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Wanted: Floating-Rate CMBS Buyers

Market turbulence continued to widen spreads on floating-rate commercial mortgage-backed securities (CMBS) last week, driving the value of the underlying bonds down to record low levels.

While sustained volatility could force values down even lower in coming weeks, the same challenging market conditions could also lure value-driven investors back into the fray. CMBS are pools of commercial mortgages that are sliced up based on their credit risk and then sold to investors as bonds.

An Aug. 17 report from Citigroup Global Markets suggests that there are now plenty of opportunities to lock in attractive floating CMBS yields with little credit risk — provided investors can stomach more wild swings in the market.

The Citigroup analyst Darrell Wheller says that the CMBS market remains “confused” about pricing: “…at this point in time, there is very little buyer support for any credit-related floating-rate CMBS.”

Despite this chaotic climate, two large CMBS deals were priced last week. Wheeler was quick to note that given the topsy-turvy state of the market, the reported pricing on these two deals may not offer an accurate benchmark. They do serve as a positive signal that the CMBS market hasn’t entirely shut down, however.

More deals could be priced before Labor Day as there is currently $30.5 billion of CMBS deals in the pipeline. Given widening spreads, too, Wheeler says that many originators are limiting the number of new mortgages they take on. The rising cost of capital has forced CMBS issuers to offer higher yields to potential bond buyers who are demanding better returns for what they perceive to be higher risk bonds.

“In the past few weeks we have highlighted how double-A bonds at swaps plus 140 basis points or single-A paper at swaps plus 200 basis points are compelling value,” says Wheeler. “To us, this is great carry, but one that will take time for the market to recognize its fundamental value.”

As of this week, four large floating rate CMBS deals continue to have their pricing dates pushed back as issuers grapple with fluid market conditions. During this extended marketing period new issue price talk has jumped from LIBOR plus 20 basis points on the AAA A1 bonds up to LIBOR plus 50 basis points.

“[We] feel like we have been transformed from being debt strategists following a healthy segment of the fixed-income markets to emergency room doctors trying to determine the patient’s time of death,” writes Wheeler, adding that credit card spreads (which are viewed as one of the safest and most predictable floating-rate debt products) have also been jumpy in recent weeks.

A succession of bad news hasn’t helped calm the market. Countrywide Financial, the largest U.S. mortgage lender, announced on Thursday that it would draw down on an $11.5 billion credit line from 40 different banks. Countrywide tapped this credit facility as a much-needed liquidity boost as the global debt markets are increasingly shying away from offering short-term financing.

Aside from residential lenders like Countrywide, the credit turmoil is also expected to impact roughly $86.7 billion in LBO (leveraged buyout) deals that were announced as far back as late February. The July 5 announcement that Blackstone Group would take Hilton Hotels Corp. private for $21.0 billion represents roughly a quarter of that debt, and the fate of that deal will be closely watched as the buyout boom continues to weaken.

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