Fed’s liquidity facility successfully anchored commercial real estate amid pandemic


W. Scott Frame, Steven Manning, and Joseph Tracy

May 24, 2022

The value of commercial real estate – especially office towers, shopping malls and hotels – suddenly became uncertain when COVID-19 arrived in the United States in late February 2020.

Part of the Federal Reserve’s response to ensure the continued flow of credit to households and businesses has been to restore the central bank’s asset-backed lending facility (TALF). Originally rolled out in 2008 as financial support amid the global financial crisis, the facility helps support the issuance of asset-backed securities by fixing the prices of top-rated bonds.

We examine the use of TALF by investors in commercial mortgage-backed securities (CMBS) during the pandemic and find that it has played a key role in supporting commercial real estate financing.

CMBS an important source of commercial real estate financing

Federal Reserve data indicates nearly $3 trillion in commercial mortgages were outstanding at the end of 2019 (excluding those financing multifamily properties). The main sources of capital were deposit taking institutions such as banks ($1.8 trillion), life insurance companies ($401 billion), CMBS ($357 billion) and investment trusts real estate ($183 billion). Thus, CMBS accounted for approximately 12% of all outstanding commercial mortgages.

CMBS are bonds created by the securitization process, with principal and interest payments coming from the underlying commercial mortgages. Securitization generally involves a process called tranching – allocating bond payments in a prescribed order among investors – with the more experienced investors being the least exposed to risk, receiving principal first and suffering losses last. Senior bonds, which make up the bulk of securitization liabilities, are generally designed to achieve the best AAA ratings to reduce interest costs.

With the onset of the pandemic, CMBS trading activity increased rapidly and yield spreads over benchmark Treasuries widened significantly in March 2020, reducing bond values. (When a bond looks riskier, its market price falls as the asking interest rate rises.)

Chart 1 illustrates these dynamics for 2020 using weekly data provided by JPMorgan Chase & Co. The chart highlights the dates of Federal Reserve announcements of the TALF program (March 23), acceptance of CMBS as eligible collateral (April 9) and the first TALF loan financing for CMBS (June 25).

Chart 1: CMBS spreads on Treasuries, trading volume declined with the Fed's TALF facility in 2020

Downloadable Grid | Chart data

CMBS spreads widened by around 70 to 250 basis points in early March. Following the announcement of the TALF and other liquidity facilities, spreads steadily declined, returning to pre-pandemic levels by the end of the year.

TALF rapidly deployed, supports CMBS in 2020

The TALF was an important part of the Federal Reserve’s response to the economic upheaval that accompanied the onset of the pandemic. It was one of several special lending facilities and provided non-recourse secured loans to investors holding AAA-rated asset-backed securities.

TALF financing was available for a wide range of collateral types, subject to limits on the remaining term and the leverage of the underlying instrument. The loans were for three years, freely repayable in advance and at a spread over the risk-free rates. The spread was set lower than prices available in the then-struggling market, but higher than pre-pandemic prices. This feature prompted investors to prepay TALF loans once tight market conditions normalized. A recent Federal Reserve working paper explores the TALF in depth.

On April 9, 2020, the Federal Reserve added outstanding CMBS as eligible collateral for lending through the TALF and funded its first securities on June 25. For a CMBS with an average life of five years, the price was set at 125 basis points (1.25 percentage points) above the three-year risk-free rate (based on index swaps at overnight) and could fund up to 85% of the security’s value (a 15% “haircut”).

TALF funding for CMBS was unique because while existing (old) securities were eligible, newly issued securities were not. The move reflected an expectation of weak issuance in the near term given the significant uncertainty surrounding commercial real estate values.

TALF funding of legacy CMBS would ultimately support new issuance by facilitating trading and price discovery and, thus, reducing the liquidity premiums that have emerged with the economic stress of the pandemic.

Chart 2 shows monthly TALF loan funding in 2020 for CMBS compared to all other types of eligible collateral, such as auto loans and credit card receivables. During this period, 257 TALF loans totaling $4.5 billion were issued, and CMBS was the most funded asset class (112 loans totaling $1.2 billion). Virtually all TALF loans took place between July and September 2020.

Chart 2: TALF loans peaked in summer 2020

Downloadable Grid | Chart data

TALF loan repayments commenced before the facility closed on December 31, 2020 (Chart 3). This is consistent with spreads returning to pre-COVID levels by the end of 2020. Only 36 TALF loans remained outstanding in January 2022, three of them backing CMBS (for a total of 24 million of dollars). The rapid uptake and withdrawal of the TALF program suggests that the facility worked as intended providing a price floor.

Chart 3: Loan repayments to the Fed's term asset-backed loan facility are dropped despite the program not being completed

Downloadable Grid | Chart data

The Fed’s credit facility has proven useful in the face of economic disruption

The Federal Reserve responded to the onset of the COVID-19 pandemic with several liquidity facilities to ensure a continued flow of credit to households and businesses. The TALF, which financed highly rated asset-backed securities, proved particularly important in supporting the financing of commercial real estate.

The structure of the TALF program provided much-needed liquidity to investors at the height of the pandemic, but it incentivized borrowers to exit when normal market conditions returned, allowing the program to unfold quickly.

about the authors

Frame W. Scott

Frame is vice president of the banking and finance group in the research department of the Federal Reserve Bank of Dallas.

Steve Manning

Manning is an undergraduate student in the Tower Scholars program at Southern Methodist University.

Joseph Tracy

Tracy is Executive Vice President and Senior Advisor in the Research Department of the Federal Reserve Bank of Dallas.

The opinions expressed are those of the authors and should not be attributed to the Federal Reserve Bank of Dallas or the Federal Reserve System.

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