Sorting the Wheat from the Chaff

Identifying relative value as investors struggle to digest a slew of transactions in a hot market.

December 15, 2016

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

Following the wild success of the last quarter’s first-ever risk-retention transaction, Wall Street banks lined up to offer traditional conduit transactions, a watered-down variant of a risk-retention transaction, plus a slew of new large loan transactions. September alone saw 10 new CMBS transactions and the announcement of 15 more (both Agency and non-Agency) by year end. Market participants shuddered under the onslaught of these new “opportunities,” and the market widened 5–30 basis points in response to the deluge in supply. Heightened market sensitivity to leverage, underwriting, and property quality have caused a pronounced market price tiering for new-issue CMBS transactions. Collateral quality in the new transactions varied greatly (our creditrejection rate is the highest it has been all year), and market reception supported the higher-quality, lower-levered transactions at the expense of more aggressive transactions. Anecdotally, a more aggressively underwritten transaction suffered relatively poor execution despite the sponsor retaining 3 percent of the transaction. Consensus views on the value of risk retention were somewhat undermined by the execution of that transaction. Credit sensitivity feels unusually high in CMBS markets right now.

CMBS Price Tiering Is Significant

Heightened market sensitivity to leverage, underwriting, and property quality have caused a pronounced market price tiering for new-issue CMBS transactions. For example, in the two pictured conduit CMBS transactions that were marketed at roughly the same time, market pricing varied widely. Despite similar ratings, the estimates of underlying collateral loan leverage in Transaction 2 were materially higher than those of Transaction 1, and investors priced the risk accordingly.

CMBS Price Tiering Is Significant

Source: JP Morgan, Guggenheim. Data as of 10.25.2016.

Post-crisis CMBS, as measured by the Barclays U.S. CMBS 2.0 index, posted a positive total return of 0.9 percent for the third quarter. The senior-most AAArated 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.

We remain active in conduit CMBS, with heightened attention to relative value offered by varying degrees of market sponsorship, but recently we have also been able to locate opportunities in select shorter-tenor large loan transactions. Insurance companies’ voracious appetite for large loan transactions in the first half of the year has abated in the second half, and large loan CMBS financings have recently offered relatively attractive opportunities. Large loan financing of non-core property types and low leverage purchase transactions have been a particular focus for us.

Large Loan Transactions Pick Up Steam

The fourth quarter has seen an increase in large loan and singleasset, single-borrower transactions compared to the summer lull. Through mid-November, nine transactions totaling $5 billion have been priced, already the largest quarterly volume of the year.

Large Loan Transactions Pick Up Steam

Source: Intex, Guggenheim. Data as of 10.31.2016.

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

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. ©2016, 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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