Commercial Mortgage Spread Commentary

By Chris Brossard, President & David Nygren, Asset Manager
Canadian Mortgage Loan Services Limited

December 2009

Commercial and Multifamily Mortgage Spreads Continue to Fall

Commercial mortgage lending spreads continued their trend again this quarter falling by some 25 to 30 basis points. Whole loan spread reductions have lagged the reduction in corporate bond and CMBS spreads dramatically. There is now a full 150 basis point premium between whole loan spreads and investment grade corporate bonds.

Current Market Spreads

During the final quarter of 2009 good quality commercial mortgages (office, industrial and retail) were attracting spreads of 250 to 280 bps wider than Government of Canada bonds (“GoCs”). Conventional multifamily mortgages were attracting somewhat less spread premium, as is typical for the Canadian market, at 215 to 245 basis points over bonds.

CMHC insured mortgage lenders have narrowed their ask to the 115 to 155 basis points range over GoCs. However the NHA MBS lenders are keeping the pressure on with quotes for five and ten year term loans under 100 bps over bonds.

Mortgage Coupons – Conventional

Mortgage coupons continued to decline modestly in the fourth quarter of 2009. Five and ten year coupon rates have declined from their peak in June by approximately 50 and 80 basis points respectively. The reduction in spread was partially offset by the recent 20 basis point expansion in Government of Canada yields in December.

The general attitude of the participants in our survey this month was positive with a relatively bullish sentiment going into 2010. Most insurance companies, pension funds, and banks indicate that they intend to be active throughout the year.

Most mortgage investors expect to face increased competition due to a healthy allocation to many mortgage programs. This is coupled with the fact that lower property values combined with tighter underwriting standards has likely reduced the size of the commercial mortgage universe. Participants anticipate however that this should be mitigated by increased transaction volume in 2010.

CMHC Insured Mortgages

This was another active year for the National Housing Act Mortgage Backed Securities (NHA MBS) and Canada Mortgage Bond (CMB) programs. NHA MBS issuance reached $134.2 billion in 2009 which almost attained the 2008 record issuance of $145 billion. The year also proved to be an active one for the CMB program which issued a total of $39.2 billion of Canada Mortgage Bonds. The CMB program continues to be an effective tool for providing cost effective funding to lenders involved in the Canadian residential market. This product, which now represents some of the largest bond issues in Canadian capital markets, now attracts a global following due to its high credit rating and attractive yield.

CMBS Spreads

CMBS Spreads continued to move in tandem with the traditional commercial debt market in Canada. Spreads contracted substantially from their record high levels in March 2009. Five year AAA spreads compressed approximately 225 basis points while 10 year BBB dropped by almost 500 basis points. Performance of Canadian CMBS product continues to be very strong.
Delinquency remained benign at approximately 0.20% from January — November 2009.

Corporate Bond Spreads

Corporate bond spreads continued to trend down in the fourth quarter. The corporate bond market finished 2009 with spreads at levels near or lower than pre-credit crunch levels. Spreads on 5 year A rated corporate paper compressed approximately 230 bps throughout the year.

This substantial compression in corporate spreads provided fixed income investors with a healthy return in 2009. The DEX all corporate index gained 16% while the DEX universe bond index gained 5.2%.

The spread differential between corporate bonds and commercial mortgages continued to expand in the fourth quarter. The spread premium between BBB rated corporate bonds and commercial mortgages has now escalated past 150 bps. This increases the attractiveness of commercial mortgage investments which is a likely explanation of a substantial increase in allocations expected in 2010. We expect this differential to tighten substantially, providing lenders an excellent investment opportunity at current spread levels.

Commercial Mortgage Spread Commentary – December 2009
© 2010 Canadian Mortgage Loan Services Limited
Reprinted with permission.