May 27, 2020
Today’s remarks by New York Fed President John Williams were illuminating as he discussed the possibility of “yield curve control” to aid the economy. This will involve the Fed buying and selling long-term bonds in order to “set” long term rates. This has not been implemented since WW II. Other countries have attempted this strategy recently, most notably Japan in setting long-term rates at 0%. The Fed continues to search for stimulative tools as they have already dropped rates to 0% for an extended period. Meanwhile, the Fed is rolling out four new previously approved facilities this week: $600 Billion Main Street Lending Program, Primary Market Corporate Credit Facility, Municipal Liquidity Facility, and Term Asset Backed Securities Loan Facility. This will place the Fed in the center of the corporate, municipal and MBS bond markets as buyer of last resort. The Main Street Lending Facility is highly anticipated, and will allow the Fed to lend (at approximately 300 over LIBOR) to companies with employees of 15,000 or less, hoping that this access to capital can help act as a springboard back to “normality”. Secretary Mnuchin indicated last week that the Treasury expected to “take losses” on these programs, implying they are almost like grants. The issue will be whether these capitalized businesses will be able to attract customers and thrive in the the present economic environment. Will customers (corporate or individual) still spend? The Treasury is “fully prepared to take losses in certain scenarios” on these programs implying that they are almost like grants. This gets back to solvency issues and whether more government grants are in order, ie. another stimulus package. After lots of hemming and hawing about “wait and see” it seems there is some new sense of urgency to pass another bill in early June. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
May 20, 2020
There is some level of reopening in all 50 states this week. Monday’s hopeful news about a potential vaccine rallied stock and debt markets. The rally may have been an overreaction, time will tell. But, both news items illuminate the situation. Various phases of restarting business is under way, with new guidelines that hopefully will prevent a second wave of infections. We are entering another “new normal” of “cautious commerce” until a medical solution is reached. Economists, politicians, policy makers, business leaders and all of society are grappling with the obvious questions about the speed and shape of the recovery. These issues were very starkly raised in yesterday’s fascinating appearance before the Senate of Fed Chair Powell and Treasury Secretary Mnuchin. First off, the CMBS market was mentioned multiple times. Senators asked about “empty malls” and the securitized loans that back them. Powell was asked by Senator Tim Scott, “Why aren’t you doing more for CMBS?” Senator Ben Sasse asked if the Fed was taking “Too much risk in CMBS?” Powell said he is supporting and monitoring CMBS, which is an “important market” but “not every problem can be addressed”. The Fed is only buying AAA bonds and he doesn’t anticipate any haircuts. After the highly watched 60 Minutes appearance, Powell continued to challenge Congress. He reiterated the tough road for the economy ahead and a potential slowing recovery. Powell called on Congress for further stimulus and reiterated the limits of the Feds power. It comes down (again) to monetary policy and fiscal policy. With the major shock to the economy over the past few months, many businesses (small and large) and governmental entities (states and cities) are reeling. If the Great Recession was basically a massive credit crisis, today’s issue is a solvency crisis. Powell reiterated that the credit markets are flush with liquidity and there is money to lend. But, many potential borrowers are not creditworthy and/or insolvent. Powell has clearly stated many times that the Fed cannot “make grants”. That puts the pressure back on Congress to provide fiscal aid in order to help with solvency. These policies are controversial as the terms “bailout” and “moral hazard” are likely to come up. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
May 13, 2020
Some good news on lending as the first CMBS securitization since pre-crisis (early March) executed better than expected on Friday. The pool consisted of above average quality loans originated pre-crisis, with no hotels and very little retail. There was oversubscribed demand and spreads were tighter than expected throughout the bond classes. CMBS originators are cautiously optimistic as new loans are being quoted. Look for leverage in the 65% range, some reserves may be required at loan closing and extra scrutiny on sponsorship. Underwriting standards will be more conservative. As CMBS originates, we have seen some life companies narrow their spreads to win business on good quality real estate.
