Cash may be trash these days, but that hasn't hurt the market for commercial mortgage-backed securities (CMBS), according to the Barron's/John B. Levy & Co. National Mortgage Survey. With investors scrambling to park cash somewhere other than money-market instruments yielding less than 1%, CMBS continue to be a major beneficiary. And trading desks report a parade of new investors in the sector.
A glance at the narrow difference in yield between triple-A and triple-B CMBS might lead a naive observer to conclude there's little risk in commercial mortgages. Triple-B's are trading with yields at a record low 0.60% behind triple-A's, with the gap having tightened some 0.40% this year alone.
But fundamentals in commercial real estate tell a different story, and loan delinquencies continue to rise. According to James Stouse, vice president with Banc of America Securities, delinquencies on properties underlying CMBS issued by conduit firms are now at 1.98%, up 0.04% in June; they stood at 1.70% as the year began. Viewing the narrow difference in yields, savvy analysts conclude that CMBS buyers are so hungry for yield that they're bidding up the lower-rated issues.
Rating the Forecasters
At the beginning of the year, we brought together a group of buyers and sellers of CMBS and asked for their mid-year projections. Their forecasts for global issuance volume in the first half ranged from a heady $38 billion to $55 billion, averaging $46 billion. The actual total was $40 billion, correctly projected by Barry Gersten, executive managing director of GMAC Commercial Mortgage. His updated forecast appears in the accompanying chart.
Although first-half volume was well below the group's projection, U.S. volume was up some 45% over the volume during the first half of 2002; non-U.S. volume was down a sharp 35%. Total U.S. CMBS issuance for mid-year 2002 was $23.5 billion, while non-U.S. issuance totaled $8.5 billion.
On average, our panel forecast triple-A interest-rate spreads to 10-year rate swaps of approximately 0.46%, a whopping 0.10% higher than it turned out. The forecast by Jim Higgins, managing director of Bear Stearns, 0.38%, looked positively rose-colored, but it was closest to the pin. The group sees year-end volume of $89 billion in global issuance — a solid performance, but no record — and spreads moving up a notch to 0.40%.
Fretting Over Freddie Mac
Freddie Mac has spent a lot of time on the front pages these days, as questions about its derivatives accounting abound.
What's bad for Freddie Mac isn't good for the CMBS market. Freddie is by far the largest holder of such securities — informed estimates list the total at about $25 billion-plus, double the nearest competitor. So, if Freddie were forced to divest its portfolio, it would have a devastating effect on the CMBS market, but no one expects that to occur.
In fact, on the commercial-mortgage side of its operation, Freddie is chugging along with business as usual. Market observers expected Freddie to buy some $500 million in new CMBS issuance in June, and it is actively competing for individual loans.
John B. Levy is president of John B. Levy & Co. Inc. in Richmond, Va. © Dow Jones & Co. Inc., 2003.
THE SPREADS AHEAD
|Name||Company||Triple-A Spreads To 10-Year Interest Rate Swaps*||Global CMBS Issuance Volume ($Billions)|
|Dave Bagnani||Fidelity Management & Research||41||75|
|Brian Baker||J.P. Morgan||39||84|
|Kent Born||PPM America||38||85|
|Mike Buchholz||Northwestern Mutual Life Ins. Co.||38||88|
|Barry Gersten||GMAC Commercial Mortgage||38||85|
|Tom Graf||Wachovia Bank||39||80|
|Jim Higgins||Bear Stearns||33||105|
|Mike Higgins||CIBC World Markets||42||85|
|Reggie Leese||State Street Research||48||85|
|John Scheurer||Allied Capital Corp.||40||90|
|Paul Vanderslice||Salomon Smith Barney||39||90|
|*In basis points, or hundredths of percentage point.|
|Source: John B. Levy & Co.|