Oct. 29 (Bloomberg) -- Mutual funds run by companies including BlackRock Inc. and T. Rowe Price Group Inc. have begun buying bonds through a $1 trillion government lending program after a June regulatory ruling cleared the way.

T. Rowe Price and BlackRock, the world’s second-biggest bond manager, began using financing provided by the Federal Reserve in July and OppenheimerFunds Inc. started to do so last month, officials at the companies said. Mutual funds have disclosed that they might invest through the government program in regulatory filings over the past two months.

The funds may be able to reap returns of 15 percent or more on commercial mortgage-backed securities while limiting losses by passing most of the credit risk to the central bank, according to Scott Buchta, head of investment strategy at Guggenheim Securities LLC in Chicago.

“This is one of those opportunities that, as an investor, we have to take advantage of,” said Krishna Memani, who heads the investment-grade fixed-income team at OppenheimerFunds, a New York-based unit of Massachusetts Mutual Life Insurance Co. in Springfield. “The key concern is what is the maximum amount of potential loss, and that is limited to our equity” investment under the program.

Managers are buying the debt after fixed-income funds attracted inflows of $254.6 billion in the first nine months of this year, 18 times as much as stock funds, according to Chicago-based Morningstar Inc.

TALF

The Term Asset-Backed Securities Loan Facility, or TALF, offers low-cost financing for up to five years to buy AAA-rated bonds backed by consumer and business loans as well as commercial mortgages.

Investors can borrow as much as 95 percent of the bonds’ value by pledging the securities, plus varying amounts of additional collateral, to the Federal Reserve Bank of New York. The borrower has no obligation to repay the loan beyond the collateral provided to the Fed, an arrangement that shifts most of the potential losses to the government.

Memani said the $8.2 billion Oppenheimer Strategic Income Fund acquired commercial mortgage-backed securities with a face value of about $780 million through TALF in September and October. The strategic income fund invested about 1 percent of its assets, or about $82 million, to buy the securities, with the remainder financed by the Fed.

Brian Beades, a spokesman for New York-based BlackRock, declined to identify the type or size of the TALF investments by its mutual funds. In April and August, BlackRock filed documents with the U.S. Securities and Exchange Commission disclosing that it had raised $264 million through a series of hedge funds created specifically to invest through TALF.

Borrowing Cap

Mutual funds were initially shut out of the program because securities law limits their use of borrowed money. Franklin Resources Inc., the San Mateo, California, parent company of the Franklin Templeton fund family, persuaded the SEC in June to classify TALF loans in the same category as reverse-repurchase agreements, allowing them to borrow more.

Franklin Resources is eligible for the program, said Stacey Johnston, a company spokeswoman. She declined to say whether the firm had invested.

When started in March, the program provided financing for bonds backed by assets such as credit card, auto and student loans. It was expanded in June to cover debt backed by mortgages on commercial property, including office towers and shopping malls.

TALF has been so successful in rekindling demand for asset- backed securities that the safest of those bonds now have yields that are below the cost of borrowing under the program. Yields on five-year commercial mortgage-bonds average 6 percent to 6.5 percent, reflecting the risks posed by rising property vacancies and borrower delinquencies.

‘Finding Opportunities’

“Our investment folks are finding more opportunities on the CMBS side than on the ABS side,” said Heather McDonold, a spokeswoman for Baltimore-based T. Rowe Price. The company participated in this month’s financing round, she said, declining to comment on how much the firm had invested.

T. Rowe Price received SEC approval earlier this month for its mutual funds to pool their TALF investments, allowing smaller funds to obtain financing without having to meet the program’s minimum borrowing requirement of $10 million. More than a dozen of the firm’s mutual funds will be eligible to buy TALF securities, with each allowed to invest as much as 5 percent of its assets, according to McDonold.

Investors seeking the financing, provided at one percentage point above benchmark rates, must buy the securities and then apply for a Fed loan through one of 22 banks and brokerages, including 18 that serve as primary dealers for the central bank.

$1 Trillion Plan

The Fed, as of Sept. 30, had lent $39 billion to 115 borrowers for the purchase of asset-backed securities and $4 billion to 57 investors for so-called legacy commercial mortgage bonds, referring to those issued prior to Jan. 1.

The Fed in February announced that the TALF program, initially set to provide as much as $200 billion in financing, might be expanded to as much as $1 trillion. The program is scheduled to end in March except for newly issued commercial mortgage-backed securities, which the Fed will continue to finance through June.

“We haven’t seen a lot of the mutual funds in the space,” said Michael Wade, head of asset-securitization origination for the Americas at Barclays Capital Inc. in New York, one of the Fed’s 18 primary dealers. “It’s more likely that mutual funds will look for opportunities in CMBS because they are pretty late to the game for consumer ABS.”

To contact the reporter on this story: Miles Weiss in Washington at mweiss@bloomberg.net

Last Updated: October 29, 2009 09:51 EDT