Commercial Mortgage-Backed Securities: Stay Disciplined
We focus on originator and manager experience as new entrants flood the CRE CLO market.
CMBS new issuance rose 66 percent in the first quarter of 2018 over the same period last year, driven primarily by single asset/single borrower (SASB) deals (up 228 percent) and, to a lesser extent, conduit CMBS (up 13 percent). Despite this strong start, we expect CMBS new issuance to slow through the remainder of the year as loan supply declines. Most pre-crisis loans have been refinanced at this point, and high property valuations have slowed commercial real estate transaction volumes. The increased competition among conduit originators, insurers, and banks will likely result in weaker underwriting standards for conduit loans. Risk retention or no, we expect conduit underwriting standards to migrate lower throughout the remainder of the year and feature more interest-only, higher loan-to-value, and storied properties.
SASB Deals Increased 228 Percent in the First Quarter
First Quarter Issuance
CMBS new issuance rose 66 percent in the first quarter of 2018 over the same period last year, driven primarily by single asset/single borrower (SASB) deals (up 228 percent) and, to a lesser extent, conduit CMBS (up 13 percent). Despite this strong start, we expect CMBS new issuance to slow through the remainder of the year as loan supply declines.
Source: Trepp, Guggenheim Investments. Data as of 3.31.2018.
Another notable development in the first quarter was the growth in CRE CLOs, with new issuance up 89 percent over the same period last year. CRE CLOs finance transitional value-add properties using short-term, floating-rate loans. In the postcrisis era, specialty lenders have offered this product to facilitate the rehabilitation and stabilization of multifamily properties. As property owners/operators move from core to value-add investing in search of higher yields, borrower demand for floating-rate loans has increased, and new lenders have moved into the space. We now see the emergence of private equity funds and others with limited track records and no demonstrated commitment to transitional lending finance entering the CRE CLO market. In addition, the property type composition has drifted significantly from its post-crisis multifamily focus to office, retail, and hotel properties. We are particularly vigilant as we review these securities, focusing particularly on originator experience and collateral composition.
Post-crisis CMBS, as measured by the Barclays U.S. CMBS 2.0 index, posted a loss of 1.2 percent for the first quarter. The senior-most AAA-rated tranche of the index had the weakest return, with a loss of 1.4 percent. AA-rated and A-rated tranches lost 0.68 percent and 0.7 percent, respectively, while BBB-rated CMBS 2.0 tranches held on to a positive total return of 1.5 percent.
We continue to 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.
Interest-Only Deals Have Increased as Conduit Underwriting Standards Weaken
Average % of Interest-Only Exposure in Conduit Deals by Vintage
We expect conduit underwriting standards to migrate lower throughout the remainder of the year and feature more interest-only, higher loan-to-value, and storied properties.
Source: Trepp, Guggenheim Investments. Data as of 3.31.2018.
—Peter Van Gelderen, Managing Director; Shannon Erdmann, Director
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*Assets under management is as of 09.30.2019 and includes leverage of $11.8bn. 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. Securities offered through Guggenheim Funds Distributors, LLC, an affiliate of Guggenheim, SI, GFIA and GPIM.
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