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Seepage From Europe Affects U.S. Commercial Real Estate Debt
By RANDALL W. FORSYTH
FRIDAY, OCTOBER 7, 2011

While the problems of the U.S. economy and stock market are homegrown, some of the effects of the European debt crisis have washed up on American shores in some of the more unlikely places.

U.S. commercial mortgage-backed securities -- the kind that finance office buildings, apartment houses and shopping malls, as opposed to the more familiar residential MBS that fund home loans -- have undergone a near-silent bear market since the summer.

The CMBS market has suffered a slide that might as well be a bear market, much like the high-yield corporate bond market. The flight to safety and away from risk since July has resulted in a sharp widening of their spread over Treasuries. To compensate for the perceived risk of commercial mortgages, the extra yield required on a benchmark measure, the Barclay Capital CMBS AAA Super Duper Index (you can't make up a name like that), hit a 20-month high of 323 basis points (3.23 percentage points), up sharply from 178 basis points in late April.

Notwithstanding the lack of an obvious connection, the European sovereign debt crisis has weighed on this sector of the U.S. credit market. "There is some worry that Eurozone banks will sell assets to raise capital and delever their balance sheets," write J.P. Morgan Securites analysts Edward J. Reardon, Meghan C. Kelleher and Joshua D. Younger.

"In CMBS, this concern centers on French banks, who were buyers of dollar-denominated, fixed-rate paper at the peak of the market. Though some unloaded risk during the recovery in 2009-2010, they retain substantial holdings: as of the second quarter of this year, the top five French banks by assets were reporting approximately €6.5 billion ($9.4 billion) in gross U.S. CMBS exposure -- more than 75% was Societe Generale," they write in a research note.

In that regard, the European Central Bank said Thursday it will extend its provision of unlimited liquidity to banks to help eurozone banks in need of funding that are shunned by their counterparts. The problem, of course, isn't European banks' holding of U.S. CMBS, but bonds of the problematic European governments.

This is an example of what happens during times of distress. Institutions sell their best assets to raise cash because iffy assets can't be sold or borrowed against. So, French banks sell U.S. CMBS under duress because of their holdings of Greek sovereign debt.

Most readers of this space do not deal in CMBS, but it is not completely removed from them. Real-estate investment trusts that invest in these securities have been hit as badly if not worse. Overlay a chart of Crexus Investment (ticker: CXS) with that of any number of classes of CMBX, the derivatives that chart the CMBS market, and the lines look about the same.

This serves as an example of how credit distress can leak across borders. With several degrees of separation, the Greek sovereign debt crisis is transmitted to the U.S. CMBS, via French banks as the agent of the contagion.

It's easy to see why global equity markets have reacted positively over the past few days to prospects that Europe wouldn't drag down the rest of world into a worse slump. Nearly $1 trillion was added to the value of U.S. equities in the past three days, according to Wilshire Associates.

Whether that continues is another questions as investors look into the face of earnings season, which starts in earnest next week.