Bloomberg News

Commercial-Mortgage Bond Rally May Have Run Out, Citigroup Says

January 31, 2012

Jan. 30 (Bloomberg) -- A rally in risky commercial-mortgage bonds may have run its course after a surge in trading, according to Citigroup Inc.

Values on so-called AM and AJ securities, some of which have been cut to junk after being assigned top grades at issuance, increased “remarkably” during the first half of January, Citigroup analysts led by Jeffrey Berenbaum said in a Jan. 27 report. A junior AAA, or AJ bond, from a deal sold by Citigroup and Deutsche Bank in 2005 was yielding 535 basis points more than the benchmark swap rate last week, compared with 1,150 basis points or 11.5 percentage points in mid- September, according to Citigroup.

Gains decelerated during the past two weeks as more investors sold, Citigroup said. Spreads probably won’t narrow further unless the gyrations that characterized markets in 2011 subside, said the analysts, who are predicting that fluctuations in values similar to those seen last year will persist in 2012.

“Volatility is unlikely to fully return to pre-crisis levels until more definitive progress is made on the European front and the domestic recovery gains momentum,” the analysts said.

Prices on some junior AAA commercial-mortgage bonds have increased by between 8 and 13 cents on the dollar over the past six weeks, compared with a gain of 6.5 cents on high-yield corporate bonds, according to Deutsche Bank AG.

“The AJ market has been on fire,” the analysts led by Harris Trifon said in a report on Jan. 27. “We expect the rally to continue for a little while,” Trifon said in a telephone interview today. “The Fed’s more accommodative policy will continue to support demand for risk assets in general, and AJs are one of the prime beneficiaries of that.”

Trading Volumes Soar

Trading volumes in lower-ranking securities tied to skyscrapers, hotels and shopping malls soared in January. About $382 million in junior AAA commercial-mortgage bonds were offered weekly this month, compared with about $182 million during a typical week in 2011, according to Citigroup.

The increase in trading was probably driven in part by holders looking to unload bonds that were purchased at issuance, according to JPMorgan Chase & Co. There is a risk that the debt has moved from “safe hands,” meaning insurance companies and money managers that typically hold investments over the long term, to “faster money,” according to the analysts led by Ed Reardon. Investors should sell weaker bonds at current prices, the analysts said.

“The magnitude and speed of the recent rally has surprised us,” the analysts said. “In a risk-off event, we expect better quality paper will be more likely to hold on to recent gains.”

--Editors: John Parry, Shannon Harrington

To contact the reporter on this story: Sarah Mulholland in New York at

To contact the editor responsible for this story: Alan Goldstein at

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