Investors are rushing to purchase bonds backed by commercial mortgages after Tuesday's announcement that the Federal Reserve banks would provide financing beginning in July to those wanting to buy older securities in this $800 billion market.
Traders had expected the Fed to include such commercial mortgage-backed securities eventually, but were surprised that the central bank moved so quickly.
"It's a huge positive," said Lisa Pendergast, the head of CMBS strategy at Royal Bank of Scotland's RBS Securities in Greenwich, Conn. "We see a lot of people buying these bonds ahead of the program's launch in July."
The central bank is already providing loans to buy newly created bonds backed by consumer loans and equipment lease loans, among other debt, through its Term Asset-Backed Securities Loan Facility.
Earlier this month the Fed proposed adding only newly created commercial mortgage-backed securities to the Talf program. On Tuesday it expanded the collateral it would accept to include so-called legacy, or existing, securities, but specified only the least risky portions of commercial mortgage bonds would be eligible.
The announced drove the markets up. The cash commercial mortgage bond market rallied Tuesday, with risk premiums tightening by about 100 basis points, to 635 basis points over interest rate swaps, according to Jim Harrington, a trader of asset-backed securities at Ryan Labs in New York.
The rally continued Wednesday morning. Risk premiums on the cash bonds tightened by another 80 basis points, to 565 basis points, on Wednesday, according to Derrick Wulf, senior portfolio manager at Dwight Asset Management.
Investors had expected the Fed would include older assets as a way to support the commercial real estate market, but many had thought "it would take longer," Harrington said.
The Fed will only accept those securities that have been able to retain their triple-A ratings with at least two credit rating agencies, and without being under review for future downgrades. The ratings must be from DBRS of Toronto, Fitch Ratings, Moody's Investors Service, Realpoint or Standard Poor's.
"Many different rating firms have CMBS expertise and are qualified to rate these securities. So out of fairness, it makes sense to include more ratings firms to encourage a competitive business environment," said Darrell Wheeler, the head of CMBS strategy at Citigroup Inc.
The Fed has also said it "may limit the volume of Talf loans secured by legacy CMBS and is considering whether to allocate such volume via an auction or other procedure."
While this may seem overly cautious, Wheeler said the move is a reminder that the Fed can provide only so much financing in the $1 trillion program. It has "limited capacity, so this is a cautionary note," he said.
Despite these restraints, the inclusion of existing commercial securities will offer a much-needed source of financing for loans, said Frank Innaurato, managing director at Realpoint.
More than $200 billion of loans backing CMBS deals are expected to mature over the next three years, with few sources of financing available for them. "It will provide a level of support, and be a way to stimulate lending and new issuance for securitization," Innaurato said. "This is one of the biggest steps taken by the Fed to revitalize CMBS."