All of the Facts; None of the Hype

TLGP Securities as Defeasance Collateral

The recent economic stimulus packages from the federal government include the Federal Deposit Insurance Corporation’s (the “FDIC”) Temporary Liquidity Guarantee Program (“TLGP”). The program allows eligible financial institutions to issue senior unsecured debt in the form of fixed income bonds that are backed by the FDIC.  Since inception of this program, there have been questions, discussions and rumors about whether or not these bonds can be included in securities portfolios for defeased loans.

The issue is being discussed among rating agencies, servicers, servicers’ legal counsel and defeasance facilitators involved in CMBS defeasances and is not anything for which one market participant can take credit.  Commercial Defeasance has actively participated in these discussions, as have our competitors and a host of other parties who have a strong interest in the subject.  However, knowing that real estate owners are making decisions about the viability of sales and refinances based in part on the cost of their potential defeasance transaction, we’re committed to providing factually accurate information about TLGP securities.

Facts:

• By far, the most common definition of eligible defeasance collateral is limited to “direct non-callable obligations of the United States of America ” (like t-bills, t-notes and STRIPS).
• TLGP securities are not direct obligations of the Unites States of America .
• The least common definitions of eligible defeasance collateral would a) allow the defeasance collateral to include bonds issued by agencies of the federal government (like FNMA, FHLB and FHLMC) and/or b) allow bonds that are backed by the full faith and credit of the United States of America.
• Bonds issued under the TLGP are guaranteed by the FDIC, which is an agency of the federal government backed by the full faith and credit of the United States of America.
• The FDIC guaranty is currently set to expire on the earlier of June 30, 2012 or the maturity date of TLGP bonds issued between October 14, 2008 and June 30, 2009 by institutions participating in the program.
• On February 24, 2009, Standard & Poor’s issued guidance as to when TLGP bonds may be used as defeasance collateral, which included several significant hurdles, including: (i) a waiver by the servicer of specific rights to collect interest on advances or to collect for certain expenses incurred in making an FDIC payment demand, (ii) a 90 day interest reserve if a TLGP bond is used to make the final balloon payment, and (iii) the servicer’s errors and omissions insurance should cover losses arising from a potential failure to make a timely payment demand to the FDIC.
• Initial indications are that servicers will not be willing to shoulder the additional burdens placed on them by the S&P requirements, particularly when other agency debt could be used under the same circumstances without the TLGP hurdles and restrictions.

Analysis:

• Covering the balloon payment is typically the most advantageous way to use higher yielding agency debt in a defeasance portfolio.  However, S&P’s requirement of a 90 day cash interest reserve is likely to negate any cost savings from using TLGP bonds, especially if more efficient traditional agency debt is available.
• The burden of the S&P hurdles falls squarely on servicers who may not agree to take on the additional requirements or may charge a fee to do so.
• The additional servicer requirements aside, it will be the rare case when the defeasance language is broad enough to permit agency securities, the borrower’s loan matures before June 30, 2012, and TLGP securities are available in the market place.
• After preliminary talks with several servicers, the same language in the loan documents that would be necessary to permit TLGP debt would also permit agency debt (like FNMA, FHLB and FHLMC)  that also has a cost advantage over treasuries and is more widely available and accepted by servicers and rating agencies with fewer hurdles.
• There have been proposals for an extension of the TLGP issuance window extending the maturity dates of the FDIC guarantee to a 10 year range.  This would increase the pool of TLGP candidates to loans with longer maturities however they would still be bound by the restrictive 90 day reserve requirements.

Advice:

• Know the facts.  Don’t believe anyone who tells you that TLGP securities are available to help every borrower on every deal.  They’re not.
• Prove it. If someone tells you they can save you thousands of dollars with TLGP bonds or TARP funds, ask them to show you a portfolio using t-bills, t-notes and STRIPS, a portfolio incorporating traditional agency debt (like FNMA, FHLB and FHLMC) and a portfolio incorporating TLGP bonds (including a 90 interest reserve if the TLGP bond is the balloon security) and then have them specifically show you the TLGP savings.
• Get a second opinion. If someone is enticing you with savings that sound too good to be true, call us.  We want to make sure you have accurate information.
• Choose wisely.  Once you’ve obtained a realistic cost estimate and decided that a sale or refinance makes sense, go with a proven defeasance facilitator that can help you quickly close your defeasance and hedge your risks without any unpleasant surprises.

At Commercial Defeasance, we always aggressively structure the most cost efficient defeasance portfolio available based upon the terms of your loan documents and our knowledge of what servicers and rating agencies will and will not allow.  When the documents permit it, we always analyze scenarios that include agency debt and TLGP bonds to solve for the least expensive portfolio.  Commercial Defeasance remains the leader in our industry by staying on top of industry developments, continuing to educate our clients on the facts, and creating innovative new services.  As defeasance continues to evolve, we want to be your reliable source for accurate and timely information.  Your long term business is our goal.

Standard & Poor's article