CMBS investors set for lucky escape
It’s the slowest train wreck of the financial crisis. Commercial real estate is still screeching roughly two years after lenders jammed on the brakes – witness the financial woes of Stuyvesant Town and Peter Cooper Village, the giant Manhattan apartment complexes acquired for $5.4 billion in 2006. Yet while regional banks are braced for a damaging impact, mortgage-backed bond investors are betting they’ll escape with just a few scratches.
That’s an astonishing turnaround from last year’s panic. The Federal Reserve’s pledge to prop up the market through a special lending facility helped, as did other measures that helped the financial world avoid total meltdown.
A proxy for the $700 billion commercial mortgage bond market, Markit’s CMBX AAA index, has risen substantially as investors have started to worry less. At first blush that’s hard to square with the real world. Commercial real estate prices are down around 44 percent from their peak, and regulators reckon loans backed by office buildings, condos and hotels are one of the big risks of 2010.
That remains the case for banks, especially the small regional variety that poured money into speculative construction and development loans, where loss rates are expected to be especially high. But investors holding top-rated commercial mortgage-backed securities have much less to worry about now that apocalypse is off the table.
First, they aren’t up against the wall as some banks are. Loans tucked into mortgage bonds tend to have much longer maturities than direct bank loans. A loan made in 2005 and repackaged into mortgage-backed securities could have another five years to run. By contrast, a 2005 loan still on a bank’s books may well need to be refinanced this year.
Special servicers, which work on behalf of mortgage bond investors, can also modify loans should borrowers run into trouble. While this may mean bondholders are stuck with an investment longer than they’d like, at least it keeps cash flowing. A Stuyvesant Town $3 billion loan is already in the hands of a special servicer.
Commercial mortgage bonds in general are also far from subprime. Barclays Capital estimates losses on 2007-vintage bonds at 16 percent, well below the 53 percent seen for subprime residential loans made the same year. Some banks with loans on their books won’t be so lucky. But shaken commercial mortgage bond investors may indeed end up walking away from the crash.