CMBS Rolls Over to Sunnier Outlook

After months of enduring dire forecast, things are beginning to look sunnier for the CMBS space. A number of multiple large transactions seen across the landscape and signs of new origination activity in the short term could mean that the clouds are begging to break. Spreads resumed tightening straight into the New Year and the pricing dynamics for the rally have remained the same into the beginning of 2010. For now the forecast is for good supply/demand technicals, good relative value versus competing asset classes and an economy that appears poised to recover, according to analysts at Barclays Capital. JP Morgan reports that since the end of November, super-senior bonds have rallied more than 150 basis points, or roughly 7 points, and the basis between TALF eligible and ineligible bonds has compressed. “From a macro perspective, an uptick is a clear positive, as it suggests that the gap between buyer and seller preferences is narrowing and could signal that some believe a bottom in prices is approaching,” explained analysts at Barclays Capital. A bottoming in the economy could give investors the incentive to start adding to real estate holdings at prices that are now back to 2001/2002 levels. According to the Moody’s CPPI index, national average property values are down 44 percent from the peak, with distressed properties down 58 percent. Market analysts believe that this index will drop another 5 percent to 10 percent as the share of distressed transactions rises, resulting in an approximate 50 percent peak-to-trough average decline before a very gradual recovery. “We expect that tighter super-senior spreads and improving expectations regarding the health of the economy will lead investors to migrate down the capital structure as they become increasingly concerned they will be under-invested or not able to capture the requisite yield among the most senior securities,” said analysts at JP Morgan. Analysts expect supply driven spread tightening on t super-senior/AM and super-senior/AJ credit curves driven by PPIP fund managers ramping up CMBS investments over the coming months. Another continuing theme in 2010 will be the strong bid for senior CMBS bonds from insurance companies spurred by changes recently implemented by the National Association of Insurance Commissioners (NAIC) that called for capital charge determination to move away from rating agencies and instead be based on a model-based approach administered by PIMCO. According to analysts at Barclays, the change will save insurers at least $5bn of capital charges and could be contributing to additional demand for fixed income investments such as CMBS. Industry analysts said that despite the more optimistic tone in the market it is likely that the CMBS universe will continue to experience an increase in the pace of credit deterioration. … The market is still bracing for what impact the rollover of CMBS loans originated with an interest-only (IO) period convert to higher debt payments as amortization kicks in will have on defaults. As the IO period ends for partial IO loans, amortization kicks in, which increases the monthly principal and interest payments and lowers the debt service coverage ratio (DSCR) for the loan. Full-term IO presents an increased risk of default at maturity, partial-term IO can lead to a higher risk of term default. Previously performing loans may no longer be able to make their new debt payment. Analysts at Wells Fargo believe that current pricing in the market on some transactions does not fully reflect the potential deterioration in DSCR due to the increased debt burden. Wells Fargo analysts looked at the $31.5 billion of partial IO loans that are making the change in the next 12 months. Of those, $2.9 billion or close to 9.5 percent will no longer be generating enough cash flow to meet monthly debt payments once amortization begins. TO READ THE FULL STORY, SUBSCRIBE NOW.