While everyone's attention is fixated on sub-prime home mortgages, another sector of the real estate lending market is weakening, with credit spreads rising daily. I am talking about commercial real estate loans. But first, where are home mortgage credit spreads today?
Everyone has heard by now of Markit's ABX indexes that follow credit default swaps on CDOs containing home mortgages. After plunging sharply, they bounced and are now going sideways. Below is a chart for A rated tranches, theoretically a strong investment grade mark. It is certainly indicating a risk much higher than A, but this is not today's subject - so let's move on.
ABX-HE A 06-2
CMBX NA-A 2
However, conditions are much worse for riskier, marginal commercial borrowers. The BB rated index has zoomed from ~190 bp to 373 bp.
CMBX NA-BB 2
Why is this important? Because, until recently at least, building activity in the commercial sector was quite strong, helping to offset somewhat the weakness in housing construction. Commercial builders, however, are more sensitive to financing costs and credit conditions than home builders because their customers, the businesses that buy or rent their properties, are driven strictly by cash flow and earnings calculations, not emotional home-buying impulses.
It seems logical to me that deteriorating credit conditions in this sector will very quickly translate into a slowdown in commercial building activity, adding another negative nudge down for the overall economy.
Everyone has heard by now of Markit's ABX indexes that follow credit default swaps on CDOs containing home mortgages. After plunging sharply, they bounced and are now going sideways. Below is a chart for A rated tranches, theoretically a strong investment grade mark. It is certainly indicating a risk much higher than A, but this is not today's subject - so let's move on.
ABX-HE A 06-2 Today I want to look at commercial mortgage loans, those used to build and buy malls, office buildings, hotels, etc. What's happening there? For the answer I once again turn to Markit and their series of CMBX indexes tracking credit spreads in the commercial market (unlike ABX, these are shown as spreads in basis points, so a rise signifies increasing risk and tightening credit conditions).
Below is a chart for credit spreads in A rated CDO tranches containing commercial mortgages. No bounce here: credit spreads have gone from 12.5 bp to 41 bp in one month. For a commercial real estate developer this is very bad news, indeed.
Below is a chart for credit spreads in A rated CDO tranches containing commercial mortgages. No bounce here: credit spreads have gone from 12.5 bp to 41 bp in one month. For a commercial real estate developer this is very bad news, indeed.
CMBX NA-A 2However, conditions are much worse for riskier, marginal commercial borrowers. The BB rated index has zoomed from ~190 bp to 373 bp.
CMBX NA-BB 2Why is this important? Because, until recently at least, building activity in the commercial sector was quite strong, helping to offset somewhat the weakness in housing construction. Commercial builders, however, are more sensitive to financing costs and credit conditions than home builders because their customers, the businesses that buy or rent their properties, are driven strictly by cash flow and earnings calculations, not emotional home-buying impulses.
It seems logical to me that deteriorating credit conditions in this sector will very quickly translate into a slowdown in commercial building activity, adding another negative nudge down for the overall economy.
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