04/16/2010

Dealers Open Up Spigot on 'Repo' Lending

As the commercial MBS rally rages on, investors are finding it easier, and often cheaper, to line up financing for bond purchases.

After starting to make credit available again to bond buyers late last year, many of the big Wall Street dealers have become more aggressive over the last month or so. "Now, it's really competitive," said one portfolio manager at a hedge fund. "We'll get two guys willing to finance us, and we can play them off each other. A couple of months ago it was just a question of whether they could do it at all."

Bank of America and J.P. Morgan are particularly willing to provide short-term loans known as repurchase agreements, or "repos." Barclays, Credit Suisse, Morgan Stanley and RBS have also been busy, and UBS seems to be stepping up its activities, investors said.

The recent surge of repo lending has coincided with a dramatic rise in CMBS prices. The rally continued this week. Bonds from Class A-4 of the benchmark GG-10 deal changed hands yesterday at about 295 bp over swaps - down 55 bp from a week earlier.

The rebounding market has given dealers more confidence to provide credit. What's more, dealers' funding costs have fallen in recent weeks. That has pushed down borrowing rates and enabled investors to boost leverage. Dealers are also more likely to offer to finance bonds they are selling now, without making investors ask for it.

Following a two-year absence, dealers resumed offering repo lines as liquidity improved in the secondary market during the latter half of last year. Most followed the lead set by the Federal Reserve's Term Asset-Backed Securities Loan Facility, or TALF, which charged investors 100 bp over swaps for loans against purchases of high-grade CMBS. The collateral is not marked to market during the three-year or five-year terms of the loans.

Early this year, dealers were permitting their best customers to borrow up to 85% of the cost of super-senior CMBS backed by well-diversified collateral pools - in other words, applying a 15% "haircut" to the purchase price. The average rate was 100 bp over Libor. On average, such buyers can now borrow up to 90% of the cost at a spread of 75-80 bp over Libor.

To be sure, the pricing for any specific repo varies. The spread on repo lines for top-tier customers can range from 50 bp to 100 bp, depending on which bonds are financed, the size and financial health of the borrower and its relationship to the dealer. The rates and haircuts are generally higher for A-M and A-J bonds, which were issued with triple-A ratings, but subordinate to super-senior paper. Top-shelf buyers of A-M paper can finance up to 80-85% of the purchase price at a spread of 100-150 bp, and A-J buyers can borrow up to 65-75% of the cost at 150-200 bp.

Lower-profile borrowers said they are generally being quoted repo rates of 100-150 bp, with a haircut of at least 15-20%, on purchases of super-senior bonds. But one CMBS buyer at a small hedge fund said he is now getting offers at 100-125 bp. "It seems to be on its way to 100-115, but I don't think we'll go below 100 bp on the inside," he said.

The terms on repo facilities usually range up to six months, with a monthly reset on the Libor rate. Until early this year, most dealers wouldn't go beyond three months. Before the credit crunch caused leveraged capital to dry up two years ago, it wasn't unusual for banks to extend repo lines with even higher leverage, much lower rates and terms of up to a year.

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