Last Nov. 3, analysts Lehman Brothers initiated a recommendation to buy five-year triple-As versus three-year and 10-year triple-A CMBS. After a good run, they are now closing out the trade.
At initiation, a duration-neutral, long five-year versus short three-year and 10-year position generated 5.9 basis points of incremental carry. Furthermore, analysts expected five-year CMBS spreads to outperform three- and 10-year spreads. The five-year portion of the swap curve was trading at historically rich levels versus the two- and 10-year swap rate, which is driven by anticipation of an aggressive Federal Reserve easing, analysts said.
Since then, analysts said that the three-five-10 CMBS spread butterfly - which is duration neutral, long 100% five-year versus short 68% three-year and 32% 10-year - has narrowed from 5.9 to 1.9 basis points, mainly because of eight basis points of widening in three-year CMBS spreads. The five-year portion of the swap curve also cheapened slightly, although it is still near historically rich levels as measured by the two-five-10 butterfly, analysts said. They now suggest that investors close the position, as the three-five-10 CMBS butterfly is in line with historical averages and at their ex-ante target level, they said. Based on a spread duration of 4.2 years, this trade generated about 17 basis points of excess return on an unleveraged basis, analysts said.
In general, analysts continue to recommend an overweight in CMBS, especially using any technically-driven spread widening to add. On credit, they prefer triple-As as underwriting trends are not favorable for the lower- investment-grade classes.
On the primary issuance front, activity was expected to pick up after the Commercial Mortgage Securities Association CMBS Investors Conference held in Miami concluded. Currently, the January pipeline shows nearly $9 billion in conduits, including LB-UBS 07-C9 for $4.5 billion.
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