DDR's Deal Signals Recovery in Credit Market?

Commercial real estate industry has long been  the alleged next leg down for the economy and financial markets. The industry not only has been plagued by defaults, declined occupancy and rent, but also the shut-down of credit market to finance property purchase and development. Since March, the credit market has been gradually easing, as shown by significant drops in credit spread. The recent success in U.S. mall owner Developers Diversified Realty Corp (DDR) in debuting the first Term Asset-Backed Securities (TALF) loan is a further evidence that commercial loan market is back to business. Under TALF, investors apply for low-cost non-recourse loans that are backed by the bond collateral. TALF has cut borrowing costs for consumer auto loans and credit cards.

According to Bloomberg,

DDR's $400 million issue is the first new U.S. commercial mortgage-backed backed security since mid-2008. The $323.5 million AAA-rated portion is expected to sell at a 1.45 to 1.60 percentage point premium to the five-year interest rate swap benchmark, or a yield of about 4.21 percent, IFR reported. Underwriter Goldman Sachs at midday lowered the yield premium from a range of 1.60 to 1.75 points, indicating it was seeing good demand from investors. By comparison, top-rated issues done under relatively conservative underwriting standards in 2004 are selling at premiums in the mid-2 percentage point range, according to Guggenheim Capital Markets.

The deal may signal some relief for the $700 billion commercial mortgage-backed securities market, which became key funding for office, retail and apartment buildings during the real estate boom.

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Disclosure: The blog author owns DDR in her personal account as of November 17,2009

The Fed maintains a sweet spot

From FOMC Statement

On the real economy:

• Economic activity has continued to pick up.
• Conditions in financial markets were roughly unchanged.
• Activity in the housing sector has increased over recent months.
• Household spending appears to be expanding but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit.
• Businesses are still cutting back on fixed investment and staffing, though at a slower pace
• Businesses continue to make progress in bringing inventory stocks into better alignment with sales.

On inflation:
With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.

Monetary policies:
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. The amount of agency debt purchases, while somewhat less than the previously announced maximum of $200 billion, is consistent with the recent path of purchases and reflects the limited availability of agency debt. In order to promote a smooth transition in markets, the Committee will gradually slow the pace of its purchases of both agency debt and agency mortgage-backed securities and anticipates that these transactions will be executed by the end of the first quarter of 2010.

Off the top of my head
The economy is in the "sweet spot" for the next 3 to 6 months-- economic activities continue to improve while monetary policies continue to be very accomodating. Cheap money is always welcomed. Stock market and bond market should be able to benefit from liquidity and subdued inflation and inflation expectations. New highs can be made. Low interest rates should continue to lead to weak US dollar. In the immediate short term, however, I would be cautious about 3-5% pullbacks of the stock market (e.g.Dow getting  to aroung 9650) as substantial resource slack may shake confidence easily after an extended rally.

What is the Fed thinking?

On September 23, the Fed released  a statement after the FOMC meeting:
http://www.federalreserve.gov/newsevents/press/monetary/20090923a.htm

On the economy,
"the Federal Open Market Committee met in August suggests that economic activity has picked up following its severe downturn. Conditions in financial markets have improved further,

.............."


On inflation,
"With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time............."


On monetary policies,
" The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt. The Committee will gradually slow the pace of these purchases in order to promote a smooth transition in markets and anticipates that they will be executed by the end of the first quarter of 2010. As previously announced, the Federal Reserve’s purchases of $300 billion of Treasury securities will be completed by the end of October 2009. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted."


The market seemed to interpret as a signal of taking money out of the economy the Fed's plan to "gradually" slow the pace of purchases agency mortgage-backed securities and agency debt and extend the process till 2010.

In the past, the Fed starts to hike rate and tighten money supply when it foresees an economic recovery or pick-up. Many, of late, have worried about inflationary pressure or even stagflation should the government and the Fed fail in the timing and manner of such exit plan (which has been shown to be often too slow or too late in the past). If this "gradually slower purchases of securities" is indeed the first step of a series of exit steps, I would think that the Fed deserves an applause in landing a perfect finale to this once-in-a-century rescue plan on the part of policymakers.

Obviously, this big applause is on the condition that we are really seeing the light at the tunnel of this historic financial turmoil instead of a double-dip. From what we see at this moment, I vote for the former. You?