Commercial Mortgage Debt Rallies as TALF Ending: Credit Markets

Commercial mortgage-backed bond returns are accelerating as the Federal Reserve ends support for the $700 billion market, showing growing confidence that loan defaults won’t derail the economic recovery.

The securities, derived from debt on skyscrapers, shopping malls and hotels, returned 7.41 percent through March 12, compared with 2.55 percent in the fourth quarter, according to a Barclays Capital index. Top-rated securities are yielding about 3.03 percentage points more than Treasuries, the lowest spread since August 2008, according to Morgan Stanley data.

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Commercial mortgage-backed securities are rallying as the Fed’s Term Asset-Backed Securities Loan Facility to buy older debt draws to a close. The jobless rate is holding at 9.7 percent, indicating employment may be stabilizing. Bond prices were pummeled during the credit crisis and even in “pretty upsetting” scenarios, the safest debt isn’t likely to lose money, said Scott Simon of Pacific Investment Management Co.

“CMBS has been doing well on its own, and it’s not on the back of TALF,” said Simon, managing director and head of mortgage- and asset-backed securities at Pimco in Newport Beach, California. “The program had more of a psychological impact rather than brute force.”

TALF provides Fed loans to purchase top-rated securities, enabling investors to boost returns with the borrowed cash. About $11.4 billion of older commercial real estate debt has been bought through TALF since the program started in July, according to Morgan Stanley. So-called legacy bonds are those that were issued before Jan. 1, 2009.

Delinquency Rate

The delinquency rate on commercial real estate loans bundled and sold into bonds rose 31 basis points to 5.73 percent in February, lower than the average increase during the previous five months of 44 basis points, Moody’s Investors Service said March 12 in a report. The delinquency rate a year ago was 1.32 percent, according to the New York-based ratings company.

Elsewhere in credit markets, the extra yield investors demand to own company bonds rather than government debt fell 5 basis points last week to 158 basis points, or 1.58 percentage point, as of March 12, according to Bank of America Merrill Lynch’s Global Broad Market Corporate index. Average yields are 4.04 percent, the data show.

Corporate bond sales worldwide totaled $79 billion last week, the most since the period ended Jan. 15, bringing the March total to $130 billion, according to data compiled by Bloomberg. Companies have sold $580.6 billion of debt this year, compared with $810.7 billion in 2009.

Leveraged Loans

Prices on the Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index, which tracks the 100 largest dollar-denominated first-lien leveraged loans, ended the week at 90.23 cents on the dollar, the highest since July 7, 2008. The index’s total return was 2.9 percent for the year.

The cost to protect against defaults on U.S. corporate bonds fell for a second week as retail sales climbed last month, signaling consumers will contribute more to economic growth.

Credit-default swaps on the Markit CDX North America Investment Grade Index Series 13, which is linked to 125 companies and used to speculate on creditworthiness or to hedge against losses, was unchanged at 83.2 basis points on March 12, after falling 2.1 percentage points for the week, according to CMA DataVision. The index declined 6.2 basis points in the week ended March 5.

Retail Sales

Shoppers braved blizzards in February, as purchases increased 0.3 percent, the fourth gain in the past five months, U.S. Commerce Department figures showed. Results for the prior two months were revised lower. Sales excluding autos rose 0.8 percent, exceeding all economists’ estimates.

In London, credit swaps on the Markit iTraxx Europe index of 125 companies with investment-grade ratings fell 2 basis points to 73.75 basis points, the lowest since Jan. 18, JPMorgan Chase & Co. prices show.

The indexes typically falls as investor confidence improves and rises as it deteriorates.

Credit-default swaps pay the buyer face value if a borrower defaults in exchange for the underlying securities or the cash equivalent. A basis point is 0.01 percentage point and equals $1,000 a year on a contract protecting against default on $10 million of debt for five years.

Two corporate-debt issuers, one in Canada and the other in Argentina, defaulted last week, raising the global total to 19 for the year, according to Standard & Poor’s.

The 12-month trailing rate for high-yield, high-risk global defaults was 9.2 percent as of March 11, S&P analysts led by Diane Vazza in New York wrote in a report. The U.S. rate was 10.9 percent, which the analysts predict will fall to 5 percent by yearend, though they said that doesn’t mean that corporate default risk is permanently lower.

Fannie Mae

Spreads on Fannie Mae and Freddie Mac’s benchmark corporate notes widened 2 basis points last week to 24 basis points, according to Bank of America Merrill Lynch index data. The spread has widened from 17 basis points, the lowest in at least 10 years, in October. It reached a record 183 basis points in November 2008.

The most “likely” reason the yield gap has widened is that “spreads had simply reached levels that were too tight, especially given the prospect of the Fed’s exit” on March 31 from a program in which it’s buying $175 billion of the debt, Rajiv Setia and James Ma, analysts in New York at Barclays Capital, wrote in a March 12 report.

Lyondell Chemical

Lyondell Chemical Co. seeks $2.25 billion of notes and a $1 billion six-year term loan to help it emerge from bankruptcy, according to people familiar with the request. The chemical and fuel company also wants a $1.75 billion asset-based revolving line of credit that won’t be funded at closing, said one of the people, who declined to be identified because the discussions are private. It also seeks a European securitization facility, the people said.

Prices on top-rated commercial mortgage-backed securities have soared to about 92.5 cents on the dollar from 61.7 cents in March 2009 before the Fed committed to financing the securities through TALF, according to Barclays Capital data. Spreads have narrowed from 12.3 percentage points a year ago, according to data from Morgan Stanley.

“While the rally was seemingly ignited by the introduction of governmental plans to reintroduce leverage into the system, its longevity was fanned by investors’ continually improving view of the world, albeit from an exceedingly dismal starting point,” JPMorgan analysts led by Alan Todd in New York said in a March 5 report.

The U.S. unemployment rate held at 9.7 percent in February and the economy lost 36,000 jobs, fewer than economists anticipated, a Labor Department report showed on March 5.

Lack of Sales

There have been no new sales of commercial-mortgage backed securities this year. The portion of TALF for newly issued commercial mortgage-backed securities was extended through June. The final round of a separate TALF program for asset-backed securities, or bonds tied to consumer and small-business loans, was held earlier this month.

Sales of commercial mortgage-backed securities plummeted to $11.15 billion in 2008 from a record $232.4 billion in 2007 as the credit market seized up, Bloomberg data show. Even with U.S. government aid, only $3.04 billion of the bonds were sold last year.

The lack of transactions chokes off funding to borrowers with maturing debt. About $28 billion in commercial mortgages packaged into bonds mature this year, according to Credit Suisse Group AG data.

Even as economic concern abates, Barclays Capital analysts said the delinquency rate will continue to climb as borrowers struggling with debt loads hand over loans to special servicers, firms that handles troubled loans.

A $3 billion mortgage on the Stuyvesant Town-Peter Cooper Village apartment complex in Manhattan, the largest loan in the commercial-mortgage bond market, was transferred to a special servicer in late January, and isn’t yet classified as delinquent, the analysts said in a March 3 report.

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