Effects of U.S. Credit Downgrade on Commercial Real Estate Lending

by Kevan McCormack, Senior Director

What do France, Germany, Canada, the UK and Denmark all have in common?  They all have higher credit ratings than our very own United States of America according to Standard and Poor’s after their recent downgrade of U.S. Debt.  We are truly living in a unique time.  For the first time in the history of our great nation, our country has lost its’ AAA Credit Rating.  This means that during WWI, the Great Depression, and WWII, the U.S. had a higher credit rating than it enjoys today!

As most people know by now, the Monday after the downgrade, the Dow lost over 640 points (the 6th largest point loss in a single day).  Tuesday the Dow recovered over 400 points, Wednesday and Thursday was practically a replay.

This week, the Fed vowed to keep lending rates at their historic lows through mid-2013.  Does this “statement” affirm the administration’s true belief, that any significant recovery in the United States market is not anticipated until after the elections?  Is this the political equivalent of “throwing in the towel?”

I suppose, the U.S. Credit Rating could be revised by S&P back to investment grade if the political discourse in the U.S. changes for the better in the coming months and the politicians produce real deficit reduction initiatives, but with such a sharp divide in policy that currently exists, there are very few that actually believe this is a realistic possibility.

So what are the effects of the volatility and the U.S. Credit Rating downgrade on commercial real estate lending?  Predictions in the financial markets are about as solid a science as predicting a tsunami in Japan when a butterfly flaps its wings in Brazil.  But we can focus on a couple of the more direct relationships to gain a better understanding of explaining our current set of events.

The bond market, like the stock market, is very nervous.  With the rollercoaster ride in the stock market, it is to nobody’s surprise that the Volatility Index (VIX) is at its’ highest in several years.  The VIX has a very strong correlation to CMBS spreads, so the fact that CMBS spreads have risen substantially over the past couple of weeks should not be a surprise.  The volatility has grown to a point where many of the pure Conduit/CMBS Lenders have basically stopped quoting new deals.  Conduits with existing product in inventory will have to make their next securitizations a little more attractive to investors (i.e. likely take a loss or at least less of a profit) just to get the loans off their books, and then they will breathe a “sigh of relief” and wait!

Wait for what?  How long will this last?  A week, a month, through 2013…no one really knows.  While some do not anticipate this state to last that long (maybe after Labor Day when everyone gets back to work and focuses on the year-end), the global markets continue to experience a string of unprecedented events which tends to fog crystal balls throughout the world.

At the bank lending level, there may be no short-term or mid-term negative effects with the current state of affairs.  Unlike the most recent events affecting banks’ lending mentality, the banks seem to be more insulated from the current set of market circumstances.  Conversely, banks may actually experience an increase in their depository base as investors flee the risk of the equity markets and hoard cash.  This could, in turn, create increased pressure for banks to become more aggressive and lend as depositors mount pressure for better interest rates on their money.

Real Estate Investors should set their financing expectations that the next few months are going to be difficult for the CMBS markets.  CMBS quotes you got in June will look little like quotes you will get today, assuming you even get a deal quoted.  Investors with bank deals should get their affairs in order and get moving before another butterfly flaps its wings.

Want to learn more about this, contact Kevan McCormack, Senior Director.