Wall Street Keeps Swagger in CMBS as Sales Surge: Credit Markets

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Photographer: Craig Warga/Bloomberg

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With almost six weeks to go in 2013, sales of commercial-mortgage bonds are already surpassing Wall Street’s forecasts for the year, defying concern that rising interest rates would stymie new deals.

Issuance of the securities is poised to exceed $80 billion, eclipsing the $60 billion that Barclays Plc predicted in January, according to analysts at the bank. Lenders have arranged $65.5 billion of offerings this year and another $14.5 billion is in the works, including a $3.5 billion deal tied to Hilton Worldwide Inc. that will be the largest such offering since before the credit crisis, Bank of America Corp. data show.

New York City landlords to South Carolina hotel operators are rushing to refinance mortgages before the Federal Reserve starts cutting stimulus that pushed interest-rate benchmarks to record lows. After Fed Chairman Ben S. Bernanke rattled investors in May by telling Congress a pullback could start this year, average borrowing costs in the CMBS market surged as much as 1.5 percentage points, prompting firms from Bank of America to JPMorgan Chase & Co. to predict a sales slowdown.

‘Wake-Up Call’

“People got a peek at what the world might look like,” said Andrew Solomon, a managing director at New York-based Angelo Gordon & Co., one of nine money managers selected in 2009 to take part in the U.S. government’s Public-Private Investment Partnership to spur the purchase of mortgage-backed securities from banks. “That was a wake-up call.”

The average cost to borrow in the CMBS market climbed to as high as 5.38 percent in deals sold earlier this month after dipping to as low as 3.9 percent in June, Bank of America data show. The increase hasn’t discouraged landlords from seeking new loans as had been anticipated, according to Alan Todd, a commercial-mortgage debt analyst at Bank of America in New York.

“A lot of borrowers are getting off the sidelines before rates go up again,” he said.

Lenders who package loans into CMBS also have picked up business from multifamily properties as Fannie Mae and Freddie Mac ratchet back loans to apartment landlords, according to Keerthi Raghavan, a debt analyst at Barclays in New York.

CMBS issuance, which ceased for 16 months starting in June 2008 amid the seizure in credit markets, is poised to more than double from last year, Bloomberg data show. Bank of America is forecasting $100 billion of offerings in 2014.

Slipping Standards

The surge in sales is fueling concern that banks are allowing lending standards to slip. Moody’s Investors Service is increasing the amount of credit protection required to garner investment-grade rankings on riskier portions of new deals, meaning underwriters have to build in a bigger cushion to protect investors from losses. Some dealers are forgoing a ranking on those securities from the firm.

The size of loans relative to property values, a ratio known as LTV, is climbing, Moody’s said in an Oct. 28 report. The average LTV increased to 103 percent in the third quarter from 102.6 percent in the prior three-month period, according to the New York-based rating company. Higher leverage makes it harder to pay off debt.

Standards for commercial real-estate lending are seen loosening further next year. About 43 percent of respondents from investors to developers surveyed by PricewaterhouseCoopers LLP and the Urban Land Institute said they expect underwriting to be less rigorous in 2014, the firms said in a report this month.

‘Reasonably Conservative’

Underwriting in new CMBS deals isn’t as bad as it was leading up to property-market crash in 2007, said Angelo Gordon’s Solomon.

“The pendulum swung so far in the opposite direction when new deals started getting done,” he said. “We’re still in a reasonably conservative space.”

Investors continue to snap up new deals with the central bank maintaining $85 billion of bond purchases and holding its interest-rate target near zero for a fifth year, pushing investors toward risker assets.

The Hilton offering, linked to 23 properties across the U.S., is expected to see “strong demand,” Jefferies Group LLC analysts led by Lisa Pendergast said in a Nov. 18 report. The underwriters are offering a top-ranked slice of the deal maturing in five years to pay 110 basis points more than the London interbank offered rate, or Libor, according to people familiar with the offering. The transaction is enabling Blackstone Group LP (BX) to pay down debt in preparation for an initial public offering.

Delinquencies Ease

Declining delinquencies and climbing property values are encouraging CMBS investors. Payments at least 30 days late on commercial mortgages packaged into bonds fell 10 basis points to 10.15 percent in October, the lowest level since December 2011, according to Nomura Holdings Inc.

Real estate values in the U.S. have recovered 70 percent of declines since bottoming in December 2009, according to the Moody’s/RCA Commercial Property Price index.

Commercial-mortgage bonds rated AAA have returned 2.12 percent this year, Bank of America Merrill Lynch index data show.

Performance next year will hinge on the timing of the Fed’s decision to wean markets off of unprecedented stimulus by tapering its bond purchases, according to JPMorgan analysts led by Ed Reardon in New York.

Maintaining Positions

CMBS buyers don’t plan to reduce holdings in 2014, with 24 percent of investors expecting to increase them and 74 percent poised to maintain current allocations, the JPMorgan analysts said in a report last week, citing an investor survey.

The demand is poised to push issuance even higher next year, Barclays’s Raghavan said.

“Everyone has pressure not to sit in cash,” he said.

Elsewhere in credit markets, AT&T Inc., the largest U.S. phone company, is planning to sell a benchmark amount of notes as soon as today. The cost to protect against losses on corporate bonds in the U.S. and Europe declined.

The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark used to hedge against losses or to speculate on creditworthiness, fell 1.2 basis points to 71.6 basis points as of 10:41 a.m. in New York, snapping a two-day increase, according to prices compiled by Bloomberg.

Europe Benchmark

The index started the week by touching 69.5 basis points, the lowest since November 2007 in data that adjust for the effects of the market’s shift to a new version of the benchmark in September.

In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings dropped 1.4 basis points to 81.3.

The indexes typically fall as investor confidence improves and rise as it deteriorates. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

AT&T may issue five-year debentures in fixed- and floating-rate portions, according to a person with knowledge of the offering. Benchmark sales are typically at least $500 million in size.

The debt, which the Dallas-based communications provider may use for general corporate purposes, is expected to be rated A3 by Moody’s Investors Service, said the person, who asked not to be identified because terms aren’t set.

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

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net

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