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Moody’s: CMBS loan delinquencies keep increasing

Courtesy of Cheeky Bastard

Hard times for the holders of CMBS loans.

Structured Credit Investor reports:

This data has come to light on the same day JPM successfully marketed JPMCC 2010-C1; this years biggest CMBS offering [which we have discussed, in depth, during past few days], twice the size of the CMBS structure RBS marketed in May.

The sale went as following [per Wall Street Journal]:

J.P. Morgan Chase Commercial Mortgage Securities Corp. sold a $716.3 million bond backed by commercial mortgages on Friday, the second such deal this year and the first to include a portion without an investment-grade rating.

 

The security, made up of loans to primarily retail stores, is just the fifth CMBS deal since the market froze during the 2008 credit crisis. The sale of the deal is another sign of investors' continued appetite for high-yielding securities, even amid jitters about the health of the global economy, the debt woes of Europe and a rise in delinquency among commercial real estate loans--to nearly 10% from below 1% before the crisis. Aware of the risks, issuers and investors alike are doing their homework on these securities, which is why so few deals have been completed.

 

Many so-called structured-finance deals are taking four to six months to put together, said Paul Norris, senior portfolio manager at Dwight Asset Management in Burlington, Vt. "We expect more deals to come, but it will take time because of the due diligence being done on any structured-finance deals," Norris said. This one has several features typical in securities issued during the market's peak in 2006: It includes loans to multiple borrowers and on differing property types. That complicates the process of assessing creditworthiness Underwriters expect the market for commercial mortgage-backed securities to ramp up in the second half, as institutions try to securitize loans made in the first six months of the year.

 

Barclays Capital researchers estimate total issuance this year will range between $15 billion and $20 billion. The J.P. Morgan offering contains 36 loans secured by first liens on 96 commercial properties. About 71% of the properties are retail stores, and more than 30% are in California or Texas.

The top-rated AAA portion, a $416.12 million slice with a weighted life average of 4.53 years, was priced to yield 3.604%. Norris said the price was about as expected. "It's neither very cheap nor very expensive," he said. "It's right in the middle."

 

The lowest-rated portion, a $14.3 million slice, was priced to yield 7.759%. Below that was an unrated portion that wasn't marketed at all. This riskiest part of a deal is typically bought by hedge funds or retained by the originator of the bond. A host of money managers, insurance companies and banks bought the deal, Norris said.

 

 

So; congratulations to JPMs Structured Products desk, but one question still remains unanswered; how, exactly, will JPM hedge potential losses from the lowest tranche which has remained sitting on JPM balance sheet.

While it is true the size of said tranche is not alarming, and even if the exposure is not hedged potential loses would not be damaging to the banks balance sheet given the gains bank has locked with marketing of this offering.

Therefore I ask this question in name of all potential future investors who might want to know who, where and based on which pricing method will sell the protection in form of a CDS on a CMBS structure which bears little resemblance to CMBS structures of the past.

I know of no derivatives desks who are willing to act as a counterparty in such a transaction; so JPMs Structured Products desk might have succumbed to hedging its exposure to non-investment grade tranche by buying in-house CDS from their derivatives trading brethren.

While the question is important [if for nothing else than for informative purposes] I do not feel the need to dissect it further. When and if the time comes for these tranches to hit the open market [probably being bought by a hedge fund with an uncontrollable risk appetite and/or hyperinflation trade] will I dig deeper into this issue.

As was noted before; the investment grade tranches are relatively safely structured and investing into an AAA one should not be a risky venture given the quality of the debt in it and the quality of the underlying collateral. Our assessment regarding the yield offered on AAA tranche still stands, and we find the yield too tight but justifiable.

 

MACRO PICTURE AND FUTURE CMBS MARKET DYNAMICS

Now let us discuss future CMBS prospects analyzing macro-economic indicators which represent the main economic vectors which directly influence CMBS market.

First we would like to note the rate of deterioration in the availability of consumer credit, which will affect lease sellers and lease buyers on the long term. With deteriorating revenues lease buyers will demand lower prices, and the amount of available space in the open market will make their request viable.

