The drought is (kind of) over!

November 16, 2009

After months of buildup, Developers Diversified Realty Corp finally sells the first commercial real estate bond in more than a year. At $400 million, it’s hardly a dramatic debut, but it’s a significant first for one of the few markets still jammed since the financial crisis.

From Reuters:

Met with strong investor interest, Developers Diversified was able to price the deal below existing levels for the CMBS issues. Its $323 million AAA-rated five-year notes came at a narrower 1.4 percentage point premium to the five-year interest rate swap benchmark, or a yield of 3.807 percent, market sources said.

Underwriter Goldman Sachs lowered yield premiums from earlier guidance levels of 1.6 to 1.75 percentage points, due to the strong buyer interest.

The yield may seem tiny, but this deal should qualify for the Federal Reserve’s TALF program, which means a healthy dose of leverage will super charge returns. (UPDATE: Taking into account the Fed’s financing, the real return would be 5.9%, according to Barclays CMBS research team.) For the run-down on TALF, check out the Fed’s website here. Oh yeah, and in case anyone forgot, these are non-recourse loans, which means the borrower has  limited downside risk.

This is still just a drop in the bucket for the commercial real estate market. There’s still the looming finance wave to deal with, and many underwater loans out there simply won’t qualify for refinancing. So far the answer has been for banks to amend and extend the terms of the loan, or put another way, delay and pray.

About $570 billion in commercial mortgages are due to be refinanced between 2010 and 2011, according to property researcher Foresight Analytics LLC in Oakland, California. The firm estimates that defaults could cause some $250 billion in commercial real estate losses to the banking sector.

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My paper “A Binomial Model of Geithner’s Toxic Asset Plan” allows the reader to estimate the overbidding in a TALF auction due to the cheap leverage. It is at http://ssrn.com/abstract=1428666