November 13, 2015
By: David R. Pascale, Jr.- George Smith Partners
Yesterday’s auction of 10 year notes was strong, with lots of bidders attracted by the higher yields. Note that the US 10 year T at 2.32% is well above the German 10 year (0.62%) and other European benchmark bonds. The 10 year seems to be settling into a new range of about 2.30% after weeks in the 1.95-2.05% range as investors watch ‘the data’ for clues to the Fed’s next move (expected to be ‘liftoff’ in December…..)
CMBS: Recent pools have seen the 10 year AAA bonds price at about Swap + 125-127, with bond buyers differentiating between pools, depending on types of collateral (hotel concentration, etc.), overall LTV and subordination levels. Some technical/hedging issues are in the forefront: (1) Swaps: the 10 year Swap has traded about 10-20 bps above the corresponding treasury for the past few years, and is now 10 bps below the Treasury. The Swap is used as a hedging strategy (since approx. 1998) for CMBS originators with regard to Treasury volatility. However, this new ‘inversion’ has made that hedging strategy somewhat uncertain, as bond buyers may now be looking at the yield over the higher index (the Treasury).
We are seeing virtually all originators now price new loans over the Swap or Treasury, whichever is higher. So as of now, new loans are being priced over the Treasury, just like the mid 1990’s. (2) The CMBX index, (an overall CMBS bond index) is what CMBS originators use to hedge credit spread volatility, typically traded very close to new issue CMBS. Now that index has ‘inverted’, dropping 10-15 bps below new issues.
With their hedging instruments diverging, originators are being careful with new quotes until a number of pools sell in this new environment. We are seeing new loan quotes anywhere from 250 to 300 over the Treasury; all in coupons at 4.80-5.30%….stay tuned…