/perspectives/sector-views/cmbs-bank-failures-portend-capital-rationing-cre

Commercial Mortgage-Backed Securities: Bank Failures Portend Capital Rationing in CRE

Increasing dispersion in CMBS as fundamental pressures mount.

May 16, 2023


This Commercial Mortgage-Backed Securities sector report is excerpted from the Second Quarter 2023 Fixed-Income Sector Views.

CMBS underperformed investment-grade corporate bonds and other structured sectors as spreads widened precipitously following the failures of Silicon Valley and Signature banks. The benchmark 10-year conduit AAA spread widened from 130 basis points to 179 basis points in the first quarter. We are skeptical of the view that recent spread widening presents a technical buying opportunity in the second quarter and believe that the CMBS market’s reaction to these bank events reflects an appropriate and evolving fundamental re-valuation of commercial real estate (CRE) risk. Broadly, we continue to maintain minimal exposure but are game planning to be opportunistic should conditions warrant. 

Regional banks comprised around 20 percent of all CRE lending in recent years and have held disproportionate market share in construction lending. In previous commentaries, we have cited the risk related to bank lenders failing to support the CRE lending market given interest rate pressures. Subsequent bank failures and the economic and regulatory fallout are material negative catalysts during already challenged times. Transaction volumes remain historically low, with few willing sellers, and arguably even fewer willing buyers. More sellers of CRE loans and properties will emerge in coming months, likely at lower prices, as capital is rationed away from out-of-favor property types. Over $400 billion of CRE loans are scheduled to mature in 2023, providing some price discovery for financing rates and valuations. Property prices are down roughly 5 percent year to date, and 9.5 percent from their peak in July 2022, and market expectations are for meaningful further declines in highly impacted property types, such as Class B office and retail.

Consistent with our post-COVID strategy, we continue to favor senior and near-senior CMBS securities for their high credit enhancement. We remain cautious on structurally subordinated CMBS bonds because of their inherent sensitivity to adverse selection or binary outcomes in the underlying collateral pool. CMBS yields are near post-GFC highs, and our preferred senior and near-senior tranches trade in the 6.5–8.5 percent yield range. With rising economic uncertainty and market complexity, we expect that investable situations with attractive loss-adjusted yields will continue to emerge in coming quarters as the drop in competition for CRE credit flows through capital markets.

Commercial Real Estate Sales Volumes Have Been Depressed This Year

Transaction volumes have been historically low, with few willing sellers, and arguably even fewer willing buyers. With rising economic uncertainty and market complexity, we expect that investable situations with attractive loss-adjusted yields will continue to emerge in coming quarters as the drop in competition for CRE credit flows through capital markets.

Very Little Industry Dispersion in the Investment-Grade Index

Source: Guggenheim Investments, Barclays, CoStar, JP Morgan. Data as of 5.3.2023.

—By Tom Nash and Hongli Yang

 
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This material contains opinions of the authors, but not necessarily those of Guggenheim Partners, LLC or its subsidiaries. The opinions contained herein are subject to change without notice. Forward-looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable but are not assured as to accuracy. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.

Investing involves risk, including the possible loss of principal. Investments in fixed-income instruments are subject to the possibility that interest rates could rise, causing their values to decline. High yield and unrated debt securities are at a greater risk of default than investment grade bonds and may be less liquid, which may increase volatility. Investors in asset-backed securities, including mortgage-backed securities and collateralized loan obligations (“CLOs”), generally receive payments that are part interest and part return of principal. These payments may vary based on the rate loans are repaid. Some asset-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 and valuation risk. CLOs bear similar risks to investing in loans directly, such as credit, interest rate, counterparty, prepayment, liquidity, and valuation risks. Loans are often below investment grade, may be unrated, and typically offer a fixed or floating interest rate.

Guggenheim Investments represents the following affiliated investment management businesses: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Partners Advisors, LLC, Guggenheim Corporate Funding, LLC, Guggenheim Partners Europe Limited, Guggenheim Partners Japan Limited, GS GAMMA Advisors, LLC, and Guggenheim Partners India Management.

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Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Corporate Funding, LLC, Guggenheim Partners Europe Limited, Guggenheim Partners Japan Limited, and GS GAMMA Advisors.

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