With the rally in Treasury rates, agency debentures and mortgages have widened out considerably while CMBS has retained its relative value to swaps and tightened versus the two sectors.
Consequently, over the past two weeks, the CMBS market has seen fairly heavy selling activity with several bid lists totaling more than $1 billion of issuance.
"The selling is a result of CMBS recent richness relative to agencies debentures and mortgages," said Darrell Wheeler, director of CMBS research at Salomon Smith Barney.
In recent months, CMBS product has clearly outperformed agencies and other mortgage product. This suggests that it is a good time to take advantage of these alternative investment opportunities, Wheeler said in a report published last Tuesday.
He also mentioned that, in the near-term, CMBS spreads will encounter resistance to further tightening to swaps.
In fact, further CMBS selling might widen spreads a couple basis points.
But given that CMBS are still cheap to swaps, it is more likely that Agency and MBS spreads will tighten.
The report stated that the "richness" of the CMBS sector to debentures and mortgages is a relative comparison as "CMBS have not been traditionally tied to these products; nonetheless, many investors use debentures and mortgages as a value proxy."
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Wheeler also highlighted the fact that the recent Treasury rally to 4.82% had created more premium-dollar CMBS bonds as well as created excellent value in super-premium CMBS bonds (bonds with dollar prices over $108).
He argued that these higher dollar bonds would benefit the most should the Treasurys sell off, as they did during the week.
In contrast, "low to mid premium bonds (bonds with a 101 to 106 dollar price) run the risk of becoming super-premium bonds, which price at wider spreads should the Treasurys rally further."
Investors should focus on the higher priced bonds that have already been priced at spreads that reflect an extreme early default and prepayment scenario.
"The amount of premium bonds outstanding has reached such a large size that it is not surprising that we find ourselves strategizing among the various levels of premium dollar prices," Wheeler added.