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CMBS Yields Fall to 2010 Low as New Sales Rise: Credit Markets

Relative yields on commercial mortgage bonds have fallen to the lowest this year as investors look beyond climbing delinquencies and unprecedented defaults in a wager the worst is over for the debt.

The $3.6 billion commercial-mortgage backed bond issued by GS Mortgage Securities Trust, used as a market barometer because it trades frequently, pays 279 basis points more than the benchmark swap rate, down from 500 basis points at the end of 2009, according to RBS Securities Inc. data. Bonds rated AA and tied to property loans have soared 9.4 percent since June 30, compared with 4.2 percent for similarly rated corporate debt, Bank of America Merrill Lynch index data show.

The Federal Reserve is fueling demand for debt backed by commercial property loans by holding interest rates near zero, boosting prices and reviving sales after the market shut down two years ago amid the worst financial crisis since the Great Depression. Wells Fargo & Co. and Bank of America Corp. are marketing the securities, two weeks after JPMorgan Chase & Co. raised $1.1 billion in this year’s largest offering of the debt.

“A lot of things look better in commercial real estate than they did a year ago,” said Brian Lancaster, a fixed-income strategist at RBS Securities in Stamford, Connecticut. “It’s not a rosy picture, but there is stabilization.”

Riskier Bonds

Falling yields on the safest class of commercial mortgage securities are driving buyers to the riskier bonds, said Scott Buchta, head of investment strategy at New York-based broker Braver Stern Securities LLC, which focuses on securitized debt.

Prices on so-called mezzanine and junior commercial-mortgage backed securities, originally rated AAA, have risen as much as 10 cents on the dollar during the past two weeks, with some debt trading as high as 104 cents on the dollar, according to Wells Fargo Securities data.

Derivative prices linked to lower-rated commercial mortgage bonds have also soared in a sign of greater confidence. Contracts on a Markit CMBX index tied to bonds rated AA at issuance have increased 15 cents to about 73 cents on the dollar during the past month, according to JPMorgan.

Elsewhere in credit markets, the extra yield investors demand to own company bonds instead of similar maturity government debt was unchanged at 168 basis points, or 1.68 percentage point, down 13 basis points since Aug. 31, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index. Yields averaged 3.416 percent.

UnitedHealth Group

UnitedHealth Group Inc., the biggest U.S. health insurer by revenue, plans to sell $750 million of debt in its first bond offering since February 2008. The insurer may issue 10- and 30-year debt as soon as today, according to a person familiar with the transaction.

Proceeds will be added to general funds and may be used to meet working capital requirements, repurchase or refinance outstanding securities, or to fund acquisitions, UnitedHealth said today in a regulatory filing that didn’t include the size or maturities of the sale.

Benchmark indicators of corporate credit risk in the U.S. and Europe fell. Credit-default swaps on the Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, declined 1.5 basis points to a mid-price of 98.7 basis points as of 11:41 a.m. in New York, according to index administrator Markit Group Ltd. In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings fell 0.2 to 101.4.

Corporate Bonds

Credit swap indexes typically fall as investor confidence improves and rise as it deteriorates. Contracts 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.

Relative yields on investment-grade corporate bonds have declined 31 basis points to 182 since this year’s peak on June 11, compared with the low of 151 in April, according to a Bank of America Merrill Lynch index.

Spreads on benchmark commercial property bonds narrowed to a low this year of 265 on Oct. 13, RBS data show.

The rally in the commercial-mortgage backed bond market has been sparked in part by investors wagering that real estate may be recovering after the worst economic downturn since World War II sapped demand for office and retail space.

Still, U.S. commercial property prices tumbled for a third straight month in August, and are now 45.1 percent below the peaks in October 2007, Moody’s Investors Service said in a report yesterday.

Building Owners

More financing has become available for building owners in the past year, which helps borrowers that have struggled to pay off maturing debt, according to RBS’ Lancaster.

Wells Fargo and Bank of America started marketing $735.9 million of bonds backed by commercial mortgages, according to a person familiar with the offering.

The pool is composed of 31.2 percent retail properties, 28.5 percent office space and 12.8 percent industrial buildings, said the person, who declined to be identified because terms aren’t public.

Deutsche Bank AG is marketing $856.6 million of bonds backed by commercial mortgages, according to a person familiar with the transaction.

Bank of America and Goldman Sachs Group Inc. are planning a $3 billion sale backed by debt left over from the 2007 buyout of Hilton Worldwide, Bloomberg News reported in June.

‘Positive News’

The offerings will add to about $4.7 billion of the bonds that have been issued this year, compared with $3.4 billion last year, according to data compiled by Bloomberg. Sales may reach $35 billion in 2011, according to S&P.

Issuance tumbled 95 percent to $11.2 billion in 2008 from a record $234 billion in 2007, choking off funding to property owners. Spreads reached more than 15 percentage points in November 2008, according to a Barclays Capital index.

“Lately we’ve actually seen some positive news,” said Tom Sontag, a money manager at Neuberger Berman Group LLC with $16 billion in assets under management. “So much negative news was priced in.”

Leasing activity in Manhattan, the largest U.S. office market, increased 51.6 percent to 17.25 million square feet in the three months ended Sept. 30 compared to a year earlier, CB Richard Ellis Group Inc. said in an Oct. 13 statement.

Late Payments

Late payments on commercial mortgages bundled and sold as bonds are at a record 8.24 percent, compared with 3.64 a year ago, according to Moody’s. About $335 billion of the securities come due through 2015, JPMorgan data shows.

“One has to question if the levels on some bonds are not ignoring the issues still facing the market,” said Darrell Wheeler, an analyst at Amherst Securities Group LP. “The refinancing problem will become larger next year and in 2012.”

With defaults rising and property prices falling, investing in anything but the most senior bonds means making bets on individual properties, according to Neuberger’s Sontag, who holds about $5 billion of commercial-mortgage securities.

“If there is an unforeseen problem with one of the largest loans in the deal, it will have a much bigger impact,” on the mezzanine and junior bonds, Sontag said. “We stay at the top of the capital structure.”

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