Friday, 21 November 2008

Another letter combination to memorise: CMBX

The last two sessions in US market have been scary, and maybe even scarier than anything seen over the last month. Dow is now down 20%+ in November, a good deal more than the 16.6% it fell in the horror month of October. It has been financials and most notably Citicorp which has been at the centre of this new meltdown.

So far, each turn in this crisis has been narrowly related to one or the other segment of asset-backed securities. First it was the CDOs containing Sub-Prime loans. Then it became clear that the market for CDSs is totally intransparent and rather dangerous to dabble in for the likes of – yes, AIG. We have the segment of CDOs based on the Alt-A segment of US mortgage loans waiting for us in March and April when large number of loans will have their teaser introductory rates reset to rates two to three times higher. Right now it is yet another letter combination that proves explosive, namely CMBS, or Commercial mortgage-backed securities.

So far it appears that a game plan for the remainder of this banking crisis is that each of the various segments of securitised loans will blow up. Each time the banks will be hit a little bit harder than expected because despite the idea of securitisation – that the banks did not want to carry the credit risk, but only to receive the fees for arranging – the banks have been greedy enough to still hold quite some risk on the books.

CMBS – to any follower of the story of the Sub-Prime CDO's there should not be any big surprises. Mortgage loans issued to commercial property owners or developers with collateral in the underlying property is now coming heavily under strain because the borrowers are beginning to default on loans. The spread of such repackaged loans had maintained a very respectable and almost constant spread over AAA rated issues of around 200 bp throughout the months of September and October. But in the beginning of this week it went badly wrong here as well. According to the spread, known as the CMBX spread, widened from 250bp on Monday to a rather impressive 850bp on Thursday. The trigger was apparently that two of the largest commercial mortgage loans granted to the Westin chain of hotels are nearing defaults.

Looking at it from a distance it does not appear that we should be anywhere near a crisis yet. The market is of about $700bn and is considered one where everyone involved is a professional – no ignorant Sub-prime borrowers around here. The rate of loans transferred to a Special server – the last step before default – doubled from mid-2007 to mid-2008. All the way from 0.5 per cent to 1 per cent. When compared to the expected default rate on certain mortgage loans of 20% it looks like small fry.

However, now the cat is out of the bag and speculators are taking aggressive bets on a collapse in this market segment. Bad news for Citi, who has reported to have an 11% exposure to this market segment. Big C closed 2007 at 29.44 . It ended at $4.71 on Thursday, down 26% from the day before, having lost some 84% of its value in 2008.

Is this the end of C? Probably not given the bailout package, but it may now be the next bank to be nationalised. Even if it does not happen the last two days prove beyond any reasonable doubt that despite the siren calls to buy stocks at the current very "cheap" levels, the uncertainty continues to grow in the real economy.

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