UPDATE 2-US CMBS rally broken after Fed announcement, data

(Recasts, adds Fed announcement)

By Al Yoon

NEW YORK May 1 (Reuters) - A six-week rally in U.S. commercial mortgage-backed securities broke on Friday amid disappointment over a Federal Reserve move to enhance demand in the bonds and as delinquencies accelerated.

The Fed on Friday tailored its Term Asset-Backed Securities Loan Facility (TALF) to offer five-year loans to investors willing to buy CMBS, partially meeting the wishes of the market that has been frozen for the past year. While the loans are longer, and therefore more desirable, than current terms, they apply to purchases of new issues and not the hordes of existing CMBS weighing on the market.

"The problem is not new CMBS," said Malcolm Montgomery, head of Shearman & Sterling LLP's real estate group in New York. "The real problem is the glut of existing CMBS."

Industry groups for months have been lobbying for a longer term lending under TALF, which has seen a lackluster response in its launch to consumer asset-backed securities financed with three-year loans. A broad CMBS rally since mid-March was largely fueled by expectations the Fed would broaden its $1 trillion lending program.

Three-year loans under TALF would fail to draw investor interest, since most commercial loans are at least five-years, investors and dealers asserted. The Commercial Mortgage Securities Association, which lobbies for the industry, in a statement said it still expects the Fed will extend TALF to legacy assets "in the weeks ahead."

Risk premiums on CMBS, under pressure from a bolt of data showing soaring delinquencies, increased further after the Fed announcement, said Chris Sullivan, chief investment officer at the United Nations Federal Credit Union in New York.

Commercial real estate is following the slump in residential property as the U.S. recession reduces land values and the revenue needed to pay debt. The bonds and loans are held widely throughout the financial system, bogging down lenders whose recoveries are key to revival of credit and stabilization of the U.S. economy.

The yield spread, a measure of risk, on the 10-year class of the widely-followed GSMS 07-GG10 bond increased to more than 8 pecentage points above its interest rate benchmark, compared with 7.55 points on Thursday, one dealer said. The issue's spread was 9.65 points a month ago, according to Trepp.

Risk premiums on a derivative index of "AAA" rated CMBS climbed about 0.5 percentage point on Friday, to more than 5 percentage points above its interest rate benchmark. The spread has declined from nearly 8 percentage points in March.

"The market reaction has been disappointment that the release did not cover seasoned CMBS," Darrell Wheeler, head of securitized asset strategy at Citigroup Inc. in New York. "We believe that seasoned CMBS coverage is still under evaluation and that it was just too early to release meaningful details on that TALF expansion."

Before the Fed announcement, reports to investors on loans backing CMBS also showed credit in April posted its largest monthly deterioration to date, according to Barclays Capital. Analysts blame part of the rise in delinquency to the lack of credit, which federal plans are trying to address.

Office, retail and multi-family building loans that are at least 30 days delinquent rose 0.48 percentage point last month to 2.45 percent of securitized loans, nearly five times that of a year ago, Trepp, which collects data on the $700 billion market, said in a report on Friday.

Despite rising delinquencies, CMBS risk premiums had dropped some two percentage points over the past several weeks on expectations that the TALF program will lend cash to investors willing to buy the bonds, helping reduce lending rates to levels that encourage fresh lending.

Some investors have determined that prices have dropped to levels that compensate for the risk that commercial property revenue and values would decline more, analysts said.

CMBS had improved on "a crescendo of short covering as risk assets and credit in general improved," the United Nation's Sullivan said.

(Additional reporting by Alister Bull in Washington)