February 17, 2017
Limited supply, voracious demand, and a general risk-on mentality fueled a rally in the fourth quarter and into early 2017 that first targeted senior risk and has grown to include subordinated risk as well. CMBS supply in 2017 will be limited as the roll-off of legacy CMBS continues to outpace new issuance. Strong demand is also likely to persist in 2017 as U.S. investors remain supportive of unusually disciplined late-cycle underwriting and European investors enter the CMBS market following U.S. adoption of risk retention rules. This solid technical supply/demand backdrop should favor CMBS investors this year.
The CMBS market shrank in 2016 as the roll-off of legacy CMBS outpaced new issuance. Strong domestic and foreign demand against a shrinking market will create a solid technical backdrop that should support further spread tightening.
Source: Trepp, Guggenheim Investments. Data as of 12.31.2016.
Despite a solid technical backdrop for CMBS, we are beginning to focus on property valuation as a prospective risk based on very low nominal interest rate levels, full occupancy and rent levels, and stable cap rate spreads. Valuations jumped higher as interest rates continued to grind lower through this credit cycle. However, when interest rates sit at near-zero levels, small nominal upward rate moves can have relatively large impacts on valuation. Further, occupancy and rent levels are relatively full following the last six years of solid property performance. We are not seeing activity that would suggest improved occupancy and/or rent performance will offset higher prospective cap rates. Finally, while we note that the spread between cap rates and interest rates is wide compared to historical standards, we believe this basis is justified as market participants remain vigilant about the risk of rising interest rates.
Post-crisis CMBS, as measured by the Bloomberg Barclays U.S. CMBS 2.0 index, posted a positive total return of 0.9 percent for the third quarter. The senior-most AAA-rated tranche of the index returned 0.5 percent, while the AA-rated, A-rated, and BBB-rated CMBS 2.0 tranches had stronger total returns of 2.1, 4.3, and 2.6 percent, respectively.
The sharp rally and low issuance volumes in the beginning of 2017 have driven us to favor shorter tenor and floating-rate securities. Additionally, our deep dive credit diligence has uncovered value in subordinated CMBS securities related to large loan transactions.
The spread between cap rates and Treasury yields is wide compared to historical standards, but that wide spread is justified due to concerns that interest rates could rise from today’s still low yields.
Source: RCA, Morgan Stanley, Guggenheim Investments. Data as of 9.30.2016.
—Peter Van Gelderen, Managing Director; Shannon Erdmann, Vice President;Simon Deery, Vice President
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. ©2017, 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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