Investment Insights What are US commercial mortgage-backed securities (US CMBS)? Introduction US Commercial mortgage-backed securities (US CMBS) are bonds collateralized by commercial real estate loans which are, in turn, secured by commercial real estate. The cash flow from the commercial mortgage loans is used to service the interest and repay the principal on the bonds. Kevin Collins Head of CMBS Credit, Invesco Fixed Income Daniel Saylor Senior Analyst, Invesco Fixed Income Background The US CMBS market began in the early 1990s after the US congress created the Resolution Trust Corporation (RTC) to resolve the savings and loan crisis. 1 S&Ls were active in mortgage, consumer and commercial lending but adopted risky lending practices that led to insolvency. The issuance of CMBS helped the RTC dispose of non-performing and distressed commercial mortgage loans as it liquidated failed S&Ls. The RTC paid discounted prices for the commercial mortgages, pooled them together, and sold them in tranches to investors in the form of securities CMBS. Growth Due to its success as an asset class, the US CMBS market continued to develop after the S&L crisis was resolved. The value of US CMBS outstanding grew from USD42 billion in 1990 to approximately USD900 billion by 2007. 2 Since then, the size of the market has declined to USD565 billon, as loans have been paid down and issuance slowed following the global financial crisis. 3 However, origination activity and corresponding US CMBS issuance has accelerated in recent years as investors have tried to gain exposure to loans with lower current loan-to-value ratios (ratio of loan amount to property value) and higher debt service coverage ratios than those originated pre-crisis. Today Today s US CMBS market is an important sector in the global fixed income market. It enables a wide range of investors to gain exposure to the US commercial real estate market and facilitates financing to real estate owners across a wide range of property types. Today, the US CMBS sector is part of the BBG BARC U.S. Aggregate Bond Index. Why consider US CMBS? A CMBS strategy can provide focused exposure to commercial real estate loans or help diversify an overall fixed income portfolio. We believe interesting opportunities currently exist in US CMBS due to strong US commercial real estate fundamentals and a growing number of US commercial real estate loans that will need to be refinanced. Further, US CMBS may provide attractive incremental yield relative to the US corporate bond market. We believe institutional money managers, insurance companies, pension funds and other investors may want to consider US CMBS for several reasons: Historically provided incremental yield relative to the US corporate bond market Limited prepayment risk due to prepayment penalties on underlying loans Diversification across property types and US states US CMBS are backed by loans secured by income-producing commercial real estate. Focused exposure to an improving US economy and a US commercial real estate market that has benefited from increased demand This document is for Qualified Investors in Switzerland, Professional Clients in Continental Europe, Dubai, Guernsey, the Isle of Man, Jersey and the UK; for Institutional Investors only in the United States and Australia; for Professional Investors in Hong Kong; for Qualified Institutional Investors in Japan; for Persons who are not members of the public (as defined in the Securities Act) in New Zealand; in Singapore for Institutional Investors and / or Accredited Investors; in Canada, this document is restricted to Accredited Investors as defined under National Instrument 45-106. It is not intended for and should not be distributed to, or relied upon by, the public or retail investors. Please do not redistribute this document.
