Commercial Mortgage-Backed Securities: Get It Where You Can
Investors flocked to floating-rate investments in 2017 as rising Libor offsets post-crisis tights in spreads.
This Commercial Mortgage-Backed Securities sector report is excerpted from the First Quarter 2018 Fixed-Income Outlook.
CMBS new issuance remained robust and pricing held steady throughout the fourth quarter. Conduit CMBS new-issuance volume was virtually unchanged from the same period in 2016, while large loan and single asset/single borrower (SASB) transaction volume soared to $14 billion, compared to $9 billion in the same period last year. The increased new issuance was almost exclusively in floating-rate transactions. Despite credit spreads being at post-crisis tights, one-month Libor’s rise from 0.77 percent on Jan. 3, 2017, to 1.57 percent at year end has caused yields to remain relatively high, and investor demand to appear insatiable. We are increasingly cautious of these floating-rate structures as investor compensation for riskier tranches is very low and deal terms tilt in borrowers’ favor with increased loan term extension options.
Large Loan and SASB New Issuance Soared in the Fourth Quarter of 2017
Large loan and single asset/single borrower (SASB) transaction volume soared to $14 billion, compared to $9 billion in the prior comparable period. The increased new issuance was almost exclusively in floating-rate transactions.
Source: Trepp, Guggenheim Investments. Data as of 1.19.2018.
Commercial real estate (CRE) market fundamentals enter 2018 somewhat mixed. Property performance growth has moderated from recent years, but is still positive. The decline in property performance growth negatively affected transaction volume in 2017, highlighting a valuation disagreement between buyers and sellers. In particular, we have noticed that buyers have slowed activity in primary markets and begun searching for opportunities in tertiary markets and value-add properties. That said, capitalization rate spreads, loan underwriting, and general economic conditions all remain favorable (perhaps with the exception of retail), and we struggle to find a catalyst that would broadly disrupt the health of the CRE market in the coming year.
Post-crisis CMBS, as measured by the Barclays U.S. CMBS 2.0 index, gained 0.5 percent in the fourth quarter. The senior-most AAA-rated tranche and AA-rated tranche of the index returned 0.3 percent and 0.8 percent, respectively, while A-rated and BBB-rated CMBS 2.0 tranches had stronger total returns of 1.1 and 1.8 percent, respectively. For the year, CMBS 2.0 returned 3.9 percent.
We favor more defensive, loss-remote investments in conduit CMBS and CRE CLO transactions. We have also remained active in SASB where the underlying property quality is high and transaction terms are fairly balanced between lender and borrower.
Underwriting Statistics Support a Constructive View of Conduit Fundamentals
Loan underwriting discipline has remained strong in CMBS. Percentage of loans with loan to value of greater than 74 percent are at post-crisis lows, while debt service coverage ratios remain high.
Source: Trepp, Guggenheim Investments. Data as of 1.19.2018. Note: There was no issuance in 2009, the year after the financial crisis.
—Peter Van Gelderen, Managing Director; Shannon Erdmann, Director; Simon Deery, Vice President
Important Notices and Disclosures
This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.
Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating rate senior secured syndicated bank loans and other floating rate securities involve special types of risks, including credit risk, interest rate risk, liquidity risk and prepayment risk. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Real Estate, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited, and Guggenheim Partners India Management. ©2018, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.
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