Commercial Mortgage-Backed Securities: Eyes Wide Shut
The CMBS market is finally growing, but recent storms and transaction structures highlight broad market complacency.
CMBS markets are set to grow for the first time in a decade. Despite Wall Street’s dire prognostications, neither risk retention nor the maturity wall destroyed the CMBS market. Risk retention was met with significant investor support, and nearly all remaining pre-crisis loans have paid off. Year-to-date issuance is 40 percent higher compared to this time last year, the result of single asset, single borrower (SASB) being up 117 percent while conduit is up 10 percent. The CMBS market is expected to grow from $450 billion to $460 billion in the fourth quarter, and should continue to expand in the near future. Property performance has leveled off from its consistent growth over the last five years, and loan credit underwriting quality has remained unusually disciplined for later-cycle credit markets, feeding complacency.
The CMBS Market Is Expected to Grow in the Fourth Quarter
Year-to-date issuance is 40 percent higher compared to this time last year, the result of single asset, single borrower (SASB) being up 117 percent while conduit is up 10 percent. The CMBS market is expected to grow from $450 billion to $460 billion in the fourth quarter, and should continue to expand in the near future.
Source: Morgan Stanley, Trepp, Guggenheim Investments. Data as of 10.23.2017.
We have observed this complacency in rating agencies and investors in Freddie Mac multifamily credit securities. The credit performance in these securities has been outstanding, with almost no defaults or delinquencies to date. Rating agencies have historically assigned the same rating and investors the same pricing to virtually all subordinate tranches in this program, regardless of geographic concentration risk. Previously, each of these securities had traded on top of one another, but in the wake of the hurricanes, market participants have priced the increased risk of storm loss by as much as 20–50 basis points. It remains to be seen whether rating agencies will take action on more exposed transactions.
Post-crisis CMBS, as measured by the Barclays U.S. CMBS 2.0 index, posted a positive total return of 0.9 percent for the third quarter. The senior-most AAA-rated tranche and AA-rated tranche of the index returned 0.9 percent and 0.8 percent, while A-rated and BBB-rated CMBS 2.0 tranches had stronger total returns of 1.4 and 1.8 percent.
We have recently focused efforts on private situations where we can influence transaction terms. We remain active in shorter floating-rate large loan and CRE CLO transactions, and have also remained active in select conduit CMBS where the underlying property quality is high and the related loan leverage is low.
Freddie Mac Securities Have a Wide Range of Exposures to Irma and Harvey
In each vintage year, market participants granted consistent ratings and pricing to Freddie Mac securitizations, regardless of geographic concentration risk. Following hurricanes Harvey and Irma, market participants have priced the increased risk of storm loss by as much as 20–50 basis points. Rating agencies have not yet taken any action. Investors should be aware of the possibility of rating agency actions on more exposed transactions.
Source: Freddie Mac, Guggenheim Investments. Data as of 10.26.2017. Each dot represents a separate issue of Freddie Mac multifamily credit securities.
—Peter Van Gelderen, Managing Director; Shannon Erdmann, Director; Simon Deery, Vice President
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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.
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