Commercial Mortgage-Backed Securities: CRE-CLO Evolution
The CRE-CLO product is in its early years while conduit is showing its age.
Collateralized loan obligations backed by commercial real estate loans (CRE-CLO) in their current form was born in 2013. Up until 2018, the market was still figuring out what type of personality the product would have, or what its structural features would be. In the last year or so, the traits that have emerged are deals with two-year reinvestment terms, maximum pool-weighted average life (WAL) of 5.5 years, and highest concentrations in multifamily properties.
As the market is maturing for CRE-CLOs, we are seeing 2019 as a breakout year in terms of liquidity with more market-makers establishing themselves. For the majority of 2018, there were only three to four dealers making daily markets on the entire capital stack of select deals. Today, seven or eight dealers are actively making markets on a larger number of bonds, with an additional three to four regional dealers actively trading the product. Bid wanted in competition (BWIC) volumes have been steadily increasing, showing more signs of a healthy secondary market. While liquidity has improved, the deal structures are still undergoing a few growing pains. For example, a few recent deals have had their structure terms retroactively changed in deal documents after market consensus grew that this was the right course of action.
Increasing BWIC Volumes Indicate Secondary Market Strength
CRE-CLO Bid List Volume ($millions)
Bid-wanted-in-competition volumes have been steadily increasing, showing more signs of a healthy secondary market.
Source: Guggenheim Investments, JP Morgan. Data as of 6.30.2019.
Beyond these few growing pains, however, borrowers, issuers, and investors find CRE-CLOs attractive versus CMBS conduits due to their greater flexibility and shorter WAL. Conduit issuance has been declining slowly, and we expect that trend to continue as the product offering is not able to compete with insurance companies, banks, and CRE-CLOs. One of the main headwinds conduit financing faces is the borrower experience with conduit servicers. Borrowers need to go through servicers to release reserve funds, approve new tenants, and in times of stress, obtain modifications. It has been notoriously difficult for borrowers to get anything done with efficiency. In CRE-CLO structures, the issuer is intimately involved in these types of requests as they manage the loans and retain them on their balance sheet.
Conduit Issuance Wanes in the Face of Competition from CRE-CLOs
New Issuance ($billions)
Conduit issuance has been declining slowly and we expect that trend to continue as the product offering is not able to compete against with insurance companies, banks, and CRE-CLOs.
Source: Guggenheim Investments, JP Morgan. Data as of 6.30.2019.
As the CRE-CLO product continues to grow, we believe its structural advantages, along with the increased liquidity, will continue to make it an attractive investment.
—Shannon Erdmann, Director; Phil Hoehn, Vice President
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