Risk markets are in the process of making a U-Turn from the risk off mentality that dominated from the beginning of December to early February. The impetus for the market malaise were hard to pinpoint. While there were several factors that were concerning, there didn’t seem to be fundamental reasons for equity markets to jump into a bear market. Some of those contributing factors were the FOMC raising of rates in December, the steep drop in oil prices, currency wars that accompanied monetary policy, the stronger US Dollar and an economy in China that is not the world wide growth engine that people had been looking for. Yes, they are all bad facts that can drive prices lower but not to the extent of that we had experienced. While equity markets made the headlines, bond markets were evern worse where both investment grade and high yield debt trading at spreads to risk free assets that hadn’t been seen since 2011 when S&P downgraded debt of the US government.
The later parts of February have brought optimism. Even more baffling than the trade off from the previous three months is what has motivated the recovery. Aside from oil markets rebounding from their lows and the US Federal Reserve indicating Federal Funds rates aren’t necessarily going to go higher in 2016, very little other fundamental factors have changed. The technical aspect of assets being too cheap is likely responsible for the recent bounce and much of the action appears to be market participants covering short positions, hoping not to get caught with positions that will put them underwater if the optimism gains momentum. As a mirror image of the most risky assets taking the worst of it in the downtrade, the most risky assets have experienced the highest increase in value over the last three weeks with equities leading that pack, up 4+% from their early February lows.
Securitized debt products have followed a similar path to broader risk markets with Commercial Real Estate debt being front and center. In the bearish markets in late 2015 through February, CMBX had become the recipient of short positions for structured product players as it is one of the only liquid product where one can monetize a negative opinion in structured products. CMBX attracted players looking to offlay risk not only for CRE debt but other structured product/asset backed securities. Sellers of risk dominated the CMBX landscape and the BBB index had widened nearly 350 basis points from early December to early February. In the market reversal over the last few weeks, it comes as no surprise but those are the same assets that have appreciated most.
As has been the case over the last year, CMBS has been a disappointment. While we are off the lows of early February, the spread tightening has been relatively muted. AAAs are in about 10 basis points with most new issues having trouble tightening from Mid 160s over swaps. While that is no better than any new issue print, the implied levels for those bonds at the lows were Mid 170s over swaps or a 10bp tightening, which pales in comparison to what other markets have done. Even more disappointing is the back of the credit curve where spreads haven’t show any resilience that broader markets have experienced and are stuck at the wide of early February. While some new investors have been attracted to the space, the back of the credit curve is still tenuous as b-piece and other credit buyers continue to show resistance in a buyer’s market. As a sign of the times, new conduit deals are coming out with decreased sizes and lower leverage than we have seen in years. Likely a result of b-piece buyers being more choosy about what loans make it into the final pools of deals that they are agreeing to purchase.
Despite the selloff in broader markets since December, on the Agency CMBS front, Fannie Mae and Freddie Mac have come out of the gate swinging to start 2016. Both agencies have stated their intent to remain extremely active in multi-family lending. Freddie Mac released a pre-calendar timeline of intended securitizations for the 1st quarter 2016, which nearly amounts to one securitization a week. Between that, the GSE’s unwavering commitment to affordable housing, and Fannie Mae’s newly announced Go Green initiative the GSE’s are positioning themselves for a banner year in the face of broader market uncertainty. With the recent improvement in the markets, particularly Fixed Income spread product, Agency CMBS spreads have tightened 10 to 15 basis point from their wide’s three weeks ago. Freddie K A2, 10 year average life, bonds are currently trading swaps plus 95 basis points, while 10 year DUS MBS spreads are pricing as tight as swaps plus 105 basis points, both levels a significant improvement from where bonds were trading hands a few weeks ago. While the GSE’s are limited to a mandated annual volume cap of $31B each, when applying permitted exclusions to the cap many market participants feel Agency CMBS volume will come close if not surpass the $100B mark in 2016. When including Ginnie Mae Project Loans on Multifamily and Healthcare properties into the mix that number will likely exceed $110B for 2016.
For informational purposes only. This commentary was written by Barry Polen and David Casden in their personal capacity. The opinions expressed are his own and do not reflect the views of Hunt Real Estate Capital, LLC or its affiliates.