US CMBS have provided incremental yield (Yield on CMBS minus yield on comparably rated sector) Baa additional yield A additional yield Aa additional Yield 12/30/11 3/30/12 6/29/12 9/28/12 12/31/12 3/29/13 6/28/13 9/30/13 12/31/13 3/31/14 6/30/14 9/30/14 12/31/14 3/31/15 6/30/15 9/30/15 12/31/15 3/31/16 6/30/16 9/30/16 12/30/16 3/31/17 6/30/17 % 6 5 4 3 2 1 Source: BBG BARC, 31 Dec. 2011 to 30 June 2017. Past performance is not a guarantee of future results. BBG BARC US CMBS 2.0 Aaa 8.5+ Year Index, BBG BARC US CMBS 2.0 Aa Year Index, BBG BARC US CMBS 2.0 A Year Index, BBG BARC US CMBS 2.0 Baa Year Index, BBG BARC Aaa Corporate Index, BBG BARCs Aa Corporate Index, BBG BARC A Corporate Index, BBG BARC Baa Corporate Index. How does a US CMBS work? US CMBS start with a pool of mortgage loans. The cash flow from this collateral pool of mortgage loans is used to service interest and repay principal on US CMBS. Typical US CMBS capital structures include multiple classes of bonds divided according to their level of expected risk and maturity. These classes have different positions in terms of priority of receiving interest and principal payments. The senior classes (lower credit risk) are scheduled to receive interest and principal payments ahead of the junior classes (higher credit risk). Any collateral losses would typically be applied to the junior classes first and distributed in order of junior to senior class. As such, the risk of not receiving interest and principal payments on a given security is greater for the junior classes relative to the senior classes. Typical US CMBS Transaction Investment Grade CMBS: Aaa/AAA Last Loss Lower Credit Risk Collateral Pool Other Investment Grade CMBS: Aa2/AA, A2/A, Baa2/BBB Non-Investment Grade CMBS: Ba2/BB, B2/B Non-Rated CMBS First Loss Higher Credit Risk For illustrative purposes only IFI approach to CMBS Invesco Fixed Income (IFI) employs a balanced top-down, bottom-up risk allocation approach in our portfolio construction process. Our top-down analysis examines factors in the broader US economy such as GDP growth, interest rates, labor market dynamics, consumer data and corporate earnings. Our analysis then defines fundamental trends in US commercial real estate such as property supply, tenant demand, occupancy rates, rental rates and financing terms to shape our outlook for various commercial real estate property types across geographic regions in the US. Our outlook for each regional market and property type helps form key rent growth and valuation assumptions used in our bottom-up analysis. Investment Insights: What are US commercial mortgage-backed securities (US CMBS)? 2
How IFI is different While many investment managers rely on external credit ratings in making CMBS investment decisions, IFI conducts a review of each credit. Our analysis considers insight from our macro team, direct real estate investors, mortgage servicers and commercial real estate loan brokers in the US. The insights of IFI s corporate credit team are also utilized to monitor tenant risk, such as potential retail store closings. Our proprietary model projects loan level defaults and corresponding loss severities for individual loans underlying each security (i.e. collateral performance ). Each loan is assigned a risk score which considers trends in debt service coverage ratios, loan-to-value ratios, occupancy rates, and payment histories. After projecting the performance of the underlying collateral, scenario analysis is conducted to project bond and transaction cash flows under base, favorable and stress scenarios. Each CMBS class is assigned a fundamental rating. These ratings are communicated across the broader IFI team. Performance of collateral pools is monitored and ratings changes are broadcast to the team. Relative value analysis compares internal ratings to projected yields to make buy and sell decisions. Performance of individual securities is closely monitored and positions are typically re-evaluated quarterly, using the most recent underlying property and loan cash flows. We believe our seasoned investment team and robust research capabilities enable us to identify attractive income opportunities and anticipate incremental credit spread tightening through disciplined security selection and timely sector allocation. CMBS assets under management across Invesco December 2006 to June 2017 CMBS AUM CMBS investment grade index spread over US Treasuries 12/06 12/07 12/08 12/09 12/10 12/11 12/12 12/13 12/14 12/15 12/16 bps USD mm 1,600 1,400 1,200 1,000 800 600 400 200 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 Source: Invesco Fixed Income and BBG BARC Live (BBG BARC CMBS Investment Grade Index, BBG BARC U.S. Treasury Index), data from 31 Dec. 2006 to 30 June 2017. 1 The large scale failure of community savings and loans institutions, or S&Ls. 2 Commercial Mortgage Securities Association (CMSA), July 2007 3 SIFMA, Sept. 2016 Investment Insights: What are US commercial mortgage-backed securities (US CMBS)? 3
