NEW YORK (Reuters) - Bonds backed by U.S. office buildings and hotels suffered their worst month ever in February as investors girded for falling property prices and rising defaults, according to Lehman Brothers.
By Al Yoon
NEW YORK (Reuters) - Bonds backed by U.S. office buildings and hotels suffered their worst month ever in February as investors girded for falling property prices and rising defaults, according to Lehman Brothers.
Commercial mortgage-backed securities lagged benchmark U.S. Treasuries by a record amount in February, even underperforming the asset class that includes bonds backed by risky subprime mortgages, according to indexes compiled by Lehman Brothers Holdings Inc.
CMBS lost 3.74 percent in February, or 5.23 percentage points behind U.S. government debt, the indexes show. Asset-backed securities lost 1.38 percent, while mortgage bonds guaranteed by government-sponsored enterprises gained 0.2 percent, they said.
!ADVERTISEMENT!Rising delinquencies in commercial real estate has prompted investors, already burned by flare-ups in residential real estate, to flee the $750 billion market that funds office buildings, hotels and shopping malls. Forecasts of a 20 percent drop in commercial property values by Moody's Investors Service and underwriter JPMorgan Chase & Co. have fueled a frenzy of selling in derivative indexes that continued on Tuesday.
There is "an underlying and pervasive unease with securitizations of all manner, and the real risk that increasing recession probabilities will adversely affect commercial property values, cashflow levels, and rents," said Christopher Sullivan, chief investment officer at the United Nations Federal Credit Union in New York.
Investors will probably demand higher and higher yields in anticipation of a worsening outlook for commercial property due to tight credit conditions, he said.
Renewed jitters were poised to send an index of CMBS to record levels on Tuesday.
The highest-rated portion of the CMBX derivative index was offered at yield spreads at 235 basis points over interest-rate swaps at mid-morning, compared with a record close of 228 basis points a few weeks ago, a dealer said. Spreads had narrowed last month as investors considered the selling overdone in a market that few expect to match the debacle seen in subprime loans.
Expected realized losses among the $3.2 trillion in commercial loans outstanding may rise to about $120 billion over time, JPMorgan strategist Alan Todd said on a conference call. That compares with expectations for $200 billion in losses out of the $1.25 trillion in subprime, he said.
As with subprime, however, a key problem is that large buyers including banks continue to pare balance sheets of risks of any kind, analysts said.
The deleveraging has even trashed returns on bonds seen as having little credit risk. Yield spreads on mortgage bonds guaranteed by government-chartered Fannie Mae and Freddie Mac neared their highest in more than two decades on Tuesday. U.S. municipal bonds backed by public finance projects dropped 4.58 percent last month, the most since April 1987, according to Lehman's indexes.
"We expect CMBS will remain under pressure," Todd said. Balance sheet constraints, announcements of commercial real estate losses by banks and increased fear concern about risk will conspire against the assets, he said.
Todd's forecasts come even as he and other JPMorgan analysts noted that fundamentals in commercial real estate are relatively firm. Overbuilding has not been an issue nationally, and a sharp increase in rents over the past few years provides a cushion in a downturn, said JPMorgan's Marc Levinson.
Delinquency rates are near historic low levels below 0.5 percent, and will likely rise as high as 2 percent this year, according to Moody's Investors Service. By contrast, prime and subprime residential mortgage default rates were 0.73 percent and 23.32 percent in December, according to FBR Investment Management research.
Issuance of CMBS has come to a halt, though Morgan Stanley and Bear Stearns last month were able to gather enough demand to sell a $1.2 billion issue backed by multiple loans. Bank of America on February 27 circulated price talk on a $2.3 billion sale but the deal's momentum has stalled, one investor said.
What's more, the promise of cheap funding for leveraged buyouts of months past has evaporated. Deals ranging from $3 billion to $8.5 billion backed by Manor Care Inc.'s nursing homes, Harrah's Entertainment Inc.'s casinos and Hilton Hotels have been bumped to the "undetermined" from first quarter business by Credit Suisse.
(Editing by Tom Hals)
