original loan files, but does not expect that the accounting firm would need to inspect underlying loan collateral or confirm loan information with the original borrower. The loan level testing would be expected to use (i) an attribute sample to estimate the frequency of non-compliance with specific eligibility requirements, (ii) a sampling unit of an individual loan, and (iii) a sample size sufficiently large to render, in the practitioner’s professional judgment, an opinion. The attestation risk should be limited to approximately 5%.

  • Form of Undertaking for TALF-eligible SBA 7(a) Pool Certificates: Pool assemblers are required to deliver an undertaking that certifies to FRBNY and TALF LLC that the small business ABS meet the TALF SBA-backed ABS eligibility requirements in the TALF terms and conditions. The pool assembler must issue a press release, notify FRBNY and all registered holders of such ABS, and repurchase such ABS if the ABS no longer meets the TALF eligibility requirements.

Additional information regarding the Federal Reserve’s updates to the TALF program:

Press Release:

TALF Legacy CMBS Terms and Conditions:



TALF Overview:

TALF Pre-Certification Requirements:

Guidance for Accounting Firms in Determining TALF Collateral Eligibility:

TALF Form of Undertaking for TALF-eligible SBA 7(a) Pool Certificates:

[1] A nationally-recognized firm would be one that submits to annual inspection by the PCAOB or one which demonstrates a strong presence in a particular market or prominence across markets.