March 20, 2008 / 7:08 PM / 12 years ago

UPDATE 2-Fed to take riskier mortgages to aid dealers

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By Richard Leong

NEW YORK, March 20 (Reuters) - Dealers can pledge an even broader array of shadowy collateral to get a portion the $75 billion in funding the U.S. Federal Reserve will dole out next week, the U.S. central bank said on Thursday.

In addition to poorly performing triple-A rated residential mortgage bonds, the Fed said it will now also take equally troubled bonds backed by mortgages for shopping malls and office buildings.

The market for commercial mortgage bonds has weakened in the wake of the mortgage market meltdown and U.S. banks may be forced to take large write-downs on those assets.

However, the banks can now exchange their triple-A rated, but poorly performing, commercial mortgage bonds for low-risk U.S. Treasury bonds at the March 27 auction of 28-day loans.

“It looks like they (the Fed) are doing all they can to pour water on the fire,” said Chris Rupkey, senior financial economist at Bank of Tokyo-Mitsubishi UFJ in New York.

The Fed’s first Term Securities Lending Facility (TSLF) auction next week is part of a $200 billion program to aid the Wall Street dealers — primarily investment banks — that do business directly with the Fed.

Most investment banks are significantly exposed to the commercial mortgage bond market, but many are trying to hedge that exposure or sell the underlying assets.

Lehman Brothers Holdings Inc LEH.N had $36.1 billion of commercial mortgages on its balance sheet as of the end of February, about a third of which were packaged into bonds.

In the debut TSLF auction, the Fed can now accept so called Schedule 2 collateral that includes riskier and less liquid securities, rather than the more narrow list of Schedule 1 collateral.

An earlier acceptance of riskier and less liquid securities by the Fed underscored the urgency of the funding needs on Wall Street before the end of the first quarter, said one analyst.

“The feedback they had gotten from the dealer community I’m sure was very much that dealers wanted to be able to finance that kind of stuff before quarter-end,” said Carl Lantz, U.S. interest rate strategist at Credit Suisse in New York.

Schedule 2 collateral includes collateralized mortgage obligations created out of bonds guaranteed by Fannie Mae and Freddie Mac and triple-A rated commercial mortgage-backed securities. It also includes previously announced private-label triple-A residential mortgage-backed securities.

While originally centered on the dodgy residential mortgage-backed securities which led to the near collapse of Bear Stearns BSC.N last week, the credit crunch spread to the commercial mortgage sector earlier this year.

Meanwhile, the Fed set the minimum fee rate for the Schedule 1 and Schedule 2 auctions at 10 basis points and 25 basis points, respectively.

On April 2, the New York Fed, which conducts open market operations for the central bank system, said it will announce the second auction to be held on April 3. (Reporting by Richard Leong, John Parry, Dan Wilchins and Burton Frierson; Editing by Tom Hals)

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