11/21/2008

CMBS Prices Crushed as Loan Woes Emerge

The commercial MBS market's freefall continued yesterday as the third large loan in a week was suddenly transferred to special servicing.

With investors worried about the possibility of other nasty surprises, demand for bonds was virtually nonexistent, causing prices to plunge to unprecedented levels. "There is little to stop the cratering of prices now," said one investor. "No one wants to throw himself in front of this moving train of a market."

Spreads on super-senior triple-A paper shot out to a record 1,600 bp over swaps on Thursday, before pulling in to 1,525 bp. The benchmark bonds were trading at just 49 cents on the dollar, translating to an eye-popping 18% yield. Just a week ago, the same bonds were trading at 74 cents on the dollar, or an 11% yield and an average spread of 810 bp. That means the paper's value plunged by one-third in a week.

The loans collateralizing the bond transactions would have to suffer a 30% loss before the super-senior bonds would be affected. The fact that such securities were commanding 18% yields suggests that the market is pricing in an economic depression. Meanwhile, the cost of buying protection against defaults has skyrocketed (see article on Page 3).

The latest leg of the long-running downturn was touched off last week when U.S. Treasury Secretary Henry Paulson officially pulled the plug on the idea of having the government buy billions of dollars of structured bonds. It accelerated on Tuesday when it became known that two large commercial mortgages originated in the second half of last year had been transferred to special servicing: a $209 million loan on Westin hotels in Tucson, Ariz., and Hilton Head, S.C., and a $125 million loan on a shopping center in Corona, Calif. (see article on Page 3).

Yesterday came word that a third large loan package - $94 million of loans to a tenant-in-common partnership on multi-family, office and retail properties - was added to special servicing, further roiling the market.

Investors have long been worried that CMBS defaults, which have remained low, would eventually spike. But signs that three large loans originated only last year were in trouble spooked the market, especially since neither the rating agencies nor servicers had warned of potential problems. The loans were all in deals that priced this year.

"Everyone was caught by surprise," an investor said. "I didn't expect there to be problems with a 2008 CMBS deal so quickly. This was just a shock."

Some thought the market overreacted. S&P noted that the borrower of the shopping-center loan was seeking to raise capital to cover loan payments. And the transfer of the latest loan to special servicing appeared to result because of the bankruptcy filing by tenant-in-common sponsor DBSI. It was not immediately clear that there are problems with the underlying properties.

Nonetheless, investors were ready to run at any sign of trouble. The news yesterday of the DBSI loan being transferred to special servicing "added fuel to a burning fire," said an analyst.

There was equally dramatic widening of spreads in the synthetic CMBX market. On Thursday, the super-senior triple-A spread of Series 5 of the CMBX index closed at 847.5 bp Thursday, up nearly threefold from 306.1 a week before. A trader said there was heavy buying of triple-A CMBX contracts by bank proprietary desks, hedge funds and money managers. Demand was spurred by investors seeking to buy protection against CMBS defaults effectively shorting the market.

The widening of CMBX spreads added to the pressure on cash bonds. "The dramatic move in spreads is being led mainly by the onslaught of buyers of protection higher up in the CMBX credit stack," said Lisa Pendergast, managing director of CMBS strategy at RBS Greenwich Capital.

"Reasons for getting short the sector range from concerns over commercial real estate fundamentals to the growing difficulties in refinancing maturing commercial debt. The spread action has been exacerbated by the growing illiquidity into yearend as both the sell-side and buy-side look to shed risk. While a short-covering rally can't be ruled out, further widening is likely into yearend."

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