Given the strong rally in legacy CMBS, many investors are questioning how much and if there is any room for further spread tightening in the sector, FTN Financial analysts said in a report released yesterday.
They said that one tool for measuring the “cheapness” of legacy CMBS is the firm's daily CMBS regression. Their analysis showed that, on average, the 2006-2007 vintage A4s are now near fair value.
But, there is a wide range of spreads within this group depending on the underlying collateral's credit quality. Analysts evaluated the recent performance of some stronger and weaker credits in A4 tranches from the 2005- 2007 vintages to show where further spread tightening can most likely happen.
Through data, analysts showed that in each case the stronger-credit A4 tranches have more-than-fully recovered from the spread-widening that occured last summer. They are also currently offered tighter versus the early-July 2011 levels. However, data demonstrated that even though the spreads on the weaker-credit A4 tranches have retreated sharply since October 2011, current offerings on these bonds are still “cheap” to July 2011 levels.
According to the data, the current-offer spreads versus the July 2011 spreads for some stronger-credit and weaker-credit A4 tranches from the 2005-2006 vintages showed that the stronger-credit A4s from each of these vintages now trade at levels that are tighter versus those from July 2011. The weaker-credit A4 from the 2006 vintage trades just slightly wider currently while the weaker-credit tranche from the 2005 vintage now trades fifteen basis points tighter.
With the 2005 vintage, analysts said it should be noted that the range of expected losses is much narrower relative to the 2006-2007 vintages. Thus, for a “weaker” credit such as GSMS 2005-GG4, their projected cumulative loss for the transaction is only 5.4% versus a defeasance-adjusted credit enhancement of about 25% for the A4 tranche, which is a coverage ratio of roughly five times. Although this bond does not seem to be a likely candidate for considerable near-term spread tightening, given its rating of 'AAA'/'AA-'/'Aa1' and yielding about 2% and a duration of roughly three years, it actually looks very favorably to 'AA'-rated corporate bonds that have similar durations yielding 1.5% or less, FTN analysts said.
Better-than-expected economic data has buyers more cheerful regarding prospects for commercial real estate as proven by the very strong demand for new-issue CMBS. Even though FTN's regression analysis and historical spreads imply that a lot further spread tightening for legacy A4s is not likely in the near term, FTN analysts stated.
The exception to this can be lower-credit quality deals from the 2007 vintage. Inspite of the recent strong spread rally, they still see value at current levels in highly-rated A4s such as those from the 2005 vintage versus alternative asset classes.