01/29/2010

Regulatory-Reform Plan Spooks Bond Market

President Obama has thrown a wrench into the long-running commercial MBS rally.

The booming demand that drove up CMBS prices for several months abruptly dried up in wake of the president's proposed financial-market reforms, which would curb investment activities at the country's largest banks.

The plan was announced on Thursday last week, when many market players returned to their desks following a largely upbeat conference in Washington sponsored by the Commercial Mortgage Securities Association. The announcement "really kind of changed everyone's tone on a dime," one CMBS trader said. "That caused people to become significantly more risk-averse."

Buyers of CMBS and REIT bonds beat a hasty retreat to the sidelines last Friday and have remained there since. Spreads on super-senior bonds widened - dramatically, in some cases - over the past week.

Many market pros view the reversal as temporary, rather than a fundamental turn in direction. They expect demand to pick up again in a few weeks as investors digest the reform plan. But trading remained light yesterday.

In some cases, spreads on super-senior CMBS widened by up to 100 bp over the past week. For example, bonds from the A-4 class of the benchmark GG-10 deal, which came to market in 2007, were changing hands at 485 bp over swaps on Monday and 525 bp yesterday, up from the 440-bp area a week ago. The going rate for comparable bonds from the GG-9 transaction, which was issued the same year, ballooned by 60 bp, to 370-375 bp.

The spread-widening trend was less pronounced among higher-quality bonds eligible for TALF financing. The Federal Reserve program, formally known as the Term Asset-Backed Securities Loan Facility, provides low-cost loans to buyers of eligible super-senior CMBS.

Spreads widened by only 10-15 bp on some of the most-sought-after CMBS. A-2 bonds from TALF-eligible transactions issued in 2007 were trading around 280 bp yesterday, while qualifying 10-year bonds from 2005 were going for 190 bp.

The investor pullback carried over to the REIT-bond market, where values had soared over the previous seven months. Just this week, spreads on securities from investment-grade issuers widened by 10-15 bp across the board, investors said.

"It's not a major selloff," one REIT analyst said. "The market is taking its cue from equities and all the stuff going on in Washington."

Secondary-market spreads on a pool of 10-year REIT bonds with an average rating of triple-B-plus stood at 226 bp over Treasurys last Friday, down from 236 bp a week earlier and 286 bp in late December, according to a weekly index compiled by Wells Fargo.

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