For insuring their own competitiveness in the marketplace lease sellers will need to further re-asses the per-square-foot prices. A conservative estimate for the next 3-9 month period is 15%-25% lower per-square-foot prices on a national level.

This is the data issued by the FED on June 7th with regards to consumer credit:

 

This data is all but assuring for those who hold CRE debt.

And let us not forget that all CMBX traded tranches are legacy tranches; meaning they consist of CRE debt issued in 2006-2007. That debt was priced and issued based on future growth projections which, as we all know, did not come to fruition. So while lower tranches of non-investment grade nature crashed in 2008 following the macro-economic problems, investment grade tranches remained valued quite high.

And then something happened in 2009. All of the sudden CMBX indexes started to diverge from their standard correlation to debt markets and started trading in correlation to equities markets. While that [and some other financing measures ] assured alpha returns for those who bought into particular CMBX tranches, it has seriously skewed the price of said tranches. 

Just to offer you an illustrative example of the movements in CMBX indexes we offer the following table [please note that all lows were achieved in 2008-Q2-2009]

 

 

While it is true certain [if not all] AAA tranches have been oversold out of fear, and not based on any rational and analytical assessment of their true value, there is no reason to believe that the value of the loans and collateral underlying the highlighted BBB tranches has gone up 100%+ due to any improvement in either the macro-economic landscape or the future prospect of the debt issuers. Quite the opposite.

While the surge in the price of legacy BBB tranches is a viable and reasonable trade if one expects either strong future growth or hyperinflation; it has no sense whatsoever in the current deflationary environment. We expect the price of said tranches to fall significantly in the close future.

The problem in the AAA tranches is less severe due to the quality of the debt which participates in said tranches structure, we do see a slight fall back in the valuations of those tranches as well, but nowhere as severe as in the BBB ones.

We see nothing but grim prospect for CMBS market in the future, with only possible upside being a result of either liquidity misallocation [due to low borrowing costs for the investors] or high inflationary environment. But the possibility of those occurring is low, and our preferable view is deflation with later transition into stagflation.

These are the charts displaying the CRE price movement data [MIT TBI]:

 

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FEW NOTES ON ABS AND ABX

Few days ago a favorable projection regarding sub-prime default rate was issued by RBS.

Bloomberg reports:

 

 

 

 

 

June 10 (Bloomberg) — The proportion of U.S. homeowners turning delinquent on mortgages backing the securities that roiled the global financial system has tumbled in the past three months, even after accounting for a typical seasonal improvement, according to RBS Securities Inc.

 

Of borrowers with subprime loans in 2007-issued bonds who had never missed payments, an average of 2.6 percent fell behind each month, a drop from 3.7 percent in February, representing a 15 percent decline after seasonal adjustments, according to RBS analysts. “We believe that the last few months’ performance points to a fundamentally positive shift in borrower behavior,” Paul Jablansky, Desmond Macauley and Ying Wang, analysts at the Stamford, Connecticut-based unit of Royal Bank of Scotland Plc, wrote in a June 8 report. If sustained, the trend can “substantially increase the attractiveness” of related bonds, they said. Slowing delinquencies on risky mortgages have helped boost prices this year for related securities without government- backed guarantees, as the U.S. employment market shows signs of stabilizing and the transactions experience what Barclays Plc analysts term “credit burnout,” or a flushing of the weakest borrowers from the pools through defaults.

 

The trend may be the first step in a lessening of pressure from distressed-property sales in the U.S. housing market, which real-estate-data firm Radar Logic Inc. said in a report today is likely to experience a “second dip” in prices to new lows after they stabilized last year following record declines.

 

Home Seizures

 

The monthly rate of new delinquencies among all loans in non-agency mortgage bonds fell to 1.2 percent as of May reports from trustees, covering payments due in April, according to Austin, Texas-based Amherst Securities Group LP. That’s the low since 2007, down from more than 2.5 percent early last year.

