Most CMBS Investors Unaffected, Watching Cyprus Crisis

The banking crisis in Cyprus and European market volatility had a bump in the road effect on the performance of securitized commercial mortgage loans, according to Barclays.

The U.S. CMBS market “quickly recovered” to finish the week mostly unchanged, analysts wrote, volatility in the CMBS sectors most likely will be contained even though “further adverse news from Europe is certainly possible.”

The connection may not be obvious. According to James Frischling, president and co-founder of NewOak, the banking system in Cyprus was built as an offshore-haven business model that was open to taking risks other European countries do not allow. Cyprus implemented the lowest corporate tax rate in the EU to attract customers worldwide, he says. Now, “the medicine it will be forced to take will forever change its status” as one of the best business places for international companies, including U.S. firms.

“With Cyprus’ need to raise 5.8 billion euros in order to receive a 10 billion euro bailout from the EU, an unprecedented levy on depositors appears inevitable,” he said.

“The latest flutter from Europe,” caused CMBS spreads to  widen out on Monday while “trading levels recovered somewhat” and 2007 vintage stock performance was roughly unchanged, according to a recent Barclays report. “It was a similar story in the new issue space, as the market awaits a stretch of conduit deals that are expected to price over the coming weeks.” Also, the flow of single-asset/borrower deals continues.

“The muted reaction to the situation in Cyprus, at least in the U.S. markets, is illuminating,” analysts wrote, because as noted in previous Barclays CMBS market outlooks for 2013, strong actions taken by central European banks “have decreased the likelihood of a sharp drop-off in risk-appetite” seen in the latter half of 2011.

Analysts warn, however, that the situation in Europe “is by no means resolved.” But it appears that investors “have to come to believe in strong central bank intervention in the event of a risk-off event,” they wrote, as a result, volatility may stay somewhat contained.

To control risk, they recommend “swapping out of 2005-06 dupers into 07 dupers for better convexity protection,” since the capital structure on 2007 vintage deals, have underperformed super-seniors from earlier vintages.