Some more “green shoots” are visible as the bridge lenders are starting originations also. The warehouse lending market (big banks lending to debt funds) has started up again, with more cautious leverage. The warehouse lenders will also monitor loan collateral more closely. Multifamily, office, industrial bridge lending is back with leverage in the 65-70% range with spreads in the L+350-450 range (as opposed to 80+% stretch bridge loans at L + 275-325 pre-COVID). As credit becomes more available, the focus will be on property specifics (location, resilience of the income, etc). Fundamentals going forward in this environment will be critical, and many of the fundamentals are dependent on the virus spread and hopes for treatments/vaccine.
Fed and Data: Fed Chair Powell’s remarks today shook markets. He called on Congress and the Administration to authorize further “fiscal support” or risk “long term damage” to the economy. He contextualized the recent unemployment reports with a stark statistic from the Fed’s recent survey, “40% of U.S. households making less than $40,000 per year lost a job in March”. Powell also (again) pushed back on suggestions that the U.S. implement negative interest rates.
Other Data: Yesterday’s CPI report contained unprecedented numbers: negative 0.8% CPI from March to April, the lowest since December 2008. However, food prices saw there biggest one month jump since April 1974 at 2.6%. The overall CPI was down due to big drops in clothing, energy and other categories. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
May 6, 2020
This morning ADP Private Sector Report was sobering to see 20.2 million people lost their jobs in April. By far the largest number since the survey began in 2002, the previous record was 835,000 in 2008. The loss represents all of the jobs created since the financial crisis. As America starts to open, there is hope that April was the bottom and we are climbing out of it. However, the daily human tragedy cannot be ignored or minimized. My heart goes out to all the families that have been affected by this virus. If the economy can be restarted safely, many analysts (including the Fed), believe that the job market can rebound over the next few quarters. However, the days of 3.0% unemployment may be at least a year away. This Friday’s unemployment figures will be closely watched. After all the major volatility in March The 10-year T is now trading in a tight range, in the .60-.75% range and is at 0.70% today. As oil rebounded from negative prices into positive territory, the Treasury yields have increased accordingly as threats of deflation have subsided for now. The CMBS market is thawing as spreads throughout the capital stack are narrowing. New originations at 60-65% LTV with all in rates in the 4% range and many loans will require a 6-month interest reserve. Expect originators to as “CMBS 3.0” begins, expect originators to be about strong collateral and strong sponsors but no hotels currently. We are seeing some bridge lenders start to quote again on well underwritten multifamily transactions. Rates are lower than “hard money” rates, but leverage has been dialed back. The 80+% of cost loans pre-COVID are now 60-65% LTC, but it’s a start. The reinstituting of bank lines to lenders and/or a restart of the CLO market will greatly help. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
April 29, 2020
Today’s Fed meeting and subsequent press conference by Fed Chair Powell was like no other in history. First off, Powell said, “We are going to see economic data for the 2nd quarter that is worse than any data we have ever seen”, this after the 1 quarter GDP contracted at a 4.8% annualized rate, the worst reading since 2008. Also, Powell’s speech and Q&A was virtual, with reporter questions being asked via a webinar. He expressed some hope for a significant bounce back in the 3rd quarter as stay at home measures are gradually rolled back. Of course, so much is dependent on the virus. Markets rallied significantly today on positive news regarding a potential treatment.
Full Range of Tools: The Fed Funds rate will remain at near zero for a while (possibly for 2-3 years) and the Fed continues to purchase about $10-15 billion per day in Treasuries and $8 billion in mortgage bonds, daily injections of capital into the repo markets.