On an absolute basis, new delinquencies also declined in early 2009, before rising later last year, reflecting the typical seasonal pattern partly related to income-tax refunds and winter holiday spending. Lenders seized a record 93,777 homes in May, up 44 percent from a year earlier, after the pace slowed amid government- encouraged efforts to rework debt, new state foreclosure rules and a flood of defaults hitting courts and loan-servicing departments, Irvine, California-based data company RealtyTrac Inc. said today. “There are still almost 5 million loans more than 90 days past due,” New York-based Radar Logic said in an e-mailed note. “As these mortgages move through the foreclosure process — slowly, for now, but perhaps more rapidly in the near future — the inventory of bank-owned homes is going to increase, barring a significant increase in the rate at which banks liquidate” seized homes.

 

Swaps Rise

 

More than 27.4 percent of mortgages underlying the $1.5 trillion of non-agency securities were at least 60 days late, in foreclosure or already turned into seized property as of April bond reports, up from 27.2 percent in January and 22.5 percent a year earlier, according to data compiled by Bloomberg.

The level peaked at 27.9 percent in February. Another 3.14 percent of loans were 30 days late as of the April bond reports, a two-year low and down from a record 4.3 percent in December 2008. Among just subprime mortgages, a total of 43.3 percent were delinquent or defaulted, the data show. TCW Group Inc., which oversees about $115 billion, is among investors that think non-agency mortgage bonds are “extremely cheap on a relative basis” because of the improving borrower performance, Bryan Whalen, co-head of the Los Angeles-based asset manager’s mortgage- and asset-backed bond group, said. He’s buying securities where “bad borrowers have been leaving the pools at a quicker rate than good borrowers can refi.”

 

Looming Defaults

 

A Markit ABX index of credit-default swaps tied to 20 subprime-loan bonds rated AAA when created in the first half of 2007 has climbed 16.9 percent this year to 40.25 yesterday, according to London-based administrator Markit Group Ltd. Higher ABX index levels generally indicate less pessimism about the bonds’ values. The ABX.HE.AAA.07-2 index, which trades at levels similar to the prices of the underlying securities in cents on the dollar, rose to 46.75 on May 3, the highest since October 2008, after falling to as low as 23.1 in April 2009, from 100 in 2007. Almost a quarter of U.S. mortgage borrowers owed more than their homes were worth in the first quarter, a situation that may eventually prompt homeowners who haven’t been delinquent to default, according to data compiled by Seattle-based Zillow.com.

 

Jumbo Loans

 

About 23 percent of Americans believe defaulting on a so- called underwater mortgage is justifiable, according to the results of a survey by Silver Spring, Maryland-based National Foundation for Credit Counseling released June 8. Subprime mortgages were given to borrowers with poor credit or high debt. Data on prime-jumbo mortgages in non-agency securities haven’t suggested the same improvement as seen with subprime debt, according to analysts including those at RBS and Credit Suisse Group. For instance, the amount of loans 30-to-60 days late among adjustable-rate jumbo mortgages in bonds created in the second half of 2006 climbed to 2.5 percent in May, from 2.2 percent the previous month, according to a Credit Suisse report last month. Jumbo mortgages are larger than government-supported Fannie Mae and Freddie Mac can finance, currently from $417,000 to $729,750 in high-cost areas.

 

While RBS optimism is always welcomed we can think of at least 100 other reasons why it is also misplaced and maybe even bordering with self-delusion.

But not to drag this article into unnecessary analysis; it is enough to say the amount of loans that are delinquent, but the properties underlying the loans are not foreclosed on, is now on the steady uprise and banks will either have to pile their money indefinitely to the FED and recoup the loses trough collecting interest rates from the FED on their money or face the loses, dilute the housing market and enter into a death spiral. And there is that deflation again which will only make things worse.

 

Trades which could be conducted based on this data are self-deducible and there is no need to list them here, but I will be more than glad to discuss them in the comments under this article.

Good luck ladies and gentleman.

 


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