CMBS Market Shows Distress As Default Fears Rise

Property values, Paulson's switch on TARP plans send spreads spiking

By Laura Mandaro
November 20, 2008

SAN FRANCISCO (MarketWatch) -- Risk premiums on commercial mortgage-backed securities spiked Wednesday, making this corner of the debt market the latest to show signs of mounting distress.

Spreads on indexes that track pools of mortgages made to real estate developers and property owners pushed through new record highs after the pending default of two large commercial mortgages amplified fears of spreading loan losses.

The reaction in the $800 billion-CMBS market reflects investors' growing realization that the economic slowdown is hurting occupancy rates and property values, increasing the risk that property owners will stop paying on their loans.

"Now the market is seeing some cracks in the foundation, some loans are starting to have difficulty, and people are becoming aware of how pervasive the debt bubble is," said Sean Dobson, chief executive of Austin, Tex.-based Amherst Holdings, which specializes in trading mortgage-backed securities.

Dobson said his firm has been advising customers to exit their CMBS positions.

"We think the lax lending standards used in residential mortgages were mirrored in commercial mortgages," he said.

Spreads on the most recent series of Markit's AAA CMBX index, which tracks credit default swaps on commercial mortgage-backed securities, on Wednesday jumped to 714 basis points, gaining about 30% from Tuesday's levels of about 550 basis points - which was already double trading levels at the start of the month.

A basis point is 1/100th of a percentage point.

Higher spreads in this index indicate the cost of protecting against a default in commercial mortgage backed securities has jumped in recent days.

On Tuesday, analysts at Credit Suisse noted that a $209 million commercial mortgage for Westin hotels in Tucson, Ariz. and Hilton Head, S.C., and a $125.2 million loan for the Promenade Shops at Dos Lagos in Southern California were transferred this month to a special servicer "due to imminent default," according to published reports.

Also weighing on the market are recent changes in the Treasury Department's $700 billion Trouble Asset Relief Program. A week ago, Treasury Secretary Henry Paulson said he was shelving a plan to buy toxic assets from banks and instead would use the money to increase banks' capital in exchange for preferred shares.

That about-face knocked the market for mortgage-backed securities, particularly residential MBS.

"The primary beneficiaries of the former TARP asset purchase program - residential and commercial mortgages - suffer the most declines," noted Bank of America Corp. debt analyst Jeffrey Rosenberg in a report.

Prices for commercial mortgage-backed securities have tumbled as spreads and yields have jumped. The AAA-rated CMBS widened on Tuesday by 265 basis points to trade at 1,120 basis points over the London interbank offered rate, according to Bank of America.

The steep drop in values of commercial mortgage-backed securities battered shares of life insurers that are big holders of this type of debt, including Hartford Financial Group (HIG), Principal Financial Group (PFG), Metlife (MET), and Prudential Financial (PRU).

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