Up next: A Main Street Lending Program will provide 4 year loans to businesses too large to benefit from the PPP program and more purchases of corporate debt. But, Powell noted that the Fed is authorized to “provide loans not grants” and the most vulnerable American individuals and businesses are not in a position to pay back loans as they have been hit so hard by this crisis. “This is the time to use the great fiscal power of the United States to do what we can to support the economy and try to get through this with as little damage to the longer-run productive capacity of the economy as possible”. Powell declared in a direct message to Congress to provide this aid. He is implying that the fiscal policy so far is good but not enough and he is continuing to push monetary policy to the limit. Focus on central banks continues tomorrow with the ECB’s policy announcement. Bank of Japan opened the week on Monday pledging unlimited bond buying, as the international adoption of Modern Monetary Theory continues. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
April 22, 2020
Recently released statistics on approximate April rent collection by product type from NAREIT and NMHC: Apartments (93% but increases in late and partial payments), Industrial (99%), Grocery Anchored Retail shopping centers (46%), Retail Malls (approx.20%), Office (89%). April collections are benefiting from tenants spending reserves/savings and following March’s partial shutdown. May collections are anticipated to be lower in the wake of April’s near total shutdown, especially for apartments and retail. The upcoming months are full of anticipation and uncertainty as society begins to reopen. The strength of the economy is based on consumer confidence which will be highly dependent on safety, both actual and perceived. Lending: The secondary market is so critical for overall CRE liquidity and is showing signs of life as some CMBS originators are considering new originations (typically 65% LTV, no hotels, limited retail, multi tenant). The industry continues to lobby the Fed and Congress to allow floating rate CLO paper to be purchased by the Fed. Life companies are still very cautious, but we are seeing more of them emerge from the initial market shock and start originating, albeit at low leverage. We are seeing the local banks continue to lend cautiously mostly on apartments. Rates/Inflation: Treasuries remain ultra low, negative oil prices are another signal that inflation is not anywhere on the horizon. The Treasury rate remains low even after the Fed cut its volume of Treasury purchases to “only” $15 billion (down from $30 billion). Stimulus: Congress passed a $480 billion bill to replenish SBA PPP program. These days that’s a relatively “small” bill. The next big multi trillion dollar package is being discussed for May (CARES2 or Stimulus 4). Infrastructure, tax incentives (restaurants, entertainment, sports, etc according to the President), and aid to state and local governments are the most discussed elements. The Mortgage Bankers Association would like to see forbearance policies codified by law and liquidity provided for loan servicers, allowing them to keep bondholders current. This would be another critical element towards restarting the securitized loan marketplace. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
April 15, 2020
Rates: Worldwide Indices remain at historic lows. The 10-year T is at 0.64% with the comparable German Bond at -0.46%. The 2-year T is at 0.20%. 30-day LIBOR is easing closer to the Fed Funds rate, down to 0.79%. Note that SOFR, the expected replacement is at 0.06%. These rates are indicative of a Federal Reserve flooding the markets with liquidity and buying a vast array of debt securities. Note that most new loan quotes are untethered from these indices as we are seeing most loans quoted as a coupon (with the notable exception of the agencies, Fannie Mae and Freddie Mac)
The Data: We are seeing the first monthly reports quantifying the damage from the Covid crisis. Today’s news included a record drop in retail sales of 8.7% including a 26% drop in restaurant sales. Other key industries hit hard were apparel (-50%), gas stations (-17.2%). Gains were seen in grocery stores and drug stores, on-line ordering and large retailers such as Walmart and Costco. Industrial reports show factory output hitting a low that has not been seen since 1946. March was a partial shutdown month; April’s reports are anticipated to be lower still. Major banks are reporting huge drops in earnings for Q1 2020 and are allocating large cash reserves in anticipation of a very rough second quarter.
The Near Future: Hopeful signs are emerging. Social measures seem to be “flattening the curve” both nationally and in some of the hot spots. The anticipation of the reopening of society over the next few months and the breadth and shape of the economic recovery is a major question with no precedent. No doubt things will be different. Governor Newsom of California discussed restaurants reopening with every other table empty, disposable menus, masked and gloved employees, and extreme cleaning. An air travel group asked, “Is this the end of the middle seat?” This “gradual reopening” with small businesses and large corporations operating at partial capacity will have economic and social consequences. Example: Is a shopping center with many businesses operating at 40-60% of Pre-COVID levels going to be able to collect full rent and pay debt service? Consumer spending accounts for approximately 70% of US economic growth. The ramp up to full recovery will be highly dependent on consumer confidence and behavior. That is tied into the science: more robust and available testing, treatments, and the widespread availability of a vaccine.
