Commercial-mortgage bond buyers are girding for the biggest deluge of offerings in seven years just as the debt becomes harder to sell amid slipping underwriting standards.
Lenders are poised to sell about $15 billion of offerings linked to properties such as shopping malls, hotels and suburban office parks in September, the highest monthly tally since the market peaked in 2007, according to Morgan Stanley. The rush is threatening to overwhelm demand for securities that are more vulnerable to landlord defaults.
"The upcoming September issuance has been perhaps the most discussed subject in CMBS," Credit Suisse Group AG analysts led by Roger Lehman wrote in a report yesterday. "The big question remains: How will the market react?"
Buyers backed away from the bonds last month amid lingering concern that geopolitical risk could spark a flight from risky assets, forcing dealers to increase yields for securities on the bottom rung of investment-grade to entice investors. Such debt is becoming challenging to place with buyers as rating companies become tougher when assigning grades because of loosening loan terms.
Banks are avoiding Moody's Investors Service grades on new deals as the firm demands extra protection for investors from defaults to achieve the grades they want, eroding bank profits. The New York-based company hasn't rated any of the portions rated BBB-, the lowest investment-grade ranking, from CMBS deals sold since April. The deals have as many as a dozen classes spanning the rating spectrum from triple A to junk.
The majority of the riskier bonds in deals this year are being rated by Fitch Ratings, DBRS Ltd. and Kroll.
Lenders are allowing property owners to pile on more debt against their buildings as they compete for deals, potentially making it harder to pay off the mortgage. The distinction between transactions sold in previous years and those sold in 2014 is becoming more apparent as deals get increasingly risky, according to JPMorgan Chase & Co.
"Investors are clearly differentiating," the New York-based analysts led by Ed Reardon wrote in a report last week.
The extra yield above benchmarks rates investors require to hold bonds rated BBB- issued in 2014 has jumped 50 basis points, or 0.5 percentage point, to 350 basis points since credit markets swooned in July, according to JPMorgan. That's almost double the increase for similar debt sold in 2012, which is yielding about 285 basis points over benchmarks, marking an increase of 26 basis points.
Wells Fargo & Co. and Royal Bank of Scotland Plc are offering as much 345 basis points in spread for a $111.5 million chunk of BBB- rated bonds, according to a person familiar with the sale, who asked not to be identified because they aren't authorized to speak publicly. The $1.38 billion transaction is set to be placed with investors next week, the person said.
Yields may climb as the month progresses, according to Morgan Stanley analysts led by Richard Hill.
"The market may be under-appreciating the sheer number of deals," the analyst wrote in a report earlier this week.
