Just a day after the original CMBX article below, the Associated Press came out with a similar, yet slightly more positive spin on the commercial real estate market, outlook. Read it all. Although there are distinctions and nuances, it looks like it’s all trending in the same direction. Down ….

Here’s a very, very interesting industry observation from an article about the “possible” downturn of the commercial real estate market, which appeared on Wall Street Journal On-Line.

A little-known credit-market index is sending ominous (and seemingly conflicting) signals about the outlook for the commercial real estate business.The index is called the CMBX. It tracks the values of bonds backed by commercial mortgages on office buildings, hotels, malls and the like. More specifically, the CMBX began trading in March 2006. It tracks the performance of commercial-real-estate bonds with different credit ratings, ranging from triple-A to double-B. Portions of the index have more than tripled this year, indicating soaring perceptions of risk.

So here’s the conflicting part: The CMBX is signaling that the odds of distress in this business are soaring (by tracking the cost of buying insurance against defaults on different kinds of bonds), even though actual commercial-real-estate defaults, unlike housing, still remain low.

WILL HISTORY REPEAT ITSELF? The CMBX is run by London-based Market Group Ltd. What’s getting insiders attention is that Market Group also runs the ABX, which tracks the riskiness of sub-prime mortgages. And the ABX showed soaring odds of mortgage defaults …. last year, as the housing crisis was about to intensify. Are they right this time, regarding commercial real estate?

Here’s what doesn’t seem to square …. when looking at CMBX -vs- actual commercial real estate default rates:

• Actual delinquencies on commercial-mortgage bonds hit a record low of 0.27% in January, according to Fitch Ratings. Among 40,000 loans in these bonds, only 293 were delinquent last month.

• The most bearish market prognosticators predict defaults on commercial mortgages will reach 2% over the next year or so, in line with the historical range.

• By comparison, however, the performance of the CMBX implies the default rate could be four times that level (or upwards of 8%), according to analysts.

• The annual cost of insuring against default on a $10 million bundle of triple-A rated commercial-real-estate-backed bonds had risen from $65,000 in early January to more than $212,000 last week, 

• A rally of the CMBX this week had reduced the cost to about $180,000 yesterday, according to Citigroup Inc. analyst Darrell Wheeler.

• While trading in these derivatives has soared, it has dried up in actual commercial-real-estate bonds, making it harder to determine what the bonds are worth.

What’s driving the “premature” write-downs? Some banks are using the CMBX to determine the size of write-downs on the values of their holdings, even though the underlying properties are still generating cash.

Developer Beware >> The poor performance of the CMBX, in turn, might be making it even harder for commercial borrowers to get access to credit in an already tight lending environment.

Tags: CMBX, State of Commercial Real Estate Industry

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