Widening CMBS spreads on both sides of the Atlantic reflect an uptick in supply but also highlight that investors are increasingly wary of the latest structures and collateral, and are demanding higher compensation as a result.
Data show US spreads have widened to their highest levels in almost two years, while the latest pricing from Europe - Deco-2015 Charlemagne, a multi-jurisdiction deal - illustrates that issuers need to pay hefty premiums to place non-Triple A bonds.
Market sources told IFR this reflected heightened investor awareness of the risks ratcheting up in CMBS deals. "Complexity is creeping back into the structure and the general quality of the collateral has been deteriorating," a European investor said.
After the financial crunch, European issuers soothed investors with straightforward structures, simple collateral such as German multi-family properties, and strong sponsors. But over time they slowly reinserted risk into the deals - with weaker sponsors and secondary/tertiary properties.
"The first post-crisis issues were really investor-friendly, but this is becoming less and less the case now, which is causing investors to take a step back," one investor said.
US conduit CMBS spreads on new-issue deals rated Single A- rose as high as 275bp in July from as low as 190bp in April, according to Morgan Stanley data. The last time spreads in the middle of the capital structure were this wide was the third quarter of 2013, according to JP Morgan data.
Another factor pushing pricing power back into the hands of investors is that issuers that exclude unfavourable ratings on lower-rung tranches end up paying for it. They are able to demand beefier margins for tranches that fail to get solid ratings from at least one major agency, according to Bank of America Merrill Lynch analyst Alan Todd.
Investors Less Naive
That trend, which Todd said had now more clearly crystallised since mid-May, might indicate that investors are less naive about the quality of the underlying collateral.
The fact that, contrary to other asset classes, the CMBS segment has not bounced back from heightened global economic uncertainties - specifically negative Greek and Chinese headlines in early summer - would appear to confirm this.
With Greek debt woes on the backburner, CMBS spreads have continued to languish at wider levels. Growing concerns over real estate loan underwriting standards could explain this, one investor at a New York-based asset manager said.
"I continue to be surprised by what I see getting underwritten."
The US investor said the continued onslaught of new deals had also kept pressure on spreads. CMBS issuance of US$71bn this year is running 26% higher than the same period of 2014, according to Bank of America Merrill Lynch data.
The European primary has also witnessed a surge in supply - with two deals pricing in the same week for the first time since the crisis. Deutsche Bank had to pay plus 525bp on BBB-/BB bonds and plus 425bp on BBB+/BBB notes at the end of July to place its Deco-2015 Charlemagne deal - 145bp more than initial talk.
Single As were also priced significantly wider to initial levels, at 290bp against 220bp.
While the two bankers blamed the painful results on general market weakness and mounting CMBS supply, the European investor was more suspicious, saying: "Investors may not want to spend their time taking a long hard look at CMBS structures and collateral that have wrinkles in them."
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