Originators want to originate new loans, investors want to buy bonds with new conservatively underwritten loans, Treasury & Federal Reserve want the new issue CMBS market to start, borrowers certainly want to take out new loans to refinance maturing loans, and yet, four months after the Treasury launched the program, not one new issue CMBS deal has come to the market.
This highlights the chicken-and-egg type problem that the CMBS market faces. Everyone knows that the new origination will be of higher quality and so should have tighter spreads than the legacy bonds. Yet, lacking an efficient hedge, all that the originators have for indication of spreads are the legacy bonds, which are still too wide for new issue deals. In other words, originators are looking for tighter and stable bond spreads to originate, and market is looking for new collateral for tighter spreads – sort of a chicken-and-egg type problem.
One solution is to wait till legacy bond spreads tighten and stabilize, giving loan originators more confidence, but that might mean new issue TALF program may not get much traction before it ends. Another approach is to accelerate the legacy TALF program by removing some of the uncertainty that borrowers in that program face today. There are two easy to implement steps that will be helpful and allow investors to buy bonds throughout the month, rather than waiting till just before the TALF subscription date. First, the price used for calculating loan amount can be adjusted for interest rate movement from purchase date to the subscription date, and second, Federal reserve can allow potential borrowers to submit a list of potential bonds for purchase before actually buying the bonds, with approvals announced two or three weeks before the subscription date. Pre-approval of bonds will be almost as effective as disclosure by the Fed of their bond approval (or rejection) methodology, which more and more market participants are asking the Fed to do, and which Fed has been reluctant to do, probably because doing so might reduce their flexibility.
Disclosure: Long PCM.