UPDATE 2-Developers Diversified deal ends CMBS drought

(Updates stocks, adds detail)

By Nancy Leinfuss

NEW YORK Nov 16 (Reuters) - U.S. mall owner Developers Diversified Realty Corp (DDR.N) snapped an 18-month dry spell in the U.S. commercial mortgage bond market by selling $400 million of securities on Monday with help from an emergency Federal Reserve lending program.

The deal was the first to be sold under the Fed's Term Asset-Backed Securities Loan Facility, known as TALF, for new issue commercial mortgage-backed securities (CMBS), a key funding tool for office, retail and apartment buildings during the real estate boom.

"We believe the deal is a crucial first step in restarting the private-label CMBS market, which has been closed since June 2008, and channeling a much-needed source of capital to the commercial real estate universe," Barclays Capital said of the first TALF deal in that segment.

The sale is an important stepping stone in the $700 billion CMBS market, seen by central bankers as one of the biggest risks to the fragile U.S. economic recovery. The market has suffered badly as the deep recession severely cut the rent revenue from commercial properties needed to pay debt service on bonds.

Met with strong investor interest, Developers Diversified was able to price the deal below existing levels for CMBS issues. Its $323 million AAA-rated five-year notes came at a narrower 1.4 percentage point premium to the five-year interest rate swap benchmark, for a yield of 3.807 percent, market sources said.

Underwriter Goldman Sachs lowered yield premiums from earlier guidance levels of 1.6 to 1.75 percentage points due to the strong buyer interest.

"The deal looked pretty clean from a collateral standpoint and the credit protection, between the over-collateralization and subordination, was incredibly high," said Dan Castro, chief risk officer at Huxley Capital Management in New York.

The offering also included two smaller non-TALF-eligible AA-rated and A-rated issues, which priced with 5.75 percent and 6.25 percent yields and also drew strong interest.

"It was the first deal in about a year and a half, so there was big demand for the small sale," said Castro.

Through its TALF program, the Fed aims to lower funding costs for issuers by offering investors financing to purchase the securities.

Laying the groundwork has been difficult for Cleveland, Ohio-based Developers Diversified and other borrowers trying to use the TALF program, investors said.

Developers Diversified, which owns 670 shopping centers in the United States, Brazil and Canada, began discussing the deal in June but faced an arduous task of clearing the collateral with the Fed, according to sources. Some properties may have not made the Fed's cut, since Developers had been working on a pair of issues totaling $550 million.

With funding nearly frozen by the lingering credit crunch, borrowers with maturing loans have had to endure grueling negotiations to extend current terms or face default.

The inability to refinance loans has already led to the biggest U.S. real estate bankruptcy, by General Growth Properties Inc GGWPQ.PK.

Recently, the Fed said banks reported that more commercial real estate loans had been extended rather than refinanced.

About $570 billion in commercial mortgages are due to be refinanced between 2010 and 2011, according to property researcher Foresight Analytics LLC in Oakland, California. The firm estimates that defaults could cause some $250 billion in commercial real estate losses to the banking sector.

Developers Diversified shares closed up 6.74 percent at $10.45 on Monday. Vornado Realty Trust (VNO.N), which said recently it was considering a TALF issue, gained 2.31 percent to $66.82. (Additional reporting by Al Yoon; Editing by Dan Grebler)