It is time to buy triple-Bs, said analysts from Salomon Smith Barney after conducting a regression analysis. They said that triple-B CMBS spreads have widened significantly over the past couple of weeks. In a recent report, researchers examined whether this steepening in the credit curve makes sense considering the recent rally in corporate bonds and alternative credit investments.
Analysts thought that considering the strength of the corporate sector in the face of a CMBS and ABS sell-off, some statistical analysis relating to the relationship between the different spread products and CMBS might offer some insight into current CMBS levels, which at first glance seem relatively cheap. They looked at new-issuance ten-year triple-B industrial index as a spread predictor and were surprised to learn that it was not really a very strong prediction factor for CMBS triple-B spreads. However, after a thorough analysis, researchers discovered that three different equations could offer fairly accurate triple-B spread predictions. But since these three different equations with similarly high predictability showed that CMBS spreads are 1.5 to 5 basis points rich is evidence that spread regression is not really a perfect science.
Analysts said that at any point in time triple-B spreads will be impacted by different factors, which cannot be built into the firm's model. In the current environment, the firm's most accurate spread regressions showed triple-Bs as just fair. However, those that have more of a weighting of corporate as well as REIT spreads have indicated some good relative value in triple-B CMBS spreads. "This suggests that investors should be rebalancing from corporate bonds that have already had strong performance into CMBS triple-Bs," wrote the analysts.
They acknowledged that there is something to be said for the tried and true portfolio investment approach to CMBS. This is specifically true when triple-B CMBS offers 50 basis points to 75 basis points more spread than similar-rated corporates, and when triple-Bs actually provide more than an 85 basis point pickup to triple-As, people usually buy the CMBS certificates. They added that this also holds true for single-A paper that currently carries a 20 basis point differential with double-A certificates. Researchers stated that buyers that accumulate subordinate CMBS certificates or single-A and triple-B CMBS over the next two weeks should outperform other credit market alternatives in the beginning of next year.
Others share a preference for triple-Bs as well. Roger Lehman of Merrill Lynch mentioned that triple-Bs were nearing fair value last week, but since corporate spreads have remained flat over the last two weeks, the tightening seen in triple-Bs is surprising this soon. Investors are seeking out quality names in the down-in-credit trade, however, and Merrill prefers to look at seasoned paper for this trade.
As well, in comments last week, JP Morgan Securities' Pat Corcoran notes that the steeper credit curve in November gave rise to a neutral holding in investment grade paper, waiting for a buy signal on triple-Bs. With REIT spreads recently 10 basis points tighter than triple-B CMBS, this "constitutes a confirming buy signal." JPMC is bullish on credit spreads at this point, joining others that expect CMBS spreads to tighten after the new year.
2003 looks bright
There are some signs that accounts are setting up for next year as expectations for tighter spreads increase. The fact that supply this month is being easily placed, without forcing any concession as many suspected, goes a long way to boosting the bias. Triple-A spreads on new issues have been at least a few basis points through secondary levels of over 50 basis points, and triple-Bs are more than 5 basis points tighter since the beginning of the month.
Supply in Q1 2003 should be light by most measured expectations - $10 billion to $11 billion. According to Lisa Pendergast at RBS Greenwich Capital, this bodes well for the sector next year, adding the fact that pipelines are currently being cleaned out, the commercial real estate market is softer, and that interest rates are up 40 basis points from 2002 lows.