Wall Street CMBS Allure Fades as Volatility Surges: Mortgages

Wall Street’s on-again, off-again love affair with commercial-mortgage-backed securities is on the rocks as markets get whipsawed by Europe’s debt crisis.

Goldman Sachs Group Inc. (GS), Deutsche Bank AG (DBK) and other banks sold $2.4 billion of new deals this month with the widest spreads this year. An index tied to lower-rated bonds issued before the financial crisis fell 7.4 percent to 56 cents on the dollar, approaching the lowest level in almost six months.

Market volatility, which rose the most last week since January, makes it harder to gauge investor demand for bonds tied to everything from shopping malls to mobile home parks. Lenders hold commercial mortgages for several months before selling them as securities, which means swings in values as they accumulate debt can eat into profits and thwart efforts to boost sales.

“Holding loans on the balance sheet has become a fairly risky process,” said Lisa Pendergast, a debt strategist at Jefferies Group Inc. (JEF) in Stamford, Connecticut. ‘There is a level of uncertainty that makes it difficult to go full-steam ahead.”

A pullback in CMBS lending would choke off funding to borrowers as more than $30 billion in debt matures this year, according to data compiled by Bloomberg.

Banks have arranged about $10 billion in CMBS sales this year. Issuance accelerated after dropping to $2.9 billion in the fourth quarter of 2011 from $8.3 billion in the previous three months as the risk of Greece defaulting soared and credit markets swooned, pushing Wall Street to the sidelines.

Crowded Market

Investment banks and other lenders crowded into the market in 2010 with a recovery on the horizon after sales plummeted to $3.4 billion in 2009 from a record $232 billion in 2007, Bloomberg data show. Demand had dried up after losses on U.S. subprime home loan bonds sparked the global financial crisis.

The number of institutions seeking to package commercial mortgages to sell as bonds ballooned to 25 in December 2010, compared with five a year earlier, Standard & Poor’s said in a report at the time.

The revival has been elusive, even as commercial-property prices rose 4.3 percent in the first quarter of 2012 compared with the same period last year, according to Washington-based research firm CoStar Group Inc. (CSGP) Valuations are still 34.5 percent below the 2007 peak and are at about the same level as in 2003.

The CMBS market has shrunk to $553 billion from $732 billion in December 2007, according to Nomura Holdings Inc.

Credit Suisse Shuttered

Credit Suisse Group AG shuttered its unit dedicated to originating commercial-property loans to bundle for sale as bonds in October, firing as many as 50 people. The move marked the second time the Zurich-based bank pulled the plug on the U.S. unit in the span of three years. The lender, one of the most prolific originators during the boom years, hasn’t completed a deal since 2008.

Cortview Capital Holdings Inc., a broker-dealer backed by Warburg Pincus LLC, jettisoned a commercial-mortgage bond team in September, six months after hiring a group led by Bill Green, the former global head of real-estate capital markets at Wachovia Corp.

Price swings in CMBS have become more exaggerated, even as the market has improved, making it harder for banks to increase issuance. Insurers, government agencies and lenders not planning on parceling the debt are beating out Wall Street to provide loans to the best borrowers.

Extra Yield

The extra yield investors demand to hold top-ranked commercial-mortgage bonds rather than Treasuries climbed 16 basis points this month to 202 basis points, or 2.01 percentage points, according to the Barclays Capital CMBS AAA Super Duper Index. The spread, which has decreased from 323 in October, is at about the same level as a year ago.

“As long as this instability persists, the direction of the CMBS market will be heavily influenced by general global financial market developments and macro-led volatility,” Credit Suisse analysts led by Roger Lehman in New York wrote in a report today.

The level on top-ranked debt maturing in about 10 years stayed within a 10 basis-point range from November 2004 through July 2007, yielding between 20 and 30 basis points more than the benchmark swap rate at issuance, Jefferies data show.

The spread on similar securities sold since the market revived in 2010 was as narrow as 100 basis points in February of last year and as wide as 200 in August, according to Nomura.

Goldman Sachs, Citigroup Inc. (C) and Jefferies sold about $1.5 billion of bonds last week, including top-ranked debt paying 140 basis points more than the benchmark swap rate, according to data compiled by Bloomberg, after initially marketing the debt to pay 115.

Deutsche Bank and Cantor Fitzgerald LP issued securities the same day to pay a 135 basis-point spread. That compares with 120 on debt sold by UBS AG (UBSN) and Barclays Plc (BARC) last month.

Volatility Index

Demand for the debt decreased as Bank of America Corp. (BAC)’s Market Risk cross-asset volatility index last week jumped the most since January amid investor concern that Greece may leave the euro area and global economic growth is slowing.

“Given how correlation across all asset classes is much higher now than it was pre-Lehman, the volatility is going to be here for years and it is going to translate into new issue pricing,” said Andrew Solomon, a managing director in New York at Angelo Gordon & Co. “The thing that is still missing is an effective means to allow originators to hedge that risk.”

Banks lining up sales could hold back from issuing deals until volatility subsides, according to Pendergast of Jefferies. Deutsche Bank, Wells Fargo & Co. (WFC), Royal Bank of Scotland Group Plc and JPMorgan Chase & Co. (JPM) are among banks planning about $6 billion in June offerings, Citigroup said in a May 18 report, citing industry newsletter Commercial Mortgage Alert.

Issuance Forecasts

Forecasts for 2012 issuance range from Wells Fargo’s $25 billion to Credit Suisse’s projection of as much as $45 billion.

Jefferies is sticking with a $40 billion estimate because mortgage rates remain below 5 percent, which is sufficient to attract borrowers, Pendergast said. Recent volatility could “slow things down,” she said.

Nomura, which at the start of the year said $27 billion to $32 billion of so-called conduit deals will be issued-- transactions that pool loans from multiple borrowers--expects it to be at the lower end, Lea Overby, a New York-based analyst at the bank, said in an e-mail this week.

“For the CMBS market to be fully functional as a first choice for borrowers, we need to get to a point where there is more consistency in the terms that originators can offer and deliver,” said Scott Singer, a principal at the Singer & Bassuk Organization LLC, a real-estate firm that represents property owners and developers arranging financing. “The originators have their eyes on the trading screen, the market is continuing to evolve for the better, but it’s a roller coaster ride along the way.”

To contact the reporter on this story: Sarah Mulholland in New York at smulholland3@bloomberg.net

To contact the editors responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net; Rob Urban at robprag@bloomberg.net

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