Understanding Commercial Mortgage Backed Securities (MBS) and Their Risks
Mortgage-backed securities (“MBS”) are fixed income investment that are backed by a pool of mortgages. MBS come in a variety of different forms such as those backed by mortgages on commercial real estate (“CMBS”) or residential real estate (“RMBS”).
Commercial Mortgage Backed Securities are complicated instruments and during periods of stress can potentially experience large losses. This became apparent during the Global Financial Crisis of 2008 (“GFC”) when the US housing market collapsed causing a lot of the mortgages in the MBS market to default, and as a result led to large losses for investors. During the GFC even those securities that were given the highest credit rating (“AAA”) by the rating agencies experienced losses, highlighting the severity of the crisis.
Recent Challenges in the European and US commercial mortgage backed securities Markets
In recent months the AAA rated European CMBS market has looked like it will experience its first loss since the GFC, which follows off the back of the US CMBS market experiencing its first loss on an AAA rated CMBS in May-24.
The property sector globally has struggled in recent years as the higher for longer interest rate environment has weighed on property valuations. Commercial real estate has not only been negatively impacted by higher interest rates, it has also suffered from a number of structural headwinds facing the sector such as changing working dynamics (with more people working from home) and disruptive companies (the Amazon effect) reducing the demand for certain sub-sectors within this market such as offices, malls, retail stores etc. As a result, it isn’t surprising that weaknesses within the commercial property sector are starting to manifest themselves in the CMBS market.
Weaknesses in the commercial mortgage backed securities market does highlight that elements of the financial system, in particular the property sector, are coming under strain but we don’t believe that this will lead to a market collapse, similar to the GFC, given that it appears to be isolated to one part of the financial market and other sectors within MBS aren’t showing similar signs of stress.
Given the headwinds mentioned above and also the losses experienced by these securities in the GFC it’s important to closely monitor the property sector with the help of your investment consultant, in particular commercial property, for further signs of market stress that could negatively impact both MBS valuations and also the financial ecosystem more broadly going forward.
Staying Informed and Proactive: Your Next Steps
The evolving landscape of the commercial mortgage backed securities market underscores the importance of staying vigilant and proactive in managing your investments. While current weaknesses in the market appear contained, we encourage you to regularly review your investment portfolio to identify any exposure to vulnerable sectors.
By staying informed and responsive to market conditions, you can better navigate potential risks and protect your financial interests. Reach out to your consultant today to discuss any concerns or adjustments needed in your strategy.
