Commercial Mortgage-Backed Securities: Get It Where You Can
Investors flocked to floating-rate investments in 2017 as rising Libor offsets post-crisis tights in spreads.
This Commercial Mortgage-Backed Securities sector report is excerpted from the First Quarter 2018 Fixed-Income Outlook.
CMBS new issuance remained robust and pricing held steady throughout the fourth quarter. Conduit CMBS new-issuance volume was virtually unchanged from the same period in 2016, while large loan and single asset/single borrower (SASB) transaction volume soared to $14 billion, compared to $9 billion in the same period last year. The increased new issuance was almost exclusively in floating-rate transactions. Despite credit spreads being at post-crisis tights, one-month Libor’s rise from 0.77 percent on Jan. 3, 2017, to 1.57 percent at year end has caused yields to remain relatively high, and investor demand to appear insatiable. We are increasingly cautious of these floating-rate structures as investor compensation for riskier tranches is very low and deal terms tilt in borrowers’ favor with increased loan term extension options.
Large Loan and SASB New Issuance Soared in the Fourth Quarter of 2017
Large loan and single asset/single borrower (SASB) transaction volume soared to $14 billion, compared to $9 billion in the prior comparable period. The increased new issuance was almost exclusively in floating-rate transactions.
Source: Trepp, Guggenheim Investments. Data as of 1.19.2018.
Commercial real estate (CRE) market fundamentals enter 2018 somewhat mixed. Property performance growth has moderated from recent years, but is still positive. The decline in property performance growth negatively affected transaction volume in 2017, highlighting a valuation disagreement between buyers and sellers. In particular, we have noticed that buyers have slowed activity in primary markets and begun searching for opportunities in tertiary markets and value-add properties. That said, capitalization rate spreads, loan underwriting, and general economic conditions all remain favorable (perhaps with the exception of retail), and we struggle to find a catalyst that would broadly disrupt the health of the CRE market in the coming year.
Post-crisis CMBS, as measured by the Barclays U.S. CMBS 2.0 index, gained 0.5 percent in the fourth quarter. The senior-most AAA-rated tranche and AA-rated tranche of the index returned 0.3 percent and 0.8 percent, respectively, while A-rated and BBB-rated CMBS 2.0 tranches had stronger total returns of 1.1 and 1.8 percent, respectively. For the year, CMBS 2.0 returned 3.9 percent.
We favor more defensive, loss-remote investments in conduit CMBS and CRE CLO transactions. We have also remained active in SASB where the underlying property quality is high and transaction terms are fairly balanced between lender and borrower.
Underwriting Statistics Support a Constructive View of Conduit Fundamentals
Loan underwriting discipline has remained strong in CMBS. Percentage of loans with loan to value of greater than 74 percent are at post-crisis lows, while debt service coverage ratios remain high.
Source: Trepp, Guggenheim Investments. Data as of 1.19.2018. Note: There was no issuance in 2009, the year after the financial crisis.
—Peter Van Gelderen, Managing Director; Shannon Erdmann, Director; Simon Deery, Vice President
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