Deutsche Bank CMBS Shows Risk Appetite Climbing Back

Greater demand for higher-yielding bonds in Deutsche Bank AG’s latest commercial mortgage-backed security has erased virtually all the risk premium investors demanded as they became more cautious in the second half of 2011.

Deutsche Bank cut yields sharply on parts of $941 million of commercial mortgage-backed securities Thursday as it priced the market’s second large multiloan issue of the year, according to investors.

The dealer slashed yield spread premiums on bonds just below the safest tier of debt. These junior AAAs have less so-called credit enhancement–a cushion that protects investors from losses in the event of default on loans to stores, offices and other buildings underlying the bonds.

That is a sign that investors are growing comfortable enough with the economic and real-estate recovery to take on more risk. Such bonds have also lagged a rally in CMBS this year, enhancing their attraction relative to top-tier debt, according to Roger Lehman, a strategist at Credit Suisse.

“Investors have zeroed in on CMBS as one of the few remaining fixed-income sectors offering yield,” said Chris Sullivan, chief investment officer at the United Nations Federal Credit Union in New York. Some yields may be too high given low interest rates and the improvement in real estate, he added.

Investor demand helped bolster the lending that is a crucial cog toward refinancing billions of dollars in loans made during the real-estate bubble. More than $65 billion in CMBS loans are scheduled to mature in 2012, and payoff rates so far this year suggest financing may be helping the market avoid some dire loss projections, analysts said.

Deutsche Bank sold 10-year AAA-rated bonds with 20.125% credit enhancement at a yield of 185 basis points over interest rate swaps, or about 3.91%, according to deal terms obtained by Dow Jones Newswires. On Wednesday, the dealer said it expected the debt to yield 225 basis points over swaps, and prior to that it was unofficially talked about at 250 basis points over swaps, investors said.

The dealer also cut yields on 10-year AAA-rated bonds with stronger, 30% credit enhancement by five basis points to 110 basis points over swaps, for a yield around 3.16%. Credit enhancement is the amount of a deal that would have to default before senior investors would see a loss.

Yields on the 10-year debt with 30% credit enhancement sit in the middle of all bonds in the $829.492 million public slice, where spreads ranged from 55 basis points to 385 basis points over swaps. An additional $111.776 million of privately offered, BBB- rated bonds were at a yield 600 basis points over swaps.

The 490-basis-point gap between the safest 10-year AAA bonds and the BBB- bonds is the smallest since Deutsche Bank’s August CMBS, when the escalating European debt crisis and a spike in credit-rating uncertainty sent investors to safer assets. The so-called credit curve was as wide as 820 basis points in December when UBS Securities had to offer investors 950 basis points over swaps to sell its lower-rated bonds.

Bond fund inflows and the pension manager requirements for yield have kept the rally in CMBS going since December, but some investors have begun to balk at the loss of yield in a market where delinquencies and losses are high. Their skepticism wasn’t enough to affect the Deutsche Bank issue, however, with the deal still garnering as much as five times the required orders even after yields were cut, one investor said.

An additional $5 billion in CMBS may sell in coming weeks, according to dealers. The credit curve is likely to flatten more, said Credit Suisse’s Lehman.

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