Commercial-Mortgage Bond Rally Stalls as Fannie Mae Sells Debt

A commercial-mortgage bond rally that pushed values up as much as 25 percent this year is stalling as planned sales from Fannie Mae threaten to overwhelm investors.

Prices on a Markit Group Ltd. CMBX index used as a gauge of demand in the $550 billion market for securities tied to shopping malls, skyscrapers and hotels fell to 75.3 cents on the dollar yesterday, the lowest in almost three weeks. The index, linked to securities rated AAA when issued in 2007 that have since been cut to junk, reached a two-year high of 78.9 cents on May 8.

Investors are pulling back after analysts at banks including Deutsche Bank AG and Nomura Holdings Inc. warned that buyers of the riskiest bonds will probably face principal losses. The sell-off is being compounded by Fannie’s Mae’s auction of about $2 billion of debt tied to apartment complexes issued during the market’s peak in 2006 and 2007.

The Fannie Mae offering “could soften things up a bit,” Brian Lancaster, a debt strategist at Royal Bank of Scotland Group Plc., based in Stamford, Connecticut, wrote in an e-mail. “Earlier in the quarter it could have been easily taken down without as much impact.”

Values of so-called AJ bonds such as the debt included in Markit’s index climbed as high as 94 cents on the dollar this month from 75 cents in December, Deutsche Bank data show.

Market ‘Impact’

The government-controlled loan financier, which has returned to profitability after being taken over by U.S. regulators in 2008, is offering the securities as it seeks to shrink its balance sheet. The Washington-based lender may follow up with similar offerings in the next several months, people familiar with the offerings said yesterday.

Executives at Fannie Mae and competitor Freddie Mac were given a goal in March of selling off at least 5 percent of illiquid holdings this year as the Federal Housing Finance Agency seeks to make the firms smaller.

The sale from Fannie Mae marks the first widely distributed offering of its kind, Deutsche Bank analysts wrote in a report today. There are 17 bonds on the lists being offered this week with an average balance of $129 million, according to the New York-based analysts led by Harris Trifon.

While the sale will probably cause relative yields to widen in the near-term, the effect should be short-lived, according to Deutsche Bank.

“After the uncertainty regarding execution passes and fears of another large list in the near future wane, the exercise could form the basis for the next tightening cycle,” if the sale goes well, the analysts said.

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