Awash in Demand, Short in Supply

A frenzied rally in April will moderate as Wall Street restarts its CMBS production engine.

May 24, 2016


This sector report is excerpted from the Second Quarter 2016 Fixed-Income Outlook.

The market rallied dramatically in March and early April, countering an equally dramatic swoon in January and February. Investors who held on recovered nearly all their losses, and new investments made during the downdraft were rewarded. Heightened market volatility, however, is not conducive to a properly functioning market, and as volatility persisted, mortgage origination and new issue CMBS supply almost ground to a halt. Secondary trading activity also suffered as dealer balance sheets declined, with private-label CMBS falling from around $8 billion to $6.5 billion since the beginning of the year, the lowest since the Federal Reserve began tracking the data in 2013. Without new issue supply or dealer inventories, investors struggled to source sufficient CMBS to meet investment needs in March and April as prices rose.

Primary Dealer Holdings of CMBS and Corporate Bonds Shrink

Dealer balance sheets continue to shrink, with primary dealer holdings of private label CMBS dropping to only $6.5 billion, its lowest level since 2013 when the Federal Reserve Bank of New York began tracking this data.

Primary Dealer Holdings of CMBS and Corporate Bonds Shrink

Source: Federal Reserve Bank of New York, Guggenheim Investments. Data as of 4.6.2016.

Post-crisis CMBS, as measured by the Barclays U.S. CMBS 2.0 index, posted a positive total return of 4.3 percent for the first quarter. All credit tranches posted strong returns for the quarter, with AAA-rated, AA-rated, A-rated, and BBB-rated CMBS 2.0 posting positive total returns of 4.3 percent, 4.9 percent, 4.3 percent, and 3.1 percent, respectively.

The market rally has persisted for more than two months now, and Wall Street dealers will likely restart new issue CMBS conduits to take advantage of the favorable selling environment. New private-label CMBS supply through the first quarter of 2016 is approximately 34 percent lower than the first quarter of 2015. While we do not expect this new supply to create meaningful pressure on bond spreads, we expect a respite from the sometimes frenzied April bid for bonds. We expect to selectively participate in the new transactions, particularly those featuring more conservative loan underwriting metrics.

Limited New CMBS Supply Versus 2015

New private-label CMBS supply through the first quarter of 2016 is approximately 34 percent lower than the first quarter of 2015. Combined with dwindling dealer inventories, the low supply drove a sharp rally in March and April. However, as market conditions have improved, we expect increased new issuance in the near term.

Limited New CMBS Supply Versus 2015

Source: Bloomberg. Data as of 3.31.2016.

—Peter Van Gelderen, Managing Director; Shannon Erdmann, Vice President; Simon Deery, Senior Associate

 
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, Guggenheim Real Estate, LLC, Transparent Value Advisors, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited and Guggenheim Partners India Management.


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