Sub-Prime Lending's Effect on Commercial Real Estate

Simple RE has an interesting post exploring the connection between conduit lending and the sub-prime mortgage meltdown.

(The observations are attributed to Dan Smith, Managing Director of RBC Capital Markets.)

So here is where the connection between sub-prime residential and the commercial loans lies; the investors who bought (and are being hurt) by the sub-prime residential mortgages are the same investors who are buying the highest risk pieces of the commercial pools. When the sub-prime market took such a large hit, the investors buying the riskiest pieces of the commercial mortgage pools walked away from the table. The conduits were left holding on to the riskiest loans.

While this was all happening, Moody's downgraded some of the bonds in the portfolios, i.e. from AAA rated to AA etc. This meant that the conduits had to pay a higher average spread to investors causing them to make less, or possibly lose money when they securitized the portfolio of loans.

What this all means is that lenders have increased their spreads to attract the highest risk investors back to the table and to compensate for the changes in the way the ratings agencies (Fitch, Standard and Poors, and Moody's) have rated the loans in their portfolio.

On a somewhat related note, the Dirt Lawyer's Blog offers a link to a Bloomberg piece on the CDO market slowing to a trickle.

The Wall Street money-machine known as collateralized debt obligations is grinding to a halt, imperiling $8.6 billion in annual underwriting fees and reducing credit for everyone from buyout king Henry Kravis to homeowners.

Sales of the securities -- used to pool bonds, loans and their derivatives into new debt -- dwindled to $9.1 billion in the U.S. this month from $42 billion in June, analysts at New York-based JPMorgan Chase & Co. said in a report yesterday. The market, which was ``virtually shut'' earlier this month, is showing ``signs of life,'' the bank said.

Investors are shunning CDOs after the near-collapse of two hedge funds run by Bear Stearns Cos. that owned the securities. Standard & Poor's downgraded bonds from 75 CDOs as mortgages to people with poor credit defaulted at record rates. Concern about losses on home loans are rattling investors across the credit spectrum.

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