Commercial Mortgage-Backed Securities: Stay Disciplined

We focus on originator and manager experience as new entrants flood the CRE CLO market.

May 17, 2018


This Commercial Mortgage-Backed Securities sector report is excerpted from the Second Quarter 2018 Fixed-Income Outlook.

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.

SASB Deals Increased 228 Percent in the First Quarter

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.

Interest-Only Deals Have Increased as Conduit Underwriting Standards Weaken

Source: Trepp, Guggenheim Investments. Data as of 3.31.2018.

—Peter Van Gelderen, Managing Director; Shannon Erdmann, Director

 
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, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited, and Guggenheim Partners India Management. ©2018, 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.


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