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Not a Light Switch But a Gradual Reopening

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.