US CMBS resilient in face of massive downgrades
NEW YORK, June 29
NEW YORK, June 29 (Reuters) - Commercial mortgage-backed securities are holding firm in the face of massive ratings downgrades, raising fresh questions about the need of government funded programs to backstop the sector.
Bonds in the $700 billion market held near Friday's levels after Standard & Poor's that day affirmed that it would adopt a more conservative outlook on the market for office, retail and apartment building debt, which may result in downgrades to a third of all outstanding CMBS.
The resilience of the CMBS market is notable since investors a month ago decried S&P's intentions, and its likely effect of limiting success of a Federal Reserve program seen as a key way to lower borrowing costs and restart lending. The Fed's Term Asset-Backed Securities Loan Facility (TALF,) which would fund investors that purchase CMBS weighing down bank balance sheets, would exclude issues that are downgraded.
But dealers are discovering investors may require only a new kind of bond, not government support. By restructuring old issues, dealers in the past two weeks began making bonds that can weather downgrades by finding investors willing to accept a riskier piece with greater return potential.
This practice of "re-remics" has increased demand for the underlying issues. If yields fall enough, it could provide relief to the market where borrowers must refinance debt under today's more stringent conditions, or face default.
"Through the private market, you can see private capital has shored up spreads even with downgrades" looming from S&P, said Alan Todd, head of CMBS strategy at JPMorgan Chase & Co. in New York.
Risk premiums on top-rated CMBS fell slightly on Monday following the S&P announcement, which came late on Friday.
The CMBS "re-remic" business has topped $1 billion and is expected to mount as investors seek to bulletproof portfolios from ratings downgrades, which can dent market values and force selling at fire sale prices, according to one primary dealer.
Improved structures are available only to a portion of the CMBS market due to the eroding picture of the underlying market for commercial real estate. Many junior bonds are expected to lose value as rising vacancies and falling rents result in losses to all but the most-protected issues.
The success of re-remics may not completely take the onus of support off the government. The TALF program for new CMBS is still expected to add much needed liquidity, Todd said.
New issue TALF, the bid for re-remics and a greater appetite for risk among other investors could cut yield spread premiums on the top, 10-year CMBS in half to near 350 basis points by year end, he said in a research note on Friday.
TALF for old CMBS, however limited, remains an important tool, said Chris Sullivan, chief investment officer at the United Nations Federal Credit Union in New York.
"I think this market will require government intervention but at a somewhat more reduced scale than previously envisioned, perhaps," Sullivan said in an email.
(Editing by Kenneth Barry)
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