July 30, 2009 / 8:54 PM / 10 years ago

Real estate reality is lost on U.S. CMBS, for now

NEW YORK (Reuters) - U.S. commercial real estate has been one of the most sour topics for financial markets in recent months but few would know it given the outperformance of bonds supported by office buildings, shopping centers and apartments.

A rally fueled by cheap valuations and government programs in commercial mortgage-backed securities has been underway since March and accelerated this month. Year-to-date returns pushed above 20 percent over benchmark government securities, according to Barclays Capital indexes.

Gains are remarkable as falling revenue from commercial properties and a severe shortage of financing continue to darken the outlook, which has been cited by banks including Goldman Sachs Group Inc. for reducing second-quarter profit.

Only emerging market and the riskiest corporate bonds have outpaced CMBS so far this year, but those rebounds come amid signs of economic rebound that would reduce defaults.

In CMBS, bank executives and analysts expect underlying loans will keep deteriorating into 2010 as revenue falls and borrowers struggle to refinance mortgages under tight underwriting requirements.

“High yield has rallied strongly and default expectations have moderated somewhat,” said Chris Sullivan, chief investment officer at the United Nations Federal Credit Union in New York. “Not so with CMBS. Default expectations have increased, but so has government attention to the sector.”

CMBS returns to Treasury benchmarks reached 20.24 percent in the year through Tuesday, partly recouping the 29.48 percent deficit from the last half of 2008, according to Barclays. High yield and emerging market bonds this year have returned 38.92 percent and 26.72 percent more than Treasuries.

“The (CMBS) market has put aside its fundamental concerns because it thinks, over the next three to four months, the technicals will outweigh” those worries, said Bryan Whalen, co-head of structured bonds at Metropolitan West Asset Management in Los Angeles.

Government intervention has been the main elixir for CMBS markets, overpowering the outlook for commercial real estate that will eventually reassert itself on prices, Whalen said.

The Federal Reserve’s Term Asset-Backed Securities Loan Facility, or TALF, first jolted CMBS from their position as one of the worst performing fixed-income assets through the depths of the financial crisis. TALF for CMBS is at an early stage, having begun for existing assets but not yet for new ones.

Meantime, the pending U.S. Treasury Public-Private Investment Plan, or PPIP, has investors and Wall Street dealers bidding up prices on CMBS and other risky debt that will be targeted by the nine managers running the funds, he said.

“The market is anticipating a huge beast... with $40 billion in buying power,” Whalen said. “Against that background, you have a rising equity market. Things feel good, and investors don’t want to be left behind.”

The disconnect between CMBS and the real estate outlook has been the focus of questions fielded by Alan Todd, a strategist at JPMorgan Chase & Co. Todd is reiterating a bullish view on top-quality CMBS, whose risk premiums he predicts will shrink as low as three percentage points above their interest rate benchmark by year end, from 6.50 percentage points.

The spread topped 14 percentage points in November, and was above 12 percentage points as recently as March.

While much of the real estate erosion was priced in, a “tremendous amount” of the rally is due to government programs, Todd said. Key to that demand is an extension of TALF beyond December, which Todd expects since issuers have lost time readying bonds for sale, and a raft of maturing commercial loans still needing access to capital, he said.

Janet Yellen, president of the Federal Reserve Bank of San Francisco, on Tuesday said her biggest concern was maturing loans on depreciated commercial properties, making the sector a “particular danger zone” for the fragile financial system.

Investors seeking TALF loans to buy eligible securities may gravitate away from the credit card and auto loan ABS, and into CMBS where some yields are double the 7.0 percent to 12 percent on the consumer debt securities, Todd said.

There may be a pitfall behind the demand for CMBS and other bonds eligible for PPIP, such as residential mortgage-backed securities, investors warned. Much of the buying appears to be from dealers loading up their inventories now for anticipated sales once PPIP funds complete fundraising, they said.

“For dealers, this is not a buy and hold strategy for them,” said Whalen, who added that rising defaults will eventually manifest themselves in lower prices.

0 : 0
  • narrow-browser-and-phone
  • medium-browser-and-portrait-tablet
  • landscape-tablet
  • medium-wide-browser
  • wide-browser-and-larger
  • medium-browser-and-landscape-tablet
  • medium-wide-browser-and-larger
  • above-phone
  • portrait-tablet-and-above
  • above-portrait-tablet
  • landscape-tablet-and-above
  • landscape-tablet-and-medium-wide-browser
  • portrait-tablet-and-below
  • landscape-tablet-and-below