Introduction

On May 1, 2009, the Federal Reserve announced modifications to the terms and conditions of its Term Asset-Backed Securities Loan Facility (TALF) to permit and facilitate the use of TALF loan funds to finance commercial mortgage-backed securities (CMBS). These modifications to the TALF, which the Fed has signaled for several weeks, include (1) the expansion of the eligibility requirements for TALF collateral to include certain CMBS; and (2) an increase in the term of TALF loans for CMBS (and certain other collateral) from three to five years.

CMBS will become eligible collateral for TALF loans, subject to the terms and conditions summarized below, for TALF fundings from and after the June 2009 funding. The initial CMBS subscription date, which will be announced shortly, will be in late June. The Federal Reserve Bank of New York (FRBNY) indicates that the subscription and settlement cycle for CMBS will occur in the latter part of each month, whereas the cycle for non-CMBS collateral will remain at the beginning of each month.

The TALF program, which funded its first round of loans on March 25, 2009, is designed to revive the market for certain asset-backed securities (ABS) by means of a loan facility under which borrowers that are eligible to access the program will receive loans funded by FRBNY.

Eligible Borrowers

A borrower under TALF must be a US entity that conducts significant operations or activities in the United States. If the borrower is a US branch or agency of a foreign bank, the borrower must maintain reserves with the Federal Reserve Bank. A borrower cannot be a US branch or agency of a foreign central bank. If the borrower is an investment fund, it must be managed by an investment manager that maintains its principal place of business in the United States. Notwithstanding the foregoing, a borrower under TALF may not be controlled by, and may not be a subsidiary or agent of, a foreign government or central bank, and a borrower under TALF may not be an investment fund that is managed by an investment manager controlled by a foreign government. Eligible borrowers may borrow under TALF only through an eligible securities dealer (a Primary Dealer) who has become a party to the TALF Master Loan and Security Agreement.

In order to borrow under TALF, an eligible borrower must provide its Primary Dealer with certain information and must enter into certain agreements with the Primary Dealer in order to enable the Primary Dealer to deal, as the authorized agent of the borrower, with FRBNY and its designees (including the Custodian, defined below).The borrower must acquire, or prepare to acquire with TALF funds, eligible TALF ABS collateral and must arrange to deliver the collateral to the Custodian. The borrower notifies the Primary Dealer of the amount of ABS collateral it intends to finance, the type of collateral and the interest rate type (fixed or floating); the Primary Dealer then submits the borrower’s information (along with other borrowers’ information) to FRBNY for processing and loan funding.

Eligible Collateral

Previously, TALF-eligible collateral consisted only of ABS with respect to which the underlying credit exposures are (1) auto loans, (2) student loans, (3) credit card loans or (4) small business loans guaranteed by the Small Business Administration. Under the revised terms and conditions of TALF, eligible collateral now includes US dollar-denominated CMBS issued on or after January 1, 2009. TALF-eligible CMBS are non-agency CMBS evidencing an interest in a pool of fully funded, first-priority, fixed-rate mortgage loans originated on or after July 1, 2008, in which principal is at least partially amortized (i.e., no interest-only payments due) during the remainder of the loans’ terms.

The security for the loans must be a mortgage or similar security interest encumbering a fee simple or leasehold estate in commercial properties located in the United States or US territories. Loans underlying TALF-eligible CMBS collateral may not have an average life greater than 10 years from the date of TALF funding.

Eligible CMBS collateral must have a credit rating, as of the closing of the TALF loan, in the highest long-term investment-grade rating category from a specified number of TALF-approved rating agencies, must not have a credit rating below the highest investment-grade rating category from any such rating agency, and must not have been placed on review or watch for downgrade. Eligible CMBS collateral will not include securities that obtain credit ratings based on a third-party guarantee.

FRBNY is in the process of reviewing all rating agencies that have expressed interest in rating TALF-financed CMBS. Prior to the first subscription date for loans with CMBS collateral, it will publish a list of approved rating agencies and the required number of agency ratings for eligible CMBS. Mortgage loans underlying eligible CMBS must have a recent underwriting on the basis of current appraisals and current, stabilized and recurring net operating income.

No specific requirements regarding diversification of loans underlying CMBS collateral have been published. FRBNY has indicated it will favor diversification regarding loan size, geography, property type and other characteristics but also that it will consider undiversified CMBS collateral in certain instances.

FRBNY’s guidance regarding CMBS indicates that borrowers who use TALF proceeds to finance CMBS may not exercise, nor refrain from exercising, any voting, consent or waiver rights under the CMBS collateral without FRBNY’s prior consent.

Loan Terms

TALF loans are made in amounts between $10 million (the minimum loan amount) and an amount equal to the value of the collateral multiplied by a fraction representing a haircut determined by the Federal Reserve based on the type of asset underlying the ABS collateral and based on the maturity date of ABS. Currently the haircuts for collateral (other than CMBS) with maturities between four and five years range from 5 percent (for student loan-backed ABS) to 16 percent (for rental fleet auto loan-backed ABS). The haircut for CMBS with an average life of up to five years will be 15 percent; for CMBS with an average life of more than five years, the haircut will increase by one percentage point per year.

TALF loans for non-CMBS collateral have terms of three years, unless the ABS collateral pledged as security will mature prior to three years from the date of the loan, in which case the loan matures upon maturity of the ABS collateral. CMBS-collateralized TALF loans, and TALF loans collateralized by student loans and SBA-guaranteed loans, may now have maturities up to five years. The Federal Reserve Board has indicated that $100 billion of TALF funds will be available for five-year TALF loans, but that limit is still being evaluated.

The interest rate for non-CMBS TALF loans can be either fixed or floating, according to whether the interest on the credit exposure underlying the ABS collateral is payable at a fixed or floating interest rate. The interest rate on non-CMBS floating-rate loans is 100 basis points over one-month LIBOR. The interest rate on fixed-rate loans is 100 basis points over a LIBOR swap rate corresponding to the maturity of the underlying ABS collateral. The interest rate for three-year CMBS-collateralized TALF loans will be 100 basis points over the three-year LIBOR swap rate, and five-year CMBS-collateralized TALF loans will bear interest at 100 basis points over the five-year LIBOR swap rate.

Subject to certain carve-outs (which include the borrower’s failure to meet borrower eligibility requirements), TALF loans are non-recourse to the borrower. The ABS collateral for a TALF loan is transferred to a master collateral account maintained by Bank of New York Mellon (the Custodian), as custodial agent for FRBNY pursuant to a Collateral Custody and Administration Agreement between Custodian and FRBNY.

Payments of interest on the TALF loan are made by Custodian to FRBNY directly from the interest payments on the ABS collateral received by Custodian in the collateral account. If interest payments on the ABS collateral are insufficient to make interest payments under the TALF loan, the applicable borrower will have 30 days from written notice of such shortfall within which to pay the shortfall amount, after which period FRBNY may exercise its remedies with respect to the borrower’s ABS collateral. For five-year CMBS-collateralized TALF loans, a certain portion of the excess of CMBS distributions over TALF loan interest will be applied toward principal in each loan year, and that portion increases in the fourth and fifth loan years.

For more information about TALF and its expansion to include CMBS collateral, please contact:

David Dubrow
dubrow.david@arentfox.com
212.484.3957

Mark Katz
katz.mark@arentfox.com
202.857.6260

Daniel Lopez
lopez.daniel@arentfox.com
202.857.6240