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Commercial-Mortgage Market Reborn Amid Risk Rally: Canada Credit

Feb. 4 (Bloomberg) -- In another sign of investors’ willingness to embrace riskier assets, Institutional Mortgage Capital is meeting potential buyers for the largest commercial mortgage-backed security offering in Canada in five years.

The C$250.4 million ($251 million) transaction would be the first public deal since IMC sold C$240 million of the securities, created by pooling a number of mortgages, in July, and only the third since the market froze during the global financial crisis. The extra yield investors demand to hold the securities instead of benchmark government debt has narrowed from as much as 500 basis points in 2009, when the country was in recession, to between 100 and 150 basis points, according to TD Asset Management data.

The Canadian market for commercial-mortgage securities stalled in 2007 as the global credit crisis swept through North America. The market, after peaking in 2006 with $4.5 billion, has yet to see the recovery experienced in the U.S., where issuance is forecast to rise by more than 50 percent to as much as $70 billion in 2013, according to Credit Suisse Group AG. DBRS Ratings Ltd. expects Canadian issuance to double this year.

“What I am seeing, as an asset class, there is a renewed appetite for CMBS that has all the robust metrics, the strong underwriting standards, all those bells and whistles” that investors want, said Yves Locas, managing director of debt syndication at National Bank of Canada, who is working on the transaction. “By year end, frankly, I wouldn’t be surprised if we had other programs emerge, not just IMC.”

Yield Differentials

The benchmark Standard & Poor’s 500 Index returned 5.2 percent in January in the strongest start to a year since 1997, leading global stocks higher. Better-than-estimated corporate profits, the end of a U.S. political logjam over spending cuts and tax increases, accelerating growth in China and signs of a recovery in Europe led investors away from the safest assets in search of higher returns.

The extra yield demanded by investors to hold below- investment grade bonds dropped to 574 basis points, or 5.74 percentage points, at the end of last month, from 880 basis points at the start of 2012, the Bank of America Merrill Lynch Canada High Yield Index shows.

In the U.S., investor demand for CMBS has pushed down the rate on the top-ranked portion of transactions maturing in 10 years to 0.72 percentage point above the benchmark swap rate of 2.06 percent, according to data compiled by Bloomberg. That difference is the narrowest since issuance revived in 2009.

‘Increased Demand’

“Risk appetite seems to be increasing in the market and securitization seems to be staging a comeback around the world and consequently it is likely that commercial-mortgage-backed securities may see increased demand in Canada over the next few years,” said Eric Lascelles, chief economist at Royal Bank of Canada’s RBC Global Asset Management, by phone from Toronto.

Elsewhere in credit markets, the government’s benchmark 10- year bonds rose, with yields falling three basis points or 0.03 percentage point, to 2.01 percent. The 2.75 percent security maturing in June 2022 rose 24 cents to C$106.26.

The extra yield investors demand to hold bonds of investment-grade Canadian companies over government securities widened on Feb. 1 to 130 basis points, from 128 basis points on Jan. 25, according to Bank of America Merrill Lynch data. Yields rose to 3.06 percent, from 2.95 percent the prior week.

Provincial bond spreads widened to 73 basis points last week, from 72 basis points the prior week, while yields increased to 2.71 percent, from 2.62 percent Jan. 25, the Bank of America Merrill Lynch index data show.

Corporate bonds have lost 0.45 percent this year, compared with a gain of 0.9 percent for high-yield Canadian debt, the Bank of America Merrill Lynch data show.

Pooled Loans

The IMC deal is a pool of 38 Canadian commercial real estate loans secured by 43 partners, according to Fitch Ratings. Retail and office properties make up the majority of the pool at 40.2 percent and 28.8 percent, respectively. Apartment buildings account for 10 percent, while health care, self-storage, industrial and hotel make up the remainder. The majority of the properties are in Canada’s largest provinces, Ontario and Quebec, with the third largest concentration in Alberta.

Fitch rates C$215.34 million of the debt AAA, with a stable outlook.

“CMBS in Canada offers a decent spread with typically good credit quality, conservative underwriting standards, recourse to borrower,” Scott DiMaggio, director of Canada fixed income at AllianceBernstein LP in New York, wrote in an e-mail. “All make it a decent asset class but with poor liquidity”

Delinquency Rates

DiMaggio said he is looking at the IMC transaction, which will be marketed to investors until Feb. 6.

The delinquency rate on Canadian CMBS since the market’s inception in 1998 is 0.32 percent, compared to 9.79 percent in the U.S, according to data from Toronto-based DBRS.

“Given the renewed interest in Canadian CMBS it is possible that more issuers will enter the market,” Jamie Feehely, managing director at DBRS, said in a Feb. 1 e-mail. There will be C$500 million of issuance this year, he said.

Moody’s Investors Service upgraded seven classes of a 2006 CMBS deal last month, citing the stabilization of Canada’s real- estate market and noting the strong demand for apartment buildings due to a growing renter base and declining home ownership and recovery in the office sector.

Investors showed their comfort with a transaction backed by a single property in December, when Brookfield Office Properties Canada LP sold C$525 million of bonds using the leases on a 47- story Toronto office skyscraper as collateral.

“As a group, the CMBS market should begin to come back from a derivative perspective, as the underlying collateral begins to improve,” said Adrian Miller, director of fixed income strategy at GMP Securities LLC, by phone from New York. “As a general trend that’s the case, that the securitization market is opening up and slowly improving.”

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