Wall Street Faces CMBS Pushback as Supply Booms
Wall Street is running into resistance unloading commercial-mortgage backed securities.
JPMorgan Chase & Co. and Barclays sweetened terms on a piece of a $1.2 billion bond deal last week to attract buyers, while Deutsche Bank AG and Cantor Fitzgerald LP increased the yield they're offering on securities today, according to people with knowledge of the matter.
Bond buyers are pushing back as banks aim to sell at least $6 billion of the debt in August in the busiest U.S. summer since before the financial crisis for securities backed by loans tied to properties such as strip malls or skyscrapers. After overlooking deteriorating underwriting standards for months, investors are becoming more selective as geopolitical turmoil sparks a flight from risky assets, according to Bank of America Corp. analysts.
"Investors couldn't get enough of these deals three weeks ago," Scott Buchta, head of fixed-income strategy at New York-based brokerage Brean Capital LLC said in a telephone interview. "The world view has changed."
The CMBS market is reviving after freezing in 2008. About $48.4 billion has been issued in 2014, with $24.8 billion since June. This year's already the busiest three-month period through August since $89.1 billion was arranged in 2007, according to JPMorgan data.
Now that sentiment is souring, interest rates on riskier deals will probably rise, according to Richard Hill, a debt analyst at Morgan Stanley. Yields on top-ranked bonds linked to commercial-property loans have climbed to 101 basis points more than Treasuries from a post-crisis low of 88 basis points on July 3, according to a Bank of America Merrill Lynch index.
"The heavy supply of new issue will highlight investors' desire to be more picky," he said. "They'll have that luxury."
JPMorgan and Barclays raised the yield by 20 basis points on the BBB- rated portion of their $1.2 billion offering last week to 345 basis points over benchmark rates after initially offering a spread of 325 basis points, according to people familiar with the sale who asked not to be named because the marketing was private.
Fitch Ratings and DBRS Ltd. rated the debt, assigning it the lowest investment-grade rankings. A basis point is 0.01 percentage point.
About a quarter of the loans backing the deal were linked to office buildings in the suburbs, a segment of the real estate market that's lagged behind the broader recovery in property values, according to Bank of America. The offering also had the highest amount of loans relative to property values, at 114.8%, of any sold since the market revived, according to Moody's.
That measure, known as loan-to-value or LTV, peaked at 118% in 2007. Rating companies take into account potential pitfalls such as a drop in building values when calculating LTV, leading to leverage ratios that can exceed 100%.
Jessica Francisco, a JPMorgan spokeswoman, and Mark Lane, a Barclays spokesman, declined to comment.
Until recently, investors in search of higher yields had been snapping up the new deals, accepting less compensation to hold securities even as rating companies and analysts warned that transactions were getting risker.
Property values in the largest U.S. cities have surpassed their 2007 peaks, encouraging demand, after plunging as much as 42% in the aftermath of the credit crisis, according to Moody's/RCA Commercial Property Price Index.
That may not be enough to offset the risk of rising debt levels, given leverage on new loans is on pace to climb to the peak that preceded the last property market crash by 2017, Moody's said in a report last month.
"The ongoing credit slippage will set the stage for the next phase of the credit cycle," Moody's analysts led by Tad Philipp wrote in the July 28 report. "Although the next downturn might not be as severe as the financial crisis, aggressively underwritten loans don't require much of a catalyst" to turn sour, they said.
Escalating conflicts in the Middle East and Russia have jolted credit markets from complacency spurred by more than five years of near-zero interest rates from the Federal Reserve.
Investors pulled a record $7.1 billion from U.S. junk-bond funds last week while at least three companies failed to complete deals in the market for speculative-grade loans. Charter Communications Inc. canceled plans to raise $4.2 billion in debt this week to finance its purchase of assets from Comcast Corp., according to a person familiar with the deal.
"While the drivers of this relatively recent sell-off are different than those of years past, it is important to note that spread widening, once it begins, can become a long-lasting cycle," JPMorgan analysts led by Ed Reardon said in report last week, advising CMBS investors to proceed with "caution."
Deutsche Bank and Cantor Fitzgerald's $1.08 billion offering is slated to be placed with investors this week, according to people familiar with the sale who asked not to be identified because terms aren't set. The transaction is linked to 85 properties across the U.S., with office-building debt comprising 26.6% of the deal and hotel loans making up 20.8%.