CRE Capital Markets Update with a focus on secondary markets: There are some glimmers of hope. Last week’s announcement that the Fed’s TALF facility was eligible to purchase legacy CMBS bonds (issued before March 23) and non CRE CLO bonds was a “good start”. CMBS AAA spreads tightened to 150-170 range over 10 year Swaps (note that at their tightest they were about Swap+80, so this isn’t terrible). The first new issue pool since the crisis hit composed of all investment grade collateral (low leverage, office and industrial dominant) may go to market in late April or early May. The CLO market is a critical component of the bridge lending as it multiplies available liquidity for lending from debt funds, banks, and other floating rate lenders. Industry councils are pushing for further expansion of TALF to include new issue CMBS and real estate CLOs as that would most effectively jump start some origination in these sectors. Bottom line is that portfolio lenders do not have the allocations or willingness to service the entire commercial real estate market efficiently. Government is listening as CRE is a major contributor to employment and GDP.
April 8, 2020
Markets look to what comes next as the U.S. is seeing some benefits of the social distancing and shelter in place rules covering most of the nation, both credit and equity markets have rallied this week. “Back to normal” will not be achieved until a vaccine and treatments are widely available. The most optimistic estimates for a mass produced vaccine are for early-mid 2021. Most likely a “new-new normal” will be in place for the next year as the world starts to reopen. Widespread testing will be needed and will be accompanied by constant vigilance and fear of another wave of outbreaks. The gradualness of the comeback will most likely result in a more U shaped recovery rather than V shaped recovery. Retail will be altered as stores will encourage spacing, dedicated customer lanes that flow in one direction through the stores, sneeze guards everywhere, gloved and masked employees and customers. Offices will feature more spacing, testing of employees, and heightened sanitation measures, and more remote working. Demand for office space may change. Consumers willingness to fly, go to restaurants, stay in hotels, and attend conventions will be changed for the foreseeable future. A growing consensus of lenders and capital providers we are speaking with feel there will be some “marking to market” of valuations even after the economy has reopened. This may create issues for appraisers and lenders as they struggle to determine “value” on the other side of this crisis. This will create opportunity in the sales market along with challenges on how to underwrite future cash flow. Today we see many banks pausing on new loan submissions as they are inundated with submissions from small businesses for Paycheck Protection Program loans and other CARES act programs. The CMBS industry is intensely lobbying for private label CMBS to be eligible for Fed purchases. This is critical as the market is now basically frozen and CMBS is about 30% of commercial lending. The “max leverage CMBS loan” exit is the defacto underwriting threshold for almost all bridge and construction loans. Also, the Banks and Life Companies cannot handle the volume, nor do they offer as much leverage. To all of our readers, please stay safe out there and stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
March 11, 2020
Stocks, bonds, and credit markets are at peak volatility as the pandemic spreads worldwide. Massive daily fluctuations have become the norm. The economy may be in recession now according to many analysts. The global economy may come to a near halt with increased unemployment, slowdowns in consumer spending and business investment. Predictions are out the window as the spread of Coronavirus has surpassed precedents such as Ebola, SARS, MERS, etc. The uncertainty is contributing to the volatility. The classic “Fed put” whereby the Fed cuts rates and soothes markets is not going to cut it this time. With treatments or vaccines most likely months or years away, markets are clamoring for the full arsenal of government tools: strong crisis level fiscal and monetary policy from the U.S., a coordinated maximum response. England did their part yesterday, as the Bank of England cut rates and Parliament committed to fiscal stimulus. This was apparent with markets plummeting after a rare Fed non-meeting emergency rate cut. Various stimulus plans are being discussed in Washington: President Trump speaks tonight, the House of Representatives is expected to pass a bill tomorrow and the Senate seems to be waiting for guidance. The Fed is pulling out all the stops. Meanwhile, next week’s meeting will almost certainly