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Junior Triple-A CMBS Yields Top 16%

Junior AAA-rated commercial mortgage-backed securities are seeing yields top 16%. The bonds, known as the AJ tranche, remain a very solid investment with little downgrade risk, said Darrell Wheeler, managing director at Citibank. "[AJs are] likely a great long-term value that can be realized over the next couple of years, even in a recession," he said.

The bonds are being affected by concerns over the economy, the liquidity crisis and performance. Although the bonds are triple-A rated, they are junior to several other tranches of AAA bonds. The yields have reached dizzying heights even though the bonds are actually more liquid than most corporate bonds.

The market is questioning whether these bonds actually deserve AAA ratings because of recent downgrades and concerns over the economy. But Wheeler pointed out that with one exception, downgrades by rating agencies have not hit any classes above the A-rated class. The agencies are also not expected to retroactively change their rating methodology, resulting in downgrades, for the AJ class, he added. Spreads on the bonds are at about swaps plus 1,200.

A loss on the AJ class, based on early 2007 subordination levels, would require pool-level defaults of 29% with 40% loss severity. Based on current delinquency rates nearing 0.55% on fixed-rate CMBS, Wheeler finds these types of losses "near impossible." The class is also buoyed by the additional 1.25% of subordination between the A-minus-rated class and BBB+ rated class, he said.

Wheeler tested the AJ classes with a severe recession stress model that decreased values on office and hotel properties by 42% and 31%, respectively. He found that few AJs classes in the post-2004 vintages would have material adverse effects. Those that performed poorly had a maximum downgrade risk on the AJs going down to BBB-rated bonds.

Under Wheeler's test, the CMBS deals with the highest subordination drops were GCCFC 2007-GG11, GSMS 2007-GG10, CSMC 2007-C4, CSMC 2007-C2, CSMC 2007-C1, CSMC 2008-C1, GCCFC 2007-GG9, CSMC 2007-C3. --Sarika Gangar 

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