Corporate bonds offer a valuable relative value benchmark comparison for CMBS 3.0 bonds, according to a report released by Royal Bank of Scotland (RBS) analysts today.

This comparability between the two sectors has resulted from their fixed-rate coupons, longer durations and similar ratings.

In their report, RBS analysis demonstrated that CMBS 3.0 A4 bonds have priced an average of 9.5 basis points wider versus generic 'AA' cash corporate bonds. This phenomenon started from when the market volatility returned to more normalized levels with the CMBS transaction called CFCRE 2011-C2.

Given that generic 'AA' cash corporate bonds now trade at T + 106 as of April 6, analysts think that CMBS 3.0 A4 bonds are fairly valued at 105 basis points to 110 basis points over swaps considering the spread differential that results.

The spreads range from roughly eight to 13 basis points. Analysts warned, however, that CMBS 3.0 bonds might underperform corporate bonds if volatility rises with investor preference shifting to bonds that they view as more liquid.

RBS analysts think that the relative value of CMBS 3.0 AM bond is best found in comparison to CMBS 3.0 and 2.0 A4 bonds. This is because the weighted average of the CMBS 3.0A4 and the AM bond spreads should, at least theoretically, trade on top of the CMBS 2.0 A4 bond spread, analysts explained. This is given that their enhancement levels and tranche thickness are roughly the same.

The firm's analysis also demonstrated that the weighted average spreads of the A4 and AM bonds in the two most recent CMBS 3.0 offerings were about 11 basis points rich to where CMBS 2.0A4 bonds were then trading, they said.

Since analysts previously established that the CMBS 3.0A4 bond was fairly valued to 'AA' corporate bonds, they said that the CMBS 3.0 AM was the rich component of the structures and thus might be at risk of underperforming.

According to analysts, investment-grade (IG) REIT bonds are a good relative value comparison to CMBS 3.0 'AA' bonds. This is because IG REITs have almost the same average debt-to-capital ratios at 52.3%  as the average CMBS 3.0 'AA' principal-to-value ratio at 51.3%, analysts stated. Historically CMBS 3.0 'AA' bonds have traded 137 basis points wider versus a generic portfolio comprising 145 IG REIT bonds across 41 different names.

However, the most recently issued CMBS 3.0 deal seemed fairly valued versus having priced the 'AA' bonds at swaps plus 225. This is five basis points inside the generic portfolio of IG REIT bonds. With IG REIT spreads trading at T + 235 basis points as of April 6, analysts have said  that CMBS 3.0 'AA' bonds are fairly valued compared at 225 basis points over swaps inspite of the market's recent weakness, they said. 

According to RBS, the principal-to-value ratios of CMBS 3.0 'A' and 'BBB-' bonds implied that these bonds should trade closer to IG REITs compared to high yield corporate bonds.

An analysis of these ratios might mean that CMBS 3.0 'A' bonds might tighten as much as 65 basis points while CMBS 3.0 'BBB-' bonds might come in as much as 220 basis points. Nevertheless, analysts said that buyers should carefully consider the differences in principal-to-value ratios of CMBS 2.0 'A' and 'BBB-' across offerings with the potential to impact pricing.

They suggested that buyers conduct a detailed credit analysis of the underlying loans backing these CMBS 3.0 bonds. They think that the offered credit enhancement that is more than similarly rated legacy CMBS bonds at issuance along with the underlying loans' strong credit considerably lessen the credit risk, RBS analysts stated.

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