Meltdown
November 18th, 2008 11:21 pm | by John Jansen |That is the word that one market participant used to describe the action in the CMBS market today. I am sorry to be writing this so late but I just found it as I checked emails and thought it worth posting.
CMBX AAAs widened by 130 basis points. AJ tranches widened 250 basis points to 350 basis points. ( I am lacking expertise in this area but believe an AJ is sort of a junior AAA piece.) And tranches below AAA widened 150 basis points to 350 basis points.
Cash CMBS underperformed the index and some AAA bonds with 30 percent protection widened 200 basis points. These are AAA bonds (allegedly) trading swaps plus 1050 basis points. That is alot of yield and alot of fear.
Quoth the Buffalo Springfield circa 1966,” Something’s happening here and what it is aint exactly clear”. It feels as though the bond markets are setting up for another patch of very rough weather.
As I write this the 2 year note is trading at a yield of 1.11 percent in Tokyo. That is lower than the previous low reached in June 2003. The three month bill traded all day today around 10 basis points.
I know that some of this reflects the massive injections of liquidity and huge purchases by central banks. But the 2 year note would not trade at this historic low yield nor would the three month bill trade as it does for such an extended period without very real fears about systemic risk.
Maybe, just maybe, blanket guarantees from governments dilute the nature of a guarantee. Maybe the market is downgrading the entire system and making the statement that blanket guarantees are worthless and that for a guarantee to have real value it must be selective and narrow in focus.
Update: I just found this story in the Wall Street Journal which fleshes out some of the reasons for the carnage. It seems that in can be summed up with one “four” letter word: Delinquent!!
See you in the morning.
10 Responses to “Meltdown”
By Obnoticus on Nov 18, 2008 | Reply
Actually one of the 07 vintage 10Y AAA CMBS that we track closed around 1150 to swaps today. I thought it’d at least take until the end of the week before it blew out to a thousand…
By Dark Space on Nov 18, 2008 | Reply
The AJ is the junior AAA. CMBS is unique – the AAA stack has an AJ, which has around 12% subordination – this is what the rating agencies consider a AAA. Then it has two AAAs above it, an AM with 20% subordination and a group of tranches with a 30% subordination. The subordination level represents how much of the underlying collateral must take a loss before the bond in question takes its first dollar of losses — so the 30% AAAs are nearly 3x what the rating agencies require.
That being said – the deal that is the focus of the WSJ article is one horrible deal. Nobody wanted it when it came out. The loans in question were some of the worst ever seen in the CMBS market. People assumed they would default and priced it in. It’s not part of the CMBX index (I don’t think, maybe it’s in 5), and I wouldn’t be surprised if JP actually still holds the subordinate bonds on their books… so, I think its actually all headline risk. 30% AAAs should never trade at double digit unlevered returns – these do not break in Great Depression scenarios. It’s similar to one of your reader’s earlier comments about BRK, except I actually think there is less risk here and more yield.
By David Merkel on Nov 18, 2008 | Reply
When the government guarantees everything, it guarantees nothing. What a mess.
(I used to love analyzing CMBS…) It was my favorite securitized sector. Wonder why the B-piece buyers didn’t kick the loans that eventually blew up out of the deals.
By y81 on Nov 19, 2008 | Reply
I used to do a lot of work for B piece buyers (though not the buyers on these JP deals). In general, they were motivated by a combination of fierce competition (“too much money chasing too few deals”), plus the fact that they were willing to own the real estate for a while if the rosy scenario didn’t play out. Now I guess they will have the chance to act on that willingness.
I have to agree with Dark Space–the current CMBS pricing makes no sense. Unfortunately, the market can stay irrational longer than you can stay solvent. Still, does anyone know a mutual fund that invests primarily or entirely in CMBS? I might risk 50 or 100 on a long term bet.
By es on Nov 19, 2008 | Reply
the main driver (besides the two loans defaulting) is that you can buy resi bonds at 15 to 20% loss adjusted returns. what that means is that under the worst expected loss scenarios, a buyer of a resi bond would still expect a 15 to 20% yield.
its pretty hard for compeating poducts to trade richer for long.
By es on Nov 19, 2008 | Reply
y81 – check out “PCM”
its a nice little closed end fund. in 2006/2007 they mostly bought 30% AAAs. before that they bought below AAA.
main risk is if no funding is available for maturing debt over the next 3 years. but at the current prive, i think you are well compensated at a 15% annual dividend
By es on Nov 19, 2008 | Reply
David -
many B-Piece buyers resold their positions in CDOs or otherwise, thus they grew complacent. plus as mentioned elsewhere, competition was fierce for their position in the capital stack.
By Red on Nov 19, 2008 | Reply
This article on the FT blog has committed the worst blogging faux pas. I’d write them an email.
http://ftalphaville.ft.com/blog/2008/11/19/18418/the-cmbs-crash/