/perspectives/sector-views/cmbs-fundamental-deterioration-is-not-fully-priced

Commercial Mortgage-Backed Securities: Fundamental Deterioration Is Not Fully Priced

We remain defensive on the sector and await a better entry point.

November 20, 2023


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

CMBS has been the weakest performing sector in structured credit year to date as valuations have adjusted to expectations of longer and more numerous loan modifications as well as lower property values. Benchmark conduit CMBS AAA credit spreads tightened by 25 basis points quarter over quarter despite the ongoing negative trend in fundamental data. Year-to-date CMBS issuance of $32 billion is down 68 percent from the prior comparable period issuance of $101 billion, a drop that mirrors the roughly 70 percent yearly decline in overall commercial real estate (CRE) transaction volume. The limited volume of transactions reduces price transparency, adding to the many uncertainties that challenge new investment capital formation. We remain defensive on CMBS credit, still believing that many securities in the sector are overpriced relative to increasing fundamental risks. Our focus is on stable income opportunities with low sensitivity to extension or recovery risks.

Credit fundamentals continue to deteriorate in the CRE market. Over 6 percent of conduit CMBS loans are currently in some state of special servicing. This number is likely to increase given the well-known problems in the office sector, and may meaningfully increase if recessionary conditions hit other property types as well. For example, multifamily property expenses are growing more quickly than rents, creating debt coverage and valuation pressure on the sector despite the underlying demographic support. With limited capital market activity, fewer CMBS loans are repaying on time as higher interest rates and lower CRE demand are making it harder for maturing CMBS loans to refinance. Only 62 percent of CMBS loans repaid on time in September, compared to 67 percent in June and 84 percent in March. Each failed refinancing adds to a substantial backlog of CRE loan issues created in this cycle.

The private and fragmented nature of the CRE market suggests a long timeline for the emergence of clarity around valuations, and we believe CMBS valuations have not yet priced in the full range of potential adverse outcomes. As such, we remain defensive on the sector and await a better entry point.

Multifamily Property Expenses Are Rising Faster than Revenues

Multifamily property expenses are growing more quickly than rents, creating debt coverage and valuation pressure on the sector despite the underlying demographic support.

Multifamily Property Expenses Are Rising Faster than Revenues

Source: Guggenheim Investments, JP Morgan. Data as of 9.30.2023.

—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.

©2023, Guggenheim Partners, LLC. All Rights Reserved. No part of this document may be reproduced, stored, or transmitted by any means without the express written consent of Guggenheim Partners, LLC.

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Investing involves risk, including the possible loss of principal.

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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