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Troubling CMBS Signs

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Bloomberg had two alarming stories up late last week. The first was titled "Commercial Mortgage-Bond Yield Spreads Rise Most Ever".

The extra yield over benchmark Treasuries that investors demand to own top-rated commercial mortgage-backed securities rose this week by the most ever, according to a Morgan Stanley index.

The average spread over similar-maturity Treasuries for AAA rated 10-year securities jumped 32 percent to 244 basis points, the index shows. The extra yield over 10-year swap rates, a more commonly used benchmark, rose 48 percent to a record 185 basis points, the biggest increase since October 1998 amid the collapse of Long Term Capital Management LP and Russia's debt default.

More investors may be becoming concerned that ratings companies haven't demanded enough protection for high-rated bond classes against a rise in loan defaults. The likelihood of a U.S. recession, concerns that bond insurers may fail and $133 billion in writedowns and credit losses at banks have roiled all markets.

"Every positive headline, spreads will rally and tighten up, and every negative one spreads will widen out'' said Chris Lau, a trader of commercial mortgage-backed securities at RBS Greenwich Capital in Greenwich, Connecticut. "Right now, the CMBS market is trading along with every other credit market. Most of the time, the news has nothing to do with CMBS.''

In addition, there was also a story entitled "Bernanke's Easing Thwarted by Surging Commercial Mortgage Rates."

Delinquencies of securitized commercial mortgages may quadruple in the next 18 months to almost 4 percent, said Kenneth Rosen, an economist at University of California, Berkeley, who runs a real estate hedge fund. About 70 percent of commercial mortgages are pooled into commercial mortgage-backed securities that are sold to investors, Rosen said.

Commercial loan rates are based on spreads, or the difference between the amount of money CMBS promise to pay investors over what the 10-year Treasury bill will pay.

Different parts of the mortgage have varying prices depending on the risk profiles of the individual slices of the security. The first part of the loan is priced in correlation with the highest-rated, or AAA, piece of the security, said Scott A. Singer, executive vice president of New York-based Singer & Bassuk Organization, which arranges financing for property sales. The rest of the mortgage costs more because it's based on the other, riskier pieces, he said.

The spread for a security's AAA tranche widened to 125 basis points, or 1.25 percentage points, on Jan. 16 from 26 basis points a year earlier, data compiled by Morgan Stanley show.

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Elaine Misonzhnik

Senior associate editor Elaine Misonzhnik has been writing for National Real Estate Investor since June 2006 and has covered commercial real estate for more than 12 years. She first became...
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