include a 0.50% to 0.75% rate cut (which will bring the Fed Funds rate back to near zero, where it sat from 2008 to 2015). They have increased overnight repo line assistance to a staggering $175 billion (note that a mere $50 billion was enough during last September’s volatility). Other tools could be deployed: a full on return to QE with the Fed buying Treasuries and Mortgage backed securities. Treasuries: the 10 year hit an all time low of about 0.38% a few days ago. Today it closed at 0.84%. The yield increase usually means things are settling down, but in this case it’s “bad”. Banks are selling Treasuries in order to hoard cash. Lending: We are hearing the gamut of reactions. Some lenders are shutting down originations temporarily, some fixed rate lenders are increasingly indicating an all in rate rather than a index and spread. Underwriting standards are being scaled back. Anticipated slowdowns in consumer spending and business investment will have consequences for real estate. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
Fed Is All In – well, almost – Lenders Struggle to Quantify and Price Risk as Indices Drop to Unprecedented Levels
March 4, 2020
Yesterday’s emergency 0.5% rate cut by the Fed was both expected and surprising. The cut was expected and it seemed sudden in its timing. Equity markets plummeted in a “buy the rumor, sell the news” scenario aka “we want the Fed to cut rates, oh my gosh, the Fed cut rates, things must be worse than we thought!” Also, investors remembered that the Fed does not have a vaccine, they cannot solve coronavirus with monetary policy! Since 1998, the Fed has announced emergency (non meeting) rate cuts 8 times (Russian debt crisis 1998, dot.com crash 2001, 9/11 2001, and during the financial crisis). Prime Rate is now 4.25%, 30 day LIBOR is 1.38, and the 30 year is 1.67%. LIBOR is expected to go to about 1.15% soon. The 10 year T hit an all time low of 0.92% yesterday. This prompted some banks to issue research papers asking, “could U.S. T rates go negative?” Capital Markets: The Agency lenders instituted floors, Fannie Mae floored the 10 year T at 1.30%, then floored again at 1.10%. 10 year agency loans are being priced at about 3.40-3.60% all in. CMBS: As one originator said, “We are in uncharted territory, everyone is watching everyone else.” Spreads for full leverage loans are anywhere from 220-275. All-in coupons 3.25-3.75%, although some low leverage loans are being quoted sub 3.00% all-in. Another originator commented, “Volatility is high, but I am quoting some all time low coupons.” Hotel loans are being closely scrutinized due to the concerns about the impact on coronavirus on travel. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
February 26, 2020
The coronavirus is causing massive market volatility as the appetite for risky assets is plummeting. The 10 year T is at an all time low closing today at 1.32%. The 30 year is at 1.80%. This is in comparison to 30 day LIBOR at 1.61% (29.9 years of “curve” is 19 bps). This shows a market that is anticipating very low economic growth and inflation for the near future. The market may or may not be overreacting. The absence of hard data and rampant speculation compounds to create massive uncertainty. The coming months will be telltale as the effects start to be measured in hard data and the spread rate becomes more apparent. We are seeing lenders institute fixed rate floors as risk spreads often widen with indexes plummeting. Some macroeconomic trends to be aware of are: (1) Coronavirus will have an immediate effect on the hospitality sector; (2) The 2020 Tokyo Olympics may be cancelled at a cost of $25B if there is no containment by May; (3) The Chinese economy is slowing and Q1 results of U.S. companies doing business in China will be affected; (4) 2020 GDP growth is expected to be 2.0%. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
February 19, 2020
For many years, inflation has been the “boy who cried wolf”, sometimes glimpsed, but never fully materializing. Bond markets have been sensitive to inflationary data, often selling off when CPI, PPI or PCE data comes in “hotter” than expected. Today’s Producer Price Index was expected to rise 0.1% in January, instead it jumped 0.5%. Did the bond market sell off and yields jump 5-10 bps? No. The bond market brushed off the news and instead focused on Fed comments warning of uncertainty due to coronavirus. Now that China/U.S. trade tensions have eased (and China is engaging in massive stimulus), global growth was expected to soar in 2020. It seems we have traded one uncertainty for a more nebulous and unknown danger. 10 year Treasury yield rose 1 bsp to 1.56%. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
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