Bloomberg News

Appaloosa Said to Fuel Trading in CMBS After Dealer Pullback

October 26, 2011

(Updates with bonds on list in ninth paragraph.)

Oct. 26 (Bloomberg) -- David Tepper’s Appaloosa Management LP is attempting to spark trading in commercial-mortgage securities by offering to buy and sell bonds with a face value of at least $8 billion after Wall Street firms pulled back from making markets in the debt.

The $15 billion investment firm is providing bids and offers on at least 49 bonds issued in 2006 and 2007 with prices from 22 cents to 61 cents on the dollar, according to three people with knowledge of the matter. The Short Hills, New Jersey-based money manager is distributing lists of the securities through Wall Street banks to other investors, said the people, who declined to be identified because the information isn’t public.

Trading in bonds tied to skyscrapers, shopping malls and other types of property has dried up as Wall Street dealers reduced their holdings of corporate debt to an eight-year low on concern that Europe’s fiscal crisis will spread to bank balance sheets and the U.S. economy is faltering. Prices on the type of securities circulated by Appaloosa, most of which have been cut to junk after being assigned AAA grades, have plunged as much as 40 points from 90 cents in April, according to Deutsche Bank AG.

“Throw in recent volatility and a potential recession and now you have an over correction with very few dealers or investors prepared to buy what look like double digit default adjusted yields,” Darrell Wheeler, a bond strategist for Austin, Texas-based Amherst Securities Group LP said.

Tepper, whose flagship hedge fund gained more than 100 percent in 2009 by betting on banks and other financial services firms, declined to comment.

Dealer Inventories

While banks typically send out lists of bonds being offered on behalf of clients, it’s unusual for a hedge fund to direct them to seek bids and offers on so many bonds in the commercial- mortgage backed securities market. Firms have been restricting trading in the lower-rated debt, Leo Huang, an investment manager overseeing commercial real-estate debt at Old Greenwich, Connecticut-based Ellington Management Group LLC said earlier this month.

Dealer inventories of corporate bonds dropped to the lowest since July 2003 the week ended Oct. 5, Fed data showed. The 22 primary dealers of U.S. government securities that trade directly with the Federal Reserve reduced inventories of corporate debt due in more than a year to $54.6 billion, down 42 percent since May. The level climbed to $55.5 billion in the week ended Oct. 12, Fed data show.

Bid-Ask Spreads

Prices on so-called AJ commercial-mortgage bonds, the type of securities on the Appaloosa lists, could drop another 5 to 15 points as dealers shun risk, hindering price appreciation, Deutsche Bank analysts said in a report last week.

The debt includes issues from underwriters including Bank of America Corp., Bear Stearns Cos., JPMorgan Chase & Co. and Lehman Brothers Holdings Inc.

A Bear Stearns portion, BSCMS 2007-PW15 AJ, can be bought and sold at 22 cents to 25 cents on the dollar, according to the people. The slice is ranked D by Standard & Poor’s and Caa1 by Moody’s Investors Service, according to data compiled by Bloomberg. A bond sold by Bank of America in 2007 that still has an investment-grade rating from Moody’s is available for between 56.5 cents and 59.5 cents, the people said.

The difference between where the investment firm is willing to buy and sell some of the bonds is about 25 times the gap for the so-called bid-ask on investment-grade corporate debt. The trading spread on company debt has increased to 12 basis points from eight basis points at the start of the year, according to JPMorgan Chase & Co. A basis point is 0.01 percentage point.

Risk Aversion

Risk aversion in the $600 billion commercial-mortgage bond market has persisted this month even as demand for company debt and high-yield notes have recovered, JPMorgan analysts said in an Oct. 21 report.

The extra yield investors demand to hold top-ranked commercial-mortgage bonds rather than Treasuries soared to 323 basis points, 3.23 percentage points, on Oct. 18, from 2.26 percentage points at the end of July, according to the Barclays Capital CMBS AAA Super Duper Index. Spreads have narrowed to 2.99 percentage points.

Relative yields on high-yield bonds have declined 181 basis points to 729 basis points since Oct. 4, Bank of America Merrill Lynch index data show.

Banks have ratcheted back originating commercial mortgages to package into securities amid the turmoil, limiting the amount of financing available for borrowers with debt coming due. Some lenders, including Credit Suisse Group AG, have exited the business as volatility erodes profit margins.

--With assistance from Shannon D. Harrington in New York. Editors: Pierre Paulden, John Parry

To contact the reporter on this story: Sarah Mulholland in New York at smulholland3@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net


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