JPM issued pricing guidance for JPMCC 2010-C1 CMBS offering yesterday.
After reading the variables surrounding the conduit offering; some new light is shined on the quality of said offering.
The increased spread of 140 bps over swaps for AAA rated tranche and a 15% credit enhancement make for a viable argument in favor of investing in the tranche in the secondary market if the price deteriorates.
Spread of 140 bps over benchmark swap rate indicates JPM is widening the yield by pricing recent deterioration in the CMBX market, and unlike RBS did not price the offering using methods such that yield mimics 2006, 2007 yields on securities of those vintages. My personal opinion on RBS offering is that the spread of only 90 bps over benchmark rate was too tight to assess for future volatility and past movements.
Change in the rating methodology also makes for a compelling argument [although I will need to look deeper into the technicality of new rating methodology to properly assess the value of the changes in it].
The investment quality of the issuers of the debt which participates in the AAA rated tranche also makes the investment comparably less risky than RBS one.
IG names such as Wal-Mart and other IG retailers certainly enhance credit quality of the tranche on its own, and the 15% credit enhancement furthers it even more.
I find the high value of LTV justifiable for the AAA tranche [given the quality of the debt ] and the DCR averaging 1.37x for the structure is safe, but still does not correlate with yield regarding risk/reward.
The nature of credit enhancement techniques used probably varies from tranche to tranche; but if I would have to guess I would say AAA is enhanced via surety bonds, while lower tranches are most likely enhanced either via LOC or CCA. Either way AAA tranche makes a valid argument with its structuralization when it comes to regarding it as a potential investment in the secondary market.
What is worrying [as we have noted in the original article about this deal] are the participative percentages of debt types. While it is true that individual investment grades of debt issuers are par excellence and are in the top 5% of their respectable industrial sector; recent default metrics among the debt issued by retailers make the distribution of debt in JPMCC 2010-C1 somewhat uneven and discount on principal should have been offered by JPM [ 50-75 bps would have been preferable in comparison to risk].
Macro view on the industry is still negative due to lesser availability of consumer credit and potential new taxes. I do not see any improvement in the next months and expect benchmark indexes to be extremely volatile but generally trading lower.
I am still unsure about lemon cost surrounding this offering since future volatility will be defined by external factors such as aforementioned consumer credit availability, new taxes and shrinking disposable income.
Since loans are new new and not refinanced old obligations sitting on the balance sheet [Thank you BoyChristmas for pointing that out to me; much appreciated], I expect lemon cost was fairly calculated [in context of no liquidity whatsoever in the underlying collateral].
All in all; very sound and healthy AAA tranche makes for a good investment in the secondary market; while lower trenches are for those with excess of funds and balls of steel. Also loss distribution plays in favor of AAA tranche more strongly than some of the offerings we have seen in the last 24 months.
Few notes on CMBX.
It is still continuing to trade downwards across the board, and I do not see any positive movements in the market which would justify any other outlook. While certain legacy tranches were oversold in early 2009; the alpha-nature of gains have shifted disequilibrium in values towards overbought and prices will need to fall below the 200 DMA, especially those BBB- and A tranches that have experienced alpha-like returns in the past year.
Hedges for these kind of securities are still unaccesible and potential investors might have a hard time to find a protection seller willing to conduct pricing on hedging instruments. General reason for that is the illiquid market in which these CMBS deals are entering, as well as the investors who can not differenciate between the structure of a legacy CMBS and CMBS 2.0 securities.
Finding liquidity for the instruments themselves will be problematic for the same reasons.
June 9 (Reuters) - JPMorgan Securities' $716.3 million commercial mortgage-backed securities conduit sale was meeting with good interest on Wednesday as price guidance emerged for the largest conduit sale in nearly two years.
The deal, dubbed "JPMCC 2010-C1," is backed by 36 fixed-rate commercial mortgage loans secured by 96 properties. JP Morgan Chase Bank loans comprise 76.4 percent of the offering, while 21.6 percent of loans come from Ladder Capital Finance, market sources said.
The deal would be just the second so-called conduit issue to hit the recovering market that provides credit for office, retail and apartment buildings since 2008. The conduit offering is seen as a key gauge of risk appetite for securities tied to the troubled commercial real estate market.
The sale's largest AAA-rated tranche, a $416.1 million 4.53-year issue, is expected to price at a spread of 140 basis points over swaps, a second AAA-rated $131.3 million 6.76-year issue is seen pricing at a spread of 160 basis points over swaps, while its $61.5 million AAA-rated 9.53-year securities are expected to come at spread of 160 basis points over swaps, market sources said.
Dwight Asset Management is looking to purchase the shortest 4.53-year tranche, rated AAA by all three major rating agencies.
"Given the current environment, we are looking for spread in the shortest possible duration. We like the five-year A1 tranche, it offers a spread of 140 basis points over swaps. We are not going to go out beyond that and take on extension risks for an additional 20 basis points," said Paul Norris, portfolio manager at Dwight Asset Management.
A HOPEFUL SIGN
The deal's AAA-rated issues carry 15 percent credit enhancement, though some investors had expected higher levels.
"We were expecting between 15 to 20 percent of credit enhancement for the AAA-rated tranches, but 15 percent is fine because all three rating agencies agreed on it, and that gives us confidence," Norris said.
Recently, banks have more actively been able to bundle together loans from several borrowers for multi-loan CMBS issues. The lending is a hopeful sign for a market whose absence led to soaring defaults and the risk of hundreds more with maturing loans finding few outlets for refinancing.
During the real estate boom, CMBS conduits were among the most important engines for growth of the CMBS market. By 2007, competition for assets grew at a feverish pace, contributing to economic growth. But the weaker underwriting standards were also responsible for some of the worst loans today.
In April, RBS priced a $309.7 million CMBS backed by multiple loans, in the first sale of its kind this year. That followed three single-borrower deals that were sold in the CMBS market in December 2009 as the market began to recover.
JPMorgan's upcoming conduit sale includes three lower-rated tranches. A $16.1 million AA-rated 9.98-year note issue that is expected to price at a spread of 225 to 240 basis points over swaps, a $26.9 million A-minus rated 9.98-year note issue that is expected to price at a spread of 325 to 340 basis points over swaps, and $14.3 million of BBB-rated 9.98-year notes that is seen pricing at a spread of 425 to 440 basis points over swaps, market sources said.
Credit enhancement levels for the AA-rated tranche is 12.75 percent, 9 percent for its A-minus tranche and 7 percent for its BBB-minus rated issue, sources said.
All in all; I posit JPM is just trying to feel the market pulse with this offering, and to see what values should it attach on future offerings and whether or not will the investors come back to investing into CMBS deals.
OT: I would like to say "Thank you" to BoyChristmas, Reggie and other participants who were engaged in the discussion about this offering and CMBS market in general. Your knowledge and input are very much appreciated.