AAA losses in CMBS typically occur in a crisis, similar to the financial crisis of 2008, and that is what has happened with top-notch commercial euro bonds.
Darren Winters breaks this down into bite sizes.
Commercial mortgage-backed securities CMBS, as the name suggests, is a security backed by commercial and multifamily mortgages rather than residential real estate.
Triple AAA credit rating is the highest rating assigned to debt by credit rating agencies, S&P and Fitch, and Moody’s.
AAA losses in CMBS, are the anomaly of a robust economic narrative and a sense of deja vu
Remember the 2008 financial crisis, or the global financial crisis GFC of 2008, which was the most severe since the Great Depression.
GFC was triggered by residential borrowers unable or unwilling to pay their inflated mortgages when borrowers bought their properties at the peak.
Fears of a tsunami of mortgage loan defaults led investors to dump mortgage-backed securities and as the market value fell, margin calls forced many investors to sell assets to raise liquidity into a declining market. The snowball effect increased selling volumes, which led to a crash in bonds, stocks and real estate. Even precious metals, sold as leveraged investors, had to raise liquidity to meet margin calls. GFC was also known as a credit squeeze.
What is the size of AAA losses in the euro CMBS?
May’s data from Deutsche Bank show that mortgage-backed securities that did not score the top triple AAA grade investment rating with the three prominent credit rating agencies lost everything, 100% of their capital.
Investors with CMBS with, AAA Original S&P rating lost 26% of their capital.
So, for the first time since Lehman’s bankruptcy, Investors holding the top-most tranche debt backed by commercial real estate have suffered losses since the housing meltdown collapsed the economy 16 years ago.
Buyers of the AAA portion of a $308 million note backed by the mortgage on the 1740 Broadway building in midtown Manhattan received less than three-quarters of their initial investment in recent weeks after the loan was dumped at a sizable discount. All low-tier creditors were wiped out, according to CMBS strategists at Barclays.
AAA losses in CMBS echoes last year’s treasury bond market crash
Darren Winters points out the concerns about deteriorating public finances in 2023 contributed to a meltdown in treasury bond prices, which triggered bank runs.
Indeed, five known banks collapsed in the US in 2023.
In Europe, Credit Suisse roiled financial markets last year when it collapsed following a string of financial problems.
So more rate hikes could mean a wave of distressed banks, bank runs, bank bail-ins, and a financially engineered depression,” written in a piece entitled Distressed Banks February 13.
But will rate cuts stem the AAA losses in CMBS and the treasury bond market?
The S&P 500 Index is at a YTD high, up 14.57%, and the technology NASDAQ is up 17.84% YTD.
So stocks could be riding the early phase of the loosening cycle with central banks in cahoots with rate cuts.
The European Central Bank trimmed its key rate in June from 4% to 3.75%, its first rate cut in nine years.
Such a move follows the Bank of Canada’s rate cut to 4.75% from 5%. Central banks in Sweden and Switzerland also have trimmed rates this year.
But it is the Federal Reserve Chairman Jerome Powell’s decision, to hold rates at 5.25%-5.5%, a 22-year high, which has spooked fixed-income bonds and CMBS.
Even Powell does not believe the job numbers. So maybe there will be a Fed rate cut in July to save the bond market?
“There’s an argument that they may be a bit overstated, but still, they’re strong. …We see gradual cooling, gradual moving toward better balance,” said Powell in his recent press meeting.
Darren Winters previously wrote, that if the job numbers were so great, why were auto loan delinquencies also at the last financial crisis level?
A buoyant job market means pay rises that keep up with inflation to more than compensate the higher interest rates costs to service the debts.
So, the reality could be that the world’s largest economy slipped into a recession last year as the treasury bond market crashed, the worst in history. The disturbing rise of Hoovervilles, and record auto loan delinquencies indicates households are experiencing hardship. The world’s largest consumer-based economy could be deep into a recession, which started in 2023.
The Fed wanted to slow the economy with restrictive monetary policy, and they could have gone overkill.
Darren Winters says he would not be surprised if the Fed commences its rate-cutting cycle in July, and if so, that might give bond investors and CMBS some relief.
AAA losses in CMBS underscore a continuing crisis in the bond market
The debt market is fretting over higher interest rates, causing loan delinquencies and defaults and could doubt whether inflation is under control, which creates maturity risks for bondholders.
Euro Bonds and US Treasuries were unloaded by investors in June 2024.
So, Japan’s largest institutional investor, Norinchukin Bank sold approximately 63 billion US dollars in overseas bonds, primarily US and European government bonds, to reduce the risk of holding low-yield bonds amidst high interest rates in the US and Europe.
What is the takeaway of AAA losses in CMBS for investors?
Steer clear from debt investments, particularly if it does not have a top-notch credit score granted by the credit rating agencies.
There could be a monetary crisis in the debt market brewing, where debt is no longer attractive. Central banks then create currency to buy the surplus bonds to suppress yields, debasing the currency further.
In this scenario, cash is trash even if the economy is in free fall.
In 2013, the Venezuelan stock market rallied 300% despite the economic and hyperinflation of 56%.
When the music stops, investors who see a currency crisis do not want to be left holding debased currencies.