With CMBS supply expected to dip in 2003 - causing triple-A CMBS spreads to tighten further -analysts believe technicals will improve for CMBS spreads, as the sector's steady performance in the last couple of years has created a growing investor base.

Various firms predicted a drop in CMBS issuance for 2003. Salomon Smith Barney researchers said that they expect a strong first half of issuance. However, fixed-rate issuance will drop, expected to finish the year below $30 billion. This is due to fewer loan originations because of a low level of loans maturing as well as higher interest rates.

In terms of total CMBS issuance for 2003, Salomon put out a low estimate of $73,500 billion (including $25 billion of international issuance) and a high estimate of $95 billion (which includes $30 billion in international issuance).

Meanwhile, researchers from JPMorgan Securities predicted that depending on interest rates, they estimate deal volume to approximate $50 billion this year, down from the $60 billion issued in 2002. Analysts from Nomura Securities, on the other hand, said that 2003 issuance will dip by 10% to 15% from 2002's issuance pegged at roughly $56.6 billion. Morgan Stanley researchers are predicting U.S. issuance will total $65 billion, assuming interest rates remain low.

The credit story

Credit was a major part of the CMBS story in 2002 as downgrades played a more significant role. Analysts said this was apparent across rating agencies.

In fact, in a recent report, Fitch Ratings said that although it expects upgrades to continue to outpace downgrades in 2003, the rating agency predicts that the ratio of upgrades to downgrades will mirror 2002, which showed a significantly higher number of downgrades than previous historical experience.

Salomon researchers said that most of the downgrades still occurred in the lower-rated classes. However, they also noted that in terms of triple-A downgrades, Moody's and Fitch had more of a share due to downgrades related to the lack of terrorism insurance on certain single asset deals.

In terms of delinquencies, Salomon researchers said that the delinquency rate has stabilized. They stated that the most recent loan loss rates have remained range bound between 35% and 45%. The analysts recommended that considering this most recent data, investors should consider a loss rate of 40%, which they called a conservative assumption. Buysiders should also consider Salomon's previously suggested 21-month recovery lag. This loss should be sufficient to consider further market deterioration. Further, any extension in the recovery lag should benefit premium bond or IO investors.

The delinquency rate will slowly rise and may end the year in the 2% to 2.5% range. However, this gradual rise would be small and should allow most investment-grade-rated bonds to increase their subordination.

Relative value

The Street is generally bullish on the CMBS market. Salomon analysts said that in an economic recovery, CMBS classes that investors have been dodging and that are cheap would probably enjoy very strong performance in 2003. They are suggesting for buysiders to overweight floating-rate triple-As, single-issuer transactions, and IOs. They said that those who are cautious of a further economic downslide should focus on the 1997 and 1998 transactions. These have seasoned significantly.

JPMorgan analysts, on the other hand, are still suggesting a moderate overweight in the sector, with a bias towards the down-in-quality trade. Despite having been bullish on premium bonds over the majority of last year, the analysts are now adopting a more neutral stance, after the sharp narrowing of premium bond concessions in July and August of last year.

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