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CRE Finance World, Summer 2012

CMBS Opportunities Still Exist, Despite the Rally VIX Has Become Quite a Good Predictor of CMBS Spreads the surging market volatility we saw the past two summers. The CMBS spreads showed little relation to the VIX in the pre-crisis VIX surged into the low 40s in mid-2010 and again in mid-2011 in period, but have become highly correlated with the VIX since the response to rising Eurozone concerns as well as last year’s debt onset of the financial crisis (Figure 2). Given this strong relation- ceiling debate and downgrade. ship, we can estimate where duper spreads could end up in the event of a broad market correction. Reactivity Advantage of Competing Sectors Has Declined Investors who may have been opting for corporate bonds over Figure 2 structured products, such as CMBS, for better spread stability, 2007-Vintage Duper Spreads and the VIX, 2005–2006 (Top) may now be losing out on yield with little incremental benefit. Prior and Jun 10–Apr 12 (Bottom) to the onset of the financial crisis, dupers were about as reactive to the overall level of market volatility as single-A corporates, but much less reactive than triple-B corporates. That relationship reversed during the financial crisis (which was centered in securitized products) with dupers becoming much more reactive than lower- rated corporates. But the reactivity gap has gradually narrowed since mid-2010. Duper reactivity is now running right in line with that of triple-B corporates and has closed the gap with single-A corporates. Figure 3 shows that so far this year, triple-B corporates and 2007-vintage dupers have tended to widen roughly 12bp for every percentage point increase in the VIX, compared to a 9–10bp widening in single-A corporates. In contrast, at the height of the crisis, duper reactivity reached as high as 30bp/ppt, versus just 11–18bp/ppt in the case of single-A and triple-B corporates. Figure 3 Vol-Adjusted 2007-Vintage Duper and Corporate Spreads, Mar 05–Apr 12 Sources: Bloomberg LP and Citi Investment Research and Analysis To be sure, in a severe and sustained episode of market turmoil, Sources: Bloomberg LP and Citi Investment Research and Analysis various competing sectors could significantly diverge again. Reactivity could surge on the sector with the most actual or As a rough rule of thumb, post-crisis 2007-vintage duper spreads perceived risk (which may not necessarily be structured products have been running around 10–12 times the prevailing level of the next time around). But for the time being, in the event of a shorter VIX, as shown in the right panel of Figure 2. So spreads could term, moderate increase in market volatility, corporate bonds seem widen to back out the 400–450bp area in the event of a replay of to have little relative benefit over the dupers. A publication of Summer issue 2012 sponsored by CRE Finance World Summer 2012 45


CRE Finance World, Summer 2012
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