The Current MBS and CMBS Markets – A Summary of Issues, Causes, and Future Markets
With today’s economic difficulties it is no surprise that the markets for MBS and CMBS are down. The financial market crisis has definitely hit our economy and the MBS and CMBS markets are no exception.
The credit meltdown has led to a curious pricing disparity in the commercial MBS market: Triple-A paper with a 5-year term is suddenly trading at spreads way above similarly rated 10-year bonds, due primarily to rising concerns about "extension risk." Last Friday, 10-year super-senior CMBS was trading at 1,050 bp over swaps, while the spread on 5-year notes swelled to 1,300 bp. Over the summer, before the credit markets went into a deep tailspin, the difference between the 5- and 10-year spreads generally was only a few basis points. The pricing difference throws bond-market convention on its head. All things being equal, long-term paper normally commands higher spreads to reflect the greater risk associated with holding investments longer. That started to change in the summer of 2007, when the credit crunch caused bond trading to slow. The benchmark classes of 10-year bonds started trading at slightly tighter spreads than 5-year paper because their larger supply offered more liquidity.
But more recently, the gap has ballooned, widening to as much as 400 bp. "The trend has really become noticeable over the past month," one investor said.
The new concern about 5-year CMBS is that the timely payoff of bonds depends on the payment streams of commercial mortgages scheduled to mature in the relatively short term, when credit conditions could make it difficult, if not impossible, for borrowers to cover balloon principal payments by refinancing. If a CMBS loan can't be refinanced, a special servicer could step in and extend the life of the loan, in turn delaying the return of principal to