Summer officially started on June 21st, but the fireworks started a day earlier with Ben Bernanke’s announcement that he would start winding down the central bank’s monetary stimulus program. In the latest round of the program known as Quantitative Easing, the Fed has been buying $85 billion worth of financial assets each month to keep long-term interest rates low. This announcement sent the financial markets into a tizzy. The last day of spring was marked with the market’s worst single-day drop since November 2011 and the 10-year Treasury yield jumping to 2.42%, its highest level in more than a year.
Temperatures are not the only thing rising as we settle into summer. Interest Rates have also spiked significantly. Less than 60 days ago, the 10-year Treasury was hovering in the 1.70 to 1.80% range, and now as we head into the first week of July, the same 10-year Treasury is in the 2.40% to 2.50% range – a 70 to 80 bps increase in a relatively short period of time. Bernanke’s announcement and the resulting volatility in the markets have had a significant impact on commercial real estate finance, particularly in the CMBS market. Almost any deal that went under application 30 days ago or more is certainly headed toward a fork in the road as closing nears. The uncertainty in the market not only led to rising interest rates but also to widening spreads as lenders had to adjust to remain profitable, creating a double whammy for Borrowers. For instance, a 10-year CMBS loan interest rate is typically priced-based on the 10-year Swap Rate plus a spread. Typical time to close a CMBS loan from the time a loan application is executed is 45-60 days, so if we look back to early May, the Swap Rate was 1.84% (on May 3rd). If the spread was 2.00%, the Borrower was looking at a sub 4% interest rate fixed for 10 years! Now it is the end of June, and it is time to close the loan. The problem is that the Swap Rate is now 2.70% (on June 28) and the spread is now 2.25% rather 2.00%. In the course of 60 days, the interest rate in this example swung 100 bps in the wrong direction for the Borrower. This type of swing could kill a deal completely and almost certainly could result in cutting the loan proceeds.
Borrowers have a bit of a dilemma on their hands. Take your lumps and lock into today’s rates or gamble and play the “wait and see” game. We have seen with the reemergence of the CMBS market a couple of years ago a similar pattern right after Memorial Day where spreads widened out significantly. Let’s just chalk it up to summer delirium. However, as the summers wore on and headed toward fall, the markets settled and spreads tightened. Will this be the case again this summer? It is possible spreads will settle down, but it is less likely that we will see rates come back down to where they were just a mere 30-60 days ago. This summer, unlike the past, started with Bernanke’s announcement of his plan to stop propping up the economy. Just the announcement alone caused a drastic movement in rates. What will happen when and if he actually implements his plan later this year? Certainly if the Fed stops buying $85 billion worth of bonds each month, there would only seem one direction for rates to go (and that is up, not down).
While the memories of sub 4% fixed-rate money are still fresh on the minds of borrowers, it cannot be forgotten that we are coming into this summer of rising interest rates off historically low rates. Prior to the crash in 2008, Borrowers were ecstatic to lock in CMBS loans for 10 years with rates in the area of low to mid 6%, so getting in today in the 5% range is still exceptional in the grand scheme of things.
Please contact any of MCA’s Senior Directors at 972-267-0600 / www.metcapital.com to further discuss your transactions that may involve using CMBS or any other type of commercial real estate finance instrument.