Commercial Mortgage-Backed Securities: Defensive Play
Volatile market conditions call for a focus on loss-remote, amortizing bonds and CRE-CLO deals with proven sponsors.
The fourth quarter of 2018 provided a stark reminder of the precarious nature of the current market environment. Concern over global growth and the policy risks around trade and foreign policy led to a spike in volatility. Given the prevailing investment environment, and with the commercial real estate (CRE) recovery entering its ninth year, we continue to favor more defensive, loss-remote, principal-bearing bonds. We also favor senior interest-only bonds in conduit CMBS and both static and managed CRE-CLO investments with proven deal sponsors at spreads similar to or better than conduit spreads.
In 2018, conduit issuance dropped to $40.2 billion from the $47.4 billion issued in 2017 and the $47.6 billion issued in 2016. Despite this decline in conduit issuance, partly precipitated by the rise in issuance of CRE-CLOs, CMBS conduit remains the largest asset class in the private commercial real estate securitized market. CRE-CLO issuance had a record year in 2018, growing over 90 percent year over year. However, in 2019 the CRE-CLO market may struggle if investor demand for wide spreads on the liabilities persists. In late 2018, the spreads on the underlying loans did not widen as much as the spreads on the bonds, so issuing a CRE-CLO during that time did not make economic sense.
Conduit underwriting has remained relatively disciplined since the financial crisis, providing higher quality collateral pools. Average new-issue conduit underwritten loan-to-value (LTV) ratios rose 0.9 percentage point to 60.3 percent in 2018, but are down from 65.7 percent in 2014. Underwriters’ restraint regarding LTV ratios has largely been driven by investor preference, as issuers who have come to market with higher LTV conduit deals have suffered from softer demand and wider spreads. While some market skeptics fear the potential for manipulation of valuations in the underwriting process, there is no arguing that LTVs have decreased in recent years. Fitch Ratings Stressed LTVs can also be seen trending downward.
New Issuance Reflects Investor Preference for Lower Loan-to-Value Ratios
While some market skeptics fear the potential for manipulation of valuations in the underwriting process, LTVs have decreased in recent years. Fitch Ratings Stressed LTVs can also be seen trending downward.
Source: Guggenheim Investments, Fitch Ratings. Data as of 12.31.2018.
We also continue to favor seasoned conduit bonds to the extent they are available in the secondary market. These often trade at the same spread as new-issue bonds with less spread duration, especially at the junior AAA to single-A rating level. This, along with the flat swap curve, results in similar yields for the seasoned bonds. Additionally, the underlying properties in the collateral have enjoyed several years of significant price appreciation along with amortization of the loans, resulting in a decline in leverage.
New Issuance Reflects Investor Preference for Lower Loan-to-Value Ratios
We favor seasoned conduit bonds to the extent they are available in the secondary market. These often trade at the same spread as new-issue bonds with less spread duration, especially at the junior AAA to single-A rating level.
Source: Guggenheim Investments, J.P. Morgan Research. Data as of 2.8.2019. Secondary cash spreads are based on the J.P. Morgan cash spreads represented in CMBX 9 (2015 vintage conduit CMBS). These are JP Morgan estimates and may not reflect levels where we can obtain bonds. Minimum/maximum = 10.19.2018–2.8.2019.
—Shannon Erdmann, Director; Phil Hoehn, Vice President; Darragh Murphy, 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, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited, and Guggenheim Partners India Management.
©2019, 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.
March 07, 2019
Late-Cycle Drama Is Unfolding
Risk assets will likely enjoy another rally while the Fed stays on hold, but the pause will only allow excesses to become more pronounced.
January 24, 2019
Amber Lights Flash at Davos
Should the mood this year at Davos prove once again to be a contra-indicator, this may be the signal that the economy is likely to re-accelerate soon and that the party in risk assets continues.
January 18, 2019
Up the Escalator, Down the Elevator
An uptick in corporate defaults in 2019 will mark the beginning of a prolonged period of stress in the corporate bond market.
Portfolio Manager Adam Bloch and Macroeconomic and Investment Research Group Director Matt Bush share insights from the first quarter 2019 Fixed-Income Outlook.
Anne Walsh, Chief Investment Officer for Fixed Income, shares insights on the fixed-income market and explains the Guggenheim approach to solving the Core Conundrum.
Guggenheim Investments represents the investment management businesses of Guggenheim Partners, LLC ("Guggenheim"). Guggenheim Funds Distributors, LLC is an affiliate of Guggenheim.
Read a prospectus and summary prospectus (if available) carefully before investing. It contains the investment objective, risks charges, expenses and the other information, which should be considered carefully before investing. To obtain a prospectus and summary prospectus (if available) click here or call 800.820.0888.
Investing involves risk, including the possible loss of principal.
*Assets under management is as of 12.31.2018 and includes leverage of $12.4bn. Guggenheim Investments represents the investment management businesses of Guggenheim Partners, LLC ("Guggenheim"), which includes Security Investors, LLC ("SI"), Guggenheim Funds Investment Advisors, LLC, ("GFIA") and Guggenheim Partners Investment Management ("GPIM") the investment advisers to the referenced funds. Securities offered through Guggenheim Funds Distributors, LLC, an affiliate of Guggenheim, SI, GFIA and GPIM.
Guggenheim Investments. All rights reserved.
Research our firm with FINRA Broker Check.
• Not FDIC Insured • No Bank Guarantee • May Lose Value
This website is directed to and intended for use by citizens or residents of the United States of America only. The material provided on this website is not intended as a recommendation or as investment advice of any kind, including in connection with rollovers, transfers, and distributions. Such material is not provided in a fiduciary capacity, may not be relied upon for or in connection with the making of investment decisions, and does not constitute a solicitation of an offer to buy or sell securities. All content has been provided for informational or educational purposes only and is not intended to be and should not be construed as legal or tax advice and/or a legal opinion. Always consult a financial, tax and/or legal professional regarding your specific situation. Investing involves risk, including the possible loss of principal.