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Investments

Commercial mortgage-backed securities market at crossroads

The commercial mortgage backed securitization market concluded 2012 with an impressive rally as bullish investors intensified their search for yield in December, according to Royal Bank of Scotland (RBS).

The bonds in the market are looking historically rich and are expected to get richer, which is creating a crossroads for the market, director of CMBS Strategy Richard Hill at RBS Global Banking & Markets, told HousingWire.

"Many factors that drove it still remain in place, which may continue to provide a wind at the market’s back. This market dynamic may create a “fork in the road” for many investors with the right course of action less transparent than Yogi Berra may depict, as he is famously quoted saying 'When you come to a fork in the road, take it,'" the report said.

Throughout 2012 a rally across CMBS happened, accelerating after Labor Day and increasing well into December.

A combination of a supply shortage of bonds, hopes of a resolution to the fiscal cliff and the recent Federal Open Market Committee statement of low interest rates will be appropriate as long as the unemployment rate remains above 6.5%, which replaced the mid-2015 mark.

"So on a historical basis, [investors] sit here and look at where bonds are trading on a price or spread bases and you say, gosh these feel sort of rich and maybe their prime for a pullback, a healthy pullback, a pause," Hill said. "However, at the same token, many of the factors that created the rally in the fourth quarter of 2012 still remain in place."

For investors who believe the "Don’t Fight the Fed!" mantra remains true in the new year, the AJ.4 classed CMBS subordinate bonds are recommended by RBS as it is believed to be 1.4 points undervalued relative to AM.4.

On the reverse, for investors who believe a healthy market correction is in order for the start of next year, AM.3 is recommended as it appears an average of 1.8 points rich to other tranches tracked after rallying 4.3 points from $85.1 to $89.4 during the past three months.

Click on the graph to view comparisons of the subordinate bonds.

"I think it’s tough to be bearish right now given the start of the year and all the technical winds that are at the market’s back," Hill said.

After half a year, the monthly CMBS delinquency reading reverted to a more stable period, according to the Trepp monthly report.

In December, the delinquency rate for commercial real estate loans in CMBS was unchanged from November at 9.71%.

Newly delinquent loans, totaling about $3.2 billion, put 59 basis points of upward pressure on the rate. In addition to newly delinquent loans decreasing from last month’s total, loan resolutions dipped in December.

More than $1.1 billion in delinquent loans were resolved with losses last month and the removal of these loans from the delinquent category accounted for 20 basis points of downward pressure on the delinquency rate.

Click on the graph to view percentage of 30-plus days delinquent.

"With the initial wave of loan maturities now behind the CMBS market, future spikes in the rate should be more modest. In fact, the forward-looking data points to lower rates over the near term," the report said.

cmlynski@housingwire.com

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