Bank Pullback Exposes Wider Spreads on Commercial Mortgage Bonds

(Bloomberg)—Bonds tied to commercial mortgages are getting punished as money managers fret that US regional bank blowups will cut the availability of credit, but investors including GMO say there are good bargains available to those willing to carefully vet the securities.

Risk premiums, or spreads, on the highest-rated commercial mortgage bonds averaged about 1.12 percentage point as of Thursday’s close. That’s close to the widest since the early part of the pandemic and before then, near the highest level since 2016.

Money managers broadly fear that nearly $1.5 trillion of commercial real estate debt is due to mature by the end of 2025, and refinancing at least some of it could be difficult, particularly after the collapse of regional lenders including Silicon Valley Bank and Signature Bank. Regional banks account for about 80% of bank lending to commercial properties, according to economists at Goldman Sachs Group Inc. But investors like GMO and Sun Life’s institutional asset management arm say panic in the commercial mortgage backed security market has gone too far. Bonds capable of withstanding even a severe market downturn are now available at bargain prices.

“A lot of pain has been priced into the CMBS market,” said Daniel Lucey, senior portfolio manager on the US total return fixed income team at SLC Management, an arm of financial services firm Sun Life. “It’s a good time to invest where the asset quality is strong.”

Top rated CMBS often have up to 30% credit support, meaning the underlying portfolio of commercial property loans would have to lose 30% of its principal before bond investors get hit, according to a recent research note by GMO. Even losses on “the most aggressively underwritten” CMBS portfolios from before the 2008 financial crisis only ever reached a little more than 11%, they wrote.

Commercial mortgage bond spreads also look cheap compared with corporate bonds, according to GMO. The gap between spreads on longer-dated CMBS and those on high-grade corporate bonds is close to its widest since 2011. During much of that period, longer-dated CMBS spreads were tighter than corporates, but now they are wider.

To some, this relative value represents a buying opportunity, particularly when the underlying properties look strong.

“The top bond in a CMBS capital structure has an incredible amount of protection against even some the most dire scenarios,” said Joe Auth, lead portfolio manager of the Opportunistic Income Strategy at GMO, the asset manager co-founded by Jeremy Grantham.

Bank of America Corp. strategists recently recommended a “neutral” allocation to some types of top rated CMBS, up from underweight. Spreads were driven up by concerns over banking system stress which pushed up market volatility, BofA’s Alan Todd said in an interview.

“The primary driver was concern about unmitigated stress in the banking system, and that’s now abated somewhat,” partly thanks to quick interventions by regulators including the Federal Deposit Insurance Corp., which took over failed banks, Todd said.

© 2023 Bloomberg L.P.

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