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There are now rumbles that TALF needs to be changed in order to help the commercial real estate industry. This appears to be fallout from S&P’s recent warning that it may soon downgrade hundreds of commercial real estate bonds. People are worried that the downgrades will make many bonds ineligible for the program. So either S&P has to be stopped from downgrading bonds or TALF needs to be modified to allow acquisition of bonds rated lower than AAA. That’s at least what this article seems to be suggesting. And it’s all based on the supposition that the lending market for commercial real estate is “closed,” with this article quoting New York Federal Reserve President William Dudley.

Of course, the lending market for commercial real estate is not closed. Yes, there is no action among conduit lenders and that needs to be reckoned with. In their peak year, conduit lenders accounted for more than $200 billion in loans. Still, that only represented about 30 percent of all commercial and multifamily originations. Other lenders–commercial banks and life insurance companies–are still active. Overall, at the end of 2008, CMBS accounted for $746.4 billion of outstanding commercial real estate debt–down from $788.2 billion the year before. (See chart here.)

The terms traditional lenders are offering are different. LTV ratios are down, as are loan sizes. Moreover, traditional lenders have not looked to up their volumes to replace the vacuum left by the dormant CMBS sector. Those are real issues to be dealt with. But to say the lending market is “closed” overstates what is going on. As evidence that financing is still available, look at the major retail REITs. Aside from General Growth Properties, every retail REIT has so far been able to deal with upcoming debt maturities. The firms have done this through successfully lining up new lines of credit, refinancing or by raising cash in various ways in order to pay down debt. Firms wouldn’t be able to do this if no commercial real estate financing was available.

So the question remains as to why TALF needs to be modified again. Remember, it was just about three weeks ago that the Federal Reserve extended TALF to include legacy CMBS loans. It also extended the time frame on loans from three years to five in order to make it easier to deal with CMBS. These were concessions to the commercial real estate industry. Now more is needed already? TALF was never going to be a panacea, but does it need to be tweaked again?

The program for existing CMBS faces challenges from the Fed’s strict eligibility criteria, which require that the securities carry a triple-A rating from at least two of five approved rating agencies and not be marked for a possible downgrade by any of them.

That became harder to achieve after Standard & Poor’s said it plans to change the way it rates CMBS, leading to broad downgrades. That in turn would shrink the universe of TALF-eligible bonds to $230 billion from $371 billion, according to a note from Barclays Capital.

The CMBS market is already up in arms about the S&P plans, and hopes are high that the Fed will be flexible and change the language to allow originally rated triple-A CMBS rather than currently rated triple-A CMBS to be pledged to TALF, said Lisa Pendergast, head of CMBS research at RBS.

There’s good reason for the Fed to do so if it wants to restart the CMBS market. Dudley, in his speech, indicated the broader importance of the CMBS market to the banking system.

“If this market is closed, then the refinancing of maturing mortgages will be exceedingly difficult, and this will exacerbate the drop in commercial real estate prices, loan defaults and the pressure on bank capital,” he said.

Investors and market participants are also submitting comments to S&P, with some protesting that the firm’s loss projections are too stringent. Others, however, welcomed the planned changes given the worsening market outlook and as a way to earn back investor confidence.