Important information This document is for Qualified Investors in Switzerland, Professional Clients in Continental Europe, Dubai, Guernsey, the Isle of Man, Jersey and the UK; for Institutional Investors only in the United States and Australia; for Professional Investors in Hong Kong; for Qualified Institutional Investors in Japan; for Persons who are not members of the public (as defined in the Securities Act) in New Zealand; in Singapore for Institutional Investors and / or Accredited Investors; in Canada, this document is restricted to Accredited Investors as defined under National Instrument 45-106. It is not intended for and should not be distributed to, or relied upon by, the public or retail investors. Please do not redistribute this document. Important information This overview contains general information only and does not take into account individual objectives, taxation position or financial needs. Nor does this constitute a recommendation of the suitability of any investment strategy for a particular investor. It is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or instrument or to participate in any trading strategy to any person in any jurisdiction in which such an offer or solicitation is not authorized or to any person to whom it would be unlawful to market such an offer or solicitation. It does not form part of any prospectus. While great care has been taken to ensure that the information contained herein is accurate, no responsibility can be accepted for any errors, mistakes or omissions or for any action taken in reliance thereon. The opinions expressed are that of Invesco Fixed Income and may differ from the opinions of other Invesco investment professionals. Opinions are based upon current market conditions, and are subject to change with notice. Past performance is no guarantee of future results. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Asset management services are provided by Invesco in accordance with appropriate local legislation and regulations. This material may contain statements that are not purely historical in nature but are forward-looking statements. These include, among other things, projections, forecasts, estimates of income, yield or return or future performance targets. These forward-looking statements are based upon certain assumptions, some of which are described herein. Actual events are difficult to predict and may substantially differ from those assumed. All forward-looking statements included herein are based on information available on the date hereof and Invesco assumes no duty to update any forward-looking statement. Risk factors are described in the Offering Memorandum. Accordingly, there can be no assurance that estimated returns or projections can be realized, that forward-looking statements will materialize or that actual returns or results will not be materially lower than those presented. All information is sourced from Invesco, unless otherwise stated. All data as of 30 June 2017 unless otherwise stated. All data is USD, unless otherwise stated. RESTRICTIONS ON DISTRIBUTION Australia. This document has been prepared only for those persons to whom Invesco has provided it. It should not be relied upon by anyone else. Information contained in this document may not have been prepared or tailored for an Australian audience and does not constitute an offer of a financial product in Australia. You may only reproduce, circulate and use this document (or any part of it) with the consent of Invesco. The information in this document has been prepared without taking into account any investor s investment objectives, financial situation or particular needs. Before acting on the information the investor should consider its appropriateness having regard to their investment objectives, financial situation and needs. You should note that this information: may contain references to dollar amounts which are not Australian dollars; may contain financial information which is not prepared in accordance with Australian law or practices; may not address risks associated with investment in foreign currency denominated investments; and does not address Australian tax issues. Issued in Australia by Invesco Australia Limited (ABN 48 001 693 232), Level 26, 333 Collins Street, Melbourne, Victoria, 3000, Australia which holds an Australian Financial Services License number 239916. Canada. This document is restricted to accredited investors as defined under National Instrument 45-106. