CMBS Savior? Developers Diversified Deal Is Nearer

Fed Worry Is Easing, Clearing Path for Test of TALF; 'We Need a Transaction Approved to Reconnect the Market' By LINGLING WEI A closely watched deal that may help uncork the commercial-property debt market is picking up steam after being threatened by some queasiness by the Federal Reserve, according to people familiar with the matter. The Fed is sending signals that its concerns over the deal are easing, paving the way for the first sale of commercial-mortgage-backed securities, or CMBS, through a major rescue program called the Term Asset-Backed Securities Loan Facility, or TALF. The credit-starved real-estate industry has been hoping that the debt sale by shopping-center giant Developers Diversified Realty Corp. would lead to other CMBS sales. Developers Diversified announced in early October that it had obtained from Goldman Sachs Group Inc. a $400 million loan, which Developers Diversified and Goldman intended to be converted into a CMBS offering through the TALF program. But the Fed, mindful of protecting taxpayers' interest, had shown reservations about financing the deal because it involves just one borrower, according to the people with knowledge of the issue. Single-borrower CMBS offerings are considered riskier than multiple-borrower deals, with the risks spread over many different borrowers as well as different kinds of commercial buildings and geographic locations. "The Fed is being very conservative, very diligent in reviewing collateral and very risk-averse," said Frank Innaurato, managing director at Realpoint LLC, a credit-ratings firm. The Fed is still reviewing the deal and may still decide it is too risky. But in recent days, the Fed has indicated progress with reviewing the 28 shopping centers owned by Developers Diversified and underlying the $400 million loan, and the deal likely will be closed in the coming weeks, the people said. If the Fed opted against the deal, Goldman likely would try to sell the $400 million loan outside of the TALF program. Representatives at the Fed, Developers Diversified and Goldman declined to comment. Mounting Worry Regulators are getting increasingly worried about the commercial real-estate market as rents and occupancies fall and defaults mount. The growing pressure bad loans are putting on the nation's financial institutions are jeopardizing the economy's recovery. Part of the problem has been the evaporation of the CMBS market, which had been one of the top sources of real-estate finance. TALF is designed to revive the CMBS market as well as markets for other securitized debt by offering low-cost financing from the Fed for investors buying these securities. Investors can borrow as much as 95% of the bonds' value by pledging the securities as collateral. That means that if there is a default, taxpayers take most of the risk. Developers Diversified Realty Corp. Developers Diversified, owner of shopping malls like the Village at Stone Oak in San Antonio, could be key in restarting the CMBS market. CMBS offerings are considered one of the key tests for the TALF program, introduced by the Fed in March. Since then, TALF has been viewed as a moderate success, helping borrowers from auto companies and credit-card issuers raise capital. The Fed has so far made about $40 billion in TALF loans to investors buying these securities, which has sparked a market rally and reduced the cost of borrowing. The Fed extended TALF to include newly issued CMBS in June. But there have been no deals so far, even though a dozen or so new CMBS deals are hoping to take advantage of the program. Like the Developers Diversified deal, these potential deals also are collateralized by multiple properties owned by one owner. While the Fed has indicated concerns over such deals, banks remain reluctant to take on "warehouse" risks associated with having to pool together loans from many borrowers. Other CMBS deals in the pipeline include those by Inland Western Retail Real Estate Trust Inc. and Vornado Realty Trust. J.P. Morgan Chase & Co. is working on both deals. "We need a transaction approved to reconnect the market," said Jeffrey DeBoer, chief executive of the Real Estate Roundtable, a lobbying body for property owners and investors. High TALF Bars The deal Developers Diversified has in the works reflects the high bars the Fed sets for the type of loan it will accept as eligible for TALF financing. The $400 million loan it got from Goldman is secured by shopping centers with stable cash flow because they are occupied by discount retailers that tend to attract business even in a recession. The $400 million loan represents about half of the value of the underlying properties. By comparison, during the years before the recession, banks were willing to lend as much as 70% of a property's value because the debt could be easily sold as CMBS. But not everyone is going to benefit from the TALF program. Tight restrictions will bar thousands of small developers and commercial-property owners with heavy debt loads from participating. Among loans that won't qualify: floating-rate mortgages, construction loans or loans secured by properties that are being "repositioned" and don't have a stabilized cash flow. Write to Lingling Wei at lingling.wei@dowjones.com