04/03/2009

Treasury Plan Seen Spurring CMBS Sales

Veteran commercial MBS investors think there's a reasonable chance that the U.S. Treasury Department's new toxic-assets program will drive up prices enough to encourage institutions to unload their holdings of super-senior CMBS.

However, most observers feel the prospects are much less certain for the portion of the program aimed at spurring sales of distressed commercial mortgages.

While many of the program's details haven't been released, Wall Street analysts have started crunching numbers based on assumptions about the financing terms likely to be offered by the government. The consensus is that the Treasury Department will offer loan rates that will enable buyers of super-senior CMBS to achieve at least a 15% leveraged return. That yield, in turn, would work out to spreads of roughly 500-600 bp over swaps for super-senior bonds, according to some estimates.

If those guesses prove correct, the CMBS market is in line for a major rally. Spreads on super-senior bonds are currently 300-400 bp wider. For example, super-senior paper from the benchmark "GG-10" securitization were trading at around 925 bp over swaps this week.

Such a rally would cause CMBS prices to rise enough to make sales palatable to many institutions, investors said. Some portfolios are now so far underwater that institutions think the prices can only go up. That leaves them unwilling to sell, so the investments continue to clog up their balance sheets. But if spreads tightened to the 500-bp area, the losses would be cut enough for many institutions to bite the bullet, according to a number of veteran investors.

Of course, that's the whole premise behind the Treasury Department's Public-Private Investment Program (PPIP) and the Federal Reserve's complementary Term Asset-Backed Securities Loan Facility (TALF). The government is betting that, by offering generous loans in a credit-starved market and limiting the downside risk for buyers, it will drive up the prices of toxic assets enough to encourage buyers and sellers to strike deals. Currently, the gap in expectations between buyers and sellers is so large, partly because of the lack of debt financing, that the secondary markets for bonds and loans have largely dried up.

Whether that premise is correct is now the source of widespread analysis, as investors try to figure out the potential ramifications of the government's efforts. For commercial real estate lenders and borrowers, the stakes are high, because lending can't resume on a widespread basis until a consensus is reached on the cost of capital.

"The government is trying to stabilize the secondary markets, which in turn would support new issuance and dealer inventories," said one veteran buy-side player. "If you want lenders to start making new loans and commit their balance sheet, first there has to be enough stability in the secondary market so that there is an exit strategy for those lenders."

PPIP has two parts: one for triple-A securities and one for loans. There is broad agreement that the Treasury Department will have an easier go on the securities side. The reason: Super-senior CMBS are relatively homogenous and have the benefit of a 30% subordination level, which protects the holders from all but the most apocalyptic scenarios predicted for the economic downturn. "We all expect these triple-As to remain triple-A," said one investor. "The problems on the CMBS side are all about oversupply and illiquidity, not about fundamental credit issues."

But the efforts to spur sales face a bigger challenge with loans, which have much wider variance in credit quality, making them harder to assess. What's more, accounting rulemakers are moving to ease the capital penalty for retaining illiquid loans, reducing the incentive of lenders to sell at discounted prices.

Many questions remain about the plans for loans, making that part of the program especially difficult to assess, market player said. It's unclear if B-notes and mezzanine loans will be eligible or if the program will be restricted to senior loans. Nor is it clear if investors will be able to bid on individual loans or only entire portfolios, or if portfolios will contain loans of varying credit quality.

Meanwhile, the announcement of PPIP last week caused loan sales to come to a virtual standstill, as buyers and sellers alike awaited more details about the program. "The announcement has virtually short-circuited the loan-sale process for now," a fund operator said, noting that sellers don't want to sell loans if prices might be higher when the program is implemented.

On the bond side, there was some criticism that PPIP would limit to five the number of asset managers eligible to bid on assets. The asset managers would form 50-50 partnerships with the government to set up funds that would buy assets. Although outside investors could buy into the funds, many market players were uneasy about the concentration of power and questioned whether the limited number of funds would restrict bidding.

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