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in an investment making decision. As with all investments there are associated inherent risks. Please obtain and review all financial material carefully before investing. Issued in Canada by Invesco Canada Ltd., 5140 Yonge Street, Suite 800, Toronto, Ontario, M2N 6X7. Europe and Dubai. This document is for Qualified Investors in Switzerland, Professional Clients in Continental Europe, Dubai, Guernsey, the Isle of Man, Jersey and the UK and is not for consumer use. This document is not intended to provide specific investment advice including, without limitation, investment, financial, legal, accounting or tax advice, or to make any recommendations about the suitability of any product for the circumstances of any particular investor. You should take appropriate advice as to any securities, taxation or other legislation affecting you personally prior to investment. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without Invesco s prior written consent. Further information is available using the contact details shown: Issued In Austria by Invesco Asset Management Österreich GmbH, Rotenturmstrasse 16-18, A-1010 Wien. Issued in France by Invesco Asset Management S.A., 16-18, rue de Londres, F-75009 Paris, which is authorised and regulated by the Autorité des marches financiers in France. Issued in Germany by Invesco Asset Management Deutschland GmbH, An der Welle 5, 60322 Frankfurt am Main, Germany. Issued in the Isle of Man by Invesco Global Asset Management DAC, Central Quay, Riverside IV, Sir John Rogerson s Quay, Dublin 2, Ireland. Regulated in Ireland by the Central Bank of Ireland. Issued in Jersey and Guernsey by Invesco International Limited, 2nd Floor, Orviss House, 17a Queen Street, St. Helier, Jersey, JE2 4WD. Invesco International Limited is regulated by the Jersey Financial Services Commission. Issued in Switzerland by Invesco Asset Management (Schweiz) AG, Talacker 34, CH-8001 Zürich. Issued in Dubai by Invesco Asset Management Limited. PO Box 506599, DIFC Precinct Building No 4, Level 3, Office 305, Dubai, UAE. Regulated by the Dubai Financial Services Authority. Issued in the United Kingdom by Invesco Asset Management Limited which is authorised and regulated by the Financial Conduct Authority. Invesco Asset Management Ltd, Perpetual Park, Perpetual Park Drive, Henley-on- Thames, RG9 1HH, UK. Investment Insights: What are US commercial mortgage-backed securities (US CMBS)? 4
Hong Kong. This document is provided to professional investors (as defined in the Securities and Futures Ordinance and the Securities and Futures (Professional Investor) Rules) only in Hong Kong. It is not intended for and should not be distributed to, or relied upon, by the members of public or the retail investors. Issued in Hong Kong by Invesco Hong Kong Limited 景順投資管理有限公司, 41/F, Champion Tower, Three Garden Road, Central, Hong Kong. Japan. This document is only intended for use with Qualified Institutional Investors in Japan. It is not intended for and should not be distributed to, or relied upon, by members of the public or retail investors. Issued in Japan by Invesco Asset Management (Japan) Limited, Roppongi Hills Mori Tower 14F, 6-10-1 Roppongi, Minato-ku, Tokyo 106-6114, Japan, which holds a Japan Kanto Local Finance Bureau Investment advisers licence number 306. New Zealand. This document is issued in New Zealand only to Persons who are not members of the public in New Zealand (as defined in the Securities Act). This document has been prepared only for those persons to whom it has been provided by Invesco. Information contained in this document may not have been prepared or tailored for a New Zealand audience. This document does not constitute and should not be construed as an offer of, invitation or proposal to make an offer for, recommendation to apply for, an opinion or guidance on Interests to members of the public in New Zealand. Any requests for information from persons who are members of the public in New Zealand will not be accepted. Issued in New Zealand by Invesco Australia Limited (ABN 48 001 693 232), Level 26, 333 Collins Street, Melbourne, Victoria, 3000, Australia, which holds an Australian Financial Services License number 239916. Singapore. This document may not be circulated or distributed, whether directly or indirectly, to persons in Singapore other than (i) to an institutional investor under Section 304 of the Securities and Futures Act (the SFA ), (ii) to a relevant person pursuant to Section 305(1), or any person pursuant to Section 305(2), and in accordance with the conditions specified in Section 305 of the SFA, or (iii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA. This document is for the sole use of the recipient on an institutional offer basis and/ or accredited investors and cannot be distributed within Singapore by way of a public offer, public advertisement or in any other means of public marketing. Issued in Singapore by Invesco Asset Management Singapore Ltd, 9 Raffles Place, #18-01 Republic Plaza, Singapore 048619. United States. This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions. Issued in the United States of America by Invesco Advisers, Inc., Two Peachtree Pointe, 1555 Peachtree Street, N.E., Suite 1800, Atlanta, GA 30309. II-CMBS-INSI-1-E 09/17 GL406