Illiquidity in the commercial mortgage-backed securities market is exacerbating the recent blowout in CMBS spreads. Spreads on 10-year, 30% subordination, AAA-rated bonds have doubled in recent weeks to reach 1,400 basis points over swaps.
Darrell Wheeler, managing director at Citigroup, said that only $963 million of CMBS actually traded last week. Most of the trades were for senior AAA-rated bonds. "Less than 0.012% of the outstanding market has recently traded," he said.
Wheeler believes that all of this qualifies the CMBS market as "not active," which allows bondholders to use alternative Financial Accounting Standards Board guidelines on valuations. The guidelines allow bonds to be marked based on discounted contractual cash flows rather than on CMBX, the synthetic CMBS index. "That still leaves the question of how to determine the appropriate discount rate," Wheeler said. "When super-duper bonds, which require 75% pool defaults at 40% loss severity to incur any principal losses, trade with an 18% yield, one has to question just what the yield is implying for perceived defaults of that bond."
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