Wall Street’s $8 Billion CMBS in Limbo as Bulls RetreatSarah Mulholland
Wall Street firms spent the past six months increasing commercial mortgage origination as investors bought the most debt in six years. That’s now backfiring as banks prepare to market $7.5 billion of loans earmarked to be sold as bonds before credit markets took a dive this month.
Investors are demanding 1.2 percentage points more than the benchmark swap rate to buy new commercial mortgage backed securities tied to shopping malls, skyscrapers, hotels and apartment buildings, according to data compiled by Bloomberg. That’s up from 72 basis points in February, the narrowest spread since sales revived in 2009, the data show. Lenders’ profits are eroded when values of the securities fall.
The CMBS market is poised for its worst month in almost two years after the Federal Reserve signaled it may curb stimulus efforts as the economy shows sign of improvement. That’s complicating efforts by banks to sell new deals and making it more expensive for landlords to refinance loans backed by everything from Manhattan office space to suburban grocery stores. Barclays Plc estimated last week that $7.5 billion in new deals would be completed in the next two months.
“This looked like it was going to be an unusually good year” for the commercial-mortgage backed securities market, said John Levy, a principal at John B. Levy & Co., a real estate investment banking firm based in Richmond, Virgina. “It throws a big monkey wrench in the works. The CMBS market will take a pretty good wallop in volume.”
Lenders led by JPMorgan Chase & Co., Deutsche Bank AG, Goldman Sachs Group Inc. and Morgan Stanley have arranged about $39.6 billion in sales this year, Bloomberg data show. Morgan Stanley and Bank of America Corp. sold top-ranked debt to pay a spread of 120 basis points over swaps yesterday, according to a person familiar with the offering, who asked not to be identified because terms aren’t public.
Banks ramped up lending to commercial property owners with CMBS issuance poised to climb 50 percent to $70 billion this year, according to Credit Suisse Group AG. Sales had rebounded after plunging to $11 billion amid the credit market seizure in 2008 from a record $232 billion in 2007.
The increase helped landlords across the U.S. retire debt, with 81 percent of mortgages maturing this year paid on time, according to JPMorgan. The bank, which is forecasting $50 billion in sales linked to multiple property owners, said last week wider spreads could “modestly” reduce sales as banks have to offer more expensive terms to adjust for lower bond values.
Loan rates for borrowers have climbed about 100 basis points, or 1 percentage point, over the past two months, JPMorgan analysts led by New York-based analyst Ed Reardon wrote in the June 21 report.
The bank switched its recommendation on CMBS to “neutral” from a “longstanding overweight,” citing continued volatility and the prospect of increasing supply.
“We did not expect CMBS to experience this steep a selloff in anticipation of the end of” the Fed’s bond-buying program, the analysts wrote.
The market is turning after lenders bulked up their commercial-mortgage bond units to satisfy investor appetite as the central bank suppressed borrowing costs, pushing investors toward riskier assets.
Bank of America in March lured Ken Cohen from UBS AG to run its commercial real estate finance group in New York after Switzerland’s largest lender cut its bonus pool.
“We continue to see opportunity in the CMBS market and are thrilled to have Ken,” Michael Nierenberg, the head of global mortgages and securitized products at Bank of America, said in an e-mail. “While there is market volatility, we are still pricing deals and continue to view the business in the long term.”
Credit Suisse began approaching borrowers this year with terms for commercial mortgages to be packaged into bonds as it sought to reenter the business after shutting its unit in 2011. The Zurich-based lender last month hired Mark Brown, a 20-year CMBS veteran, to restart the origination business, a person with knowledge of the move said, who asked not to be identified as it wasn’t publicly announced. Drew Benson, a Credit Suisse spokesman, declined to comment on the group’s plans.
Fed Chairman Ben. S. Bernanke’s comments have roiled markets for residential and commercial property bonds even as real estate strengthens.
Commercial real estate prices increased 0.4 percent in April, and have gained 40 percent since bottoming in January 2012, according to Moody’s Investors Service. The S&P/Case-Shiller index of property values increased 12.1 percent from April 2012, the biggest year-over-year gain since March 2006, after advancing 10.9 percent a month earlier, a report showed today in New York.
Still, U.S. homebuilders have fallen 19.6 percent through yesterday from a May 14 peak, close to the 20 percent threshold considered to be a bear market. An ABX index of home-loan bonds without government backing created in 2006 has dropped more than 6 percent this month. A similar index tied to commercial property bonds plunged 8.6 percent to 68.05.
“The velocity of the decline has caught a lot of levered players including dealers off guard,” said Harrison Choi, a bond manager for TCW Group Inc., which oversees about $131 billion in assets. “You are seeing a very defensive stance from dealers, which will obviously hurt liquidity across numerous asset classes.”
The surge in borrowing costs will likely push property owners to the sidelines as they wait to see which way the market goes, according Levy of Levy & Co. Still, long-term interest rates are low by historical standards and aren’t likely to fall back to the levels seen earlier this year, he said.
“I have been telling all my clients that the market is abnormally low so you should back up the truck and load up on all of this long-term fixed-rate debt while it’s available,” he said, speaking about the costs of borrowing prior to the surge starting in May. “It’s not expensive now, it’s just less cheap.”