The United States Government Accountability Office published its report on the US government’s Troubled Asset Relief Program last Friday.
It’s a voluminous work, but definitely worth perusing if you have time as it offers some very interesting detail into the implementation of the Tarp and related programs thus far, as well as associated future risks.
While the report’s primary conclusion is that the “Treasury needs to strengthen its decision-making process on the Term Asset-Backed Securities Loan Facility,” its findings on CMBS might be deemed a touch more worrying. Specifically, the GAO noted (emphasis FT Alphaville’s):
While GAO found that the overall risks TALF poses to TARP funds are likely minimal, GAO analyses showed that CMBSs potentially pose higher risk of loss than ABSs. As shown in figure 1, ongoing uncertainty in the commercial real estate market and TALF exposure to legacy CMBSs warrant ongoing monitoring.
And here’s the chart:
The problem appears to be that CMBS losses could have been greatly underestimated by the Treasury in its initial assessments. According to the GAO, losses on CMBS might exceed $500m for the Treasury in the worst case scenario, as opposed to the Treasury’s own view of no losses at all.
As the report explained it:
While Treasury has determined that CMBS-related losses are unlikely for a number of reasons, our analysis shows that if the commercial real estate markets were to be affected similarly to real estate markets in 2008, the potential for loss exists under a worst-case scenario. Treasury and its contractor said that CMBS losses were unlikely for a number of reasons ranging from the relatively large haircuts (at least 15 percent) required on CMBS loans to the level of credit enhancement associated with CMBSs accepted for TALF.
However, due in part to the recently weak economy, commercial real estate continues to undergo price deterioration that potentially poses risks to the TALF legacy CMBS portfolio and could lead to increased delinquencies and defaults on commercial real estate mortgages. For example, the potential risks that CMBSs pose to TALF, and thus to TARP, are underscored by the fact that 63 percent of TALF’s CMBS portfolio was underwritten in 2006 and 2007, when underwriting standards were at their worst. Moreover, as figure 6 shows, commercial real estate prices have been falling since early 2008, following the deterioration in the overall U.S. economy, and shortly thereafter CMBS delinquencies began to rise sharply. The Federal Reserve and Treasury have continued to note their ongoing concerns about this segment of the market.
Their conclusion being (our emphasis):
In light of the ongoing distress in the commercial real estate market, we analyzed the prices and values of 99 percent of the CMBS collateral backing loans made by FRBNY during the third quarter of 2009. We compared the prices at the time the loans were made with the lowest prices in November 2008, a period of extreme stress for CMBSs. Our analysis revealed that if legacy CMBSs accepted as TALF collateral as of September 2009 reached market values equivalent to November 2008 levels, about 88 percent of such collateral would have fallen to levels at which the TALF borrower’s equity would be eliminated.
Moreover, more than $3.5 billion owed by TALF borrowers—or about 85 percent of the total value of TALF legacy CMBS loans—would have negative equity in this scenario. This extreme market stress scenario would result in a loss in market value on the part of these TALF borrowers of nearly $1.2 billion. The haircut investment for these borrowers totals $665 million, providing significant economic incentive to walk away, which would result in a worst-case loss of about $500 million for TALF.
Related links:
Talf gaffe at the Fed – FT Alphaville
New issue CMBSuccess under the Talf - FT Alphaville
Delinquent CMBS, the `C’ stands for climbing – FT Alphaville