NEW YORK, Sept 4 (IFR) - Banks will be forced to sell billions of dollars of commercial mortgage bonds into a weak market this month, and new regulations could leave them facing losses.
The advent of the Volcker Rule banning proprietary trading makes it harder for banks to hold bonds they cannot sell - at the price they want - until a later date.
The US$10bn-$12bn of deals lined up to hit the CMBS market in September comes while spreads are at two-year wides, and the new rules and heavy forward pipeline give banks little wiggle room to delay selling them.
Many of the deals bundle together loans issued in June and July, when rates were much lower. New bonds that price now at much wider spreads will likely leave some underwriting banks in the red.
“On some loans underwriters are going to lose money,” one sellside source told IFR. “If you couldn’t sell Triple Bs in ‘07, it wouldn’t move the market. Volcker now says you can’t not sell.”
Banks knew the regulations were coming into effect in July, but they did not envisage the market turbulence that accompanied their arrival.
Volatility in broader markets has created havoc for rates, sending senior 10-year CMBS Triple A spreads gapping out 33bp in the last 14 weeks and 80bp on Triple B minus slices of debt.
Those spreads have delivered a double whammy for a market faced with heavy supply while adjusting to the new regulations, which largely take away the pricing advantage banks held when selling new deals.
In the past, underwriters could tell investors - accurately or not - they had successfully syndicated a deal through its riskiest tranches at levels that matched a prior deal’s pricing.
Investors had no way to tell if the banks were being truthful about how much was being sold at what price, severely limiting their ability to fully judge the merits of any deal.
The banks meanwhile could fudge the numbers - and if they ended up not selling the amount they tried to at the price they wanted, they could hold on to the bonds until better days ahead.
Under the new regulations, however, underwriting banks have to account for “reasonable expected near-term demand”, or RENTD. They must file RENTD estimates with every bond they sell.
The goal is to clamp down on banks’ proprietary trading, especially at the expense of the investors they sell to.
This is achieved by requiring underwriters to match their allotments with their demands - if the RENTD filings vary wildly from amounts sold, regulators can penalize the bank in question.
“You can’t take an allotment of bonds as an underwriting position unless down the line you believe you have the ability to place it in a reasonable amount of time under Volcker,” said Scott Cammarn, a partner at law firm Cadwalader, Wickersham & Taft.
This marks a sea change for buyside and sellside alike, who are now on a much more level playing field that no longer gives underwriters the upper hand in controlling where bonds price.
And even though regulators have yet to specify what the potential RENTD penalties are, the new rules are being taken very seriously by most in the industry.
“You can book it as an investment from the start, rather than as an underwriting position. But you can’t take the position into the trading account as an underwriting position if your intent is to keep it rather than place it in a reasonable amount of time,” Cammarn told IFR.
“Disregarding this Volcker Rule requirement will eventually come to the regulators’ attention,” he said.
In addition, there are plenty of other reasons for banks not to be carrying extra bond inventories on their balance sheets.
A looming rates hike from the Federal Reserve, as well as the prospect of still more supply coming down the pipeline in October, puts pressure on banks to move bonds now - even at a loss.
And so does the rolling need to keep business flowing.
“People get fired in our business if people can’t sell bonds,” said Rick Jones, an attorney at Dechert. (Reporting by Joy Wiltermuth; Editing by Natalie Harrison and Marc Carnegie)