Why the commercial mortgage bond market looks dire right now



Commercial real estate was said to be one of the safest stocks of the past decade.

But the coronavirus has turned the whole notion of ‘security’ upside down, emptying streets, shops, hotels, office buildings and other shared spaces, as cities rush to slow its spread. The uncertainty left creditors bracing for an avalanche of missed payments.

How bad is it? Real estate appraisers are unlikely to see buildings in person for weeks, if not months, so unlike the flood of expected worker layoffs, any real reduction in real estate values ​​remains far away.

But the carnage, as in corporate debt markets, is already being found in the prices of commercial real estate bonds where two weeks of dysfunction, margin calls and asset liquidations have taken their toll, especially for investors buying property. bonds or making loans with borrowed money, called leverage.

“It’s amazing to me that more and more people aren’t paying more attention to leverage, because it’s always been a killer in an environment like this,” Manager Christopher Sullivan told MarketWatch. portfolio to the United Nations Federal Credit Union in New York. Wednesday.

“This is a real black swan event,” he said of the pandemic. “But market participants have also had little to do with the likelihood of this happening.”

And by one important measure – the bond offer lists – there are still parties looking to raise funds, reduce their risk, or simply get rid of entire swathes of exposure.

On Wednesday, Wall Street dealers circulated a list of nearly $ 2.1 billion of mostly lower-rated commercial mortgage bonds under the headline “liquidation” in hopes of attracting offers.

The “talk,” or a rough estimate of what brokers think bonds could fetch, ranged from $ 20 to $ 90, according to the list seen by MarketWatch. Without default, bonds most often pay back at prices of $ 100.

U.S. stocks saw a bit more breathing space on Wednesday from expectations that Congress will soon pass a nearly $ 2 trillion aid package to offset the fallout from the coronavirus outbreak, along with the Dow Jones Industrial Average DJIA,
+ 0.87%
ending the day up 2.4%.

Tom Barrack, managing director of Colony Capital Inc, warned in a weekend article of a “domino effect” of margin calls, foreclosures and borrower defaults in the US commercial real estate debt market of nearly $ 16 trillion against the “invisible enemy” of COVID-19, the disease caused by the coronavirus.

Importantly, unlike corporate bonds, most commercial real estate bonds are not yet eligible for the broad bailouts deployed this month by the Federal Reserve to help restore order in financial markets. shaken.

Read: Here’s a breakdown of the Fed’s expanded bailouts to keep credit in circulation during the pandemic

Hope is for a wider safety net soon, especially as commercial real estate bonds could be vulnerable to a wave of downgrades, as they were a decade ago, if credit conditions remain tight and homeowners are starting to default.

Like ten years ago, shares of publicly traded mortgage companies that rely on leverage to increase their bond-lending and buying capabilities have been punished, sometimes taking $ 1 off. assets and turning them into $ 15 by borrowing $ 14.

Read: Mortgage REITs Are Under Pressure Even The Fed May Not Be Able To Release

But recent record bond outflows have also stung fund managers.

Deutsche Bank analysts led by Ed Reardon found fund managers to far outperform others in offering ‘for sale’ bonds on Wall Street offer lists over the past two weeks .

Here’s their chart showing the nearly $ 10 billion rise in commercial mortgage bonds offered on bond offer lists in the first three weeks of March.

“Last week most listings didn’t even receive offers,” said Adam Murphy, founder of Empirasign, a platform that tracks bond trading activity. He also said some sellers this week are turning to “all or nothing” listings instead.

“The reason for this can be twofold,” he said. “Either you receive a margin call and have to liquidate several positions simultaneously. Or they are people who are trying to find a faster transaction method.


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