Time to Focus on Neglected Credits

A technical pricing dislocation in subordinated CMBS and non-traditional CRE offers a compelling entry point for commercial mortgage investors.

March 17, 2016


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

The cumulative effect of voluntary prepayments and mortgage defaults has caused the 2016 ‘maturity wall’—a dramatic name coined by Wall Street to describe the large number of 2006-vintage commercial loans needing to refinance in 2016— to shrink from about $110 billion two years ago to only $67 billion today. An effective combination of strong real estate fundamentals, improved credit availability, and ample investor demand helped well-performing properties refinance prior to maturity. The market easily accommodated this refinancing activity, balancing somewhat more aggressive underwriting standards—relative to immediately after the financial crisis—with increasingly conservative securitization structures. A similar pattern for 2017 maturities is emerging, and we expect the overwhelming majority of performing 2006- and 2007-vintage loans to refinance without significant event.

Diminishing Maturity Wall for Commercial Real Estate Loans

Concerns of a wave of commercial real estate maturities scheduled to take place in 2016 have diminished, as strong investor demand and improved credit availability allowed many borrowers to refinance prior to maturity. The 2016 ‘maturity wall’ looks significantly smaller today with approximately $67 billion of commercial real estate loans scheduled to mature in 2016, down from a $110 billion two years ago.

Diminishing Maturity Wall for Commercial Real Estate Loans

Source: Bloomberg, Guggenheim Investments. Data as of 2.29.2016

Post-crisis CMBS, as measured by the Barclays U.S. CMBS 2.0 Index, posted a positive return of 1 percent for 2015, with the strongest performance delivered at the top of the capital structure. AAA-rated CMBS 2.0 posted a positive 1.2 percent total return for 2015, outperforming total returns of 0.8 percent, -0.3 percent, and -1.9 percent in AA-rated, A-rated and BBB-rated CMBS 2.0, respectively. Macro events led to market volatility across risk asset classes towards the end of 2015 and into the beginning of 2016. As a result, newly-issued CMBS spreads have been at or near their 52-week wides.

The recent pricing weakness in certain sectors of the CMBS market has created some compelling opportunities, most notably in subordinated conduit CMBS and in financing non-traditional property types. As investors retrenched during the volatile start to 2016, yields for subordinated CMBS and loans related to nontraditional commercial property types rose dramatically. Our review of these securities determined that the pricing correction was unrelated to the underlying property performance, loan underwriting standards, and securitization credit enhancements. We believe this recent technical pricing dislocation offers a compelling entry point for investors in these securities.

Risk-Averse Markets Contributed to Widening CMBS Spreads

Spreads in the primary CMBS market widened along the capital stack in conjunction with general credit markets weakness that resulted from investors flight to quality. In 2016, primary CMBS spreads may continue to see some upward pressure as a result of regulatory changes, but any spread widening should be relatively contained as the sector attracts more capital from fixed-income investors seeking better relative value to corporate bonds.

Risk-Averse Markets Contributed to Widening CMBS Spreads

Source: Guggenheim Investments, Wells Fargo Research. Data as of 2.29.2016. New Issue XA is a type of interest-only tranche.

—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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