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
February 5, 2020
Last Friday the 10 year closed at 1.50% just 14 bps above its all time low, as coronavirus fears spurred a flight to safety. This week’s upbeat data turned things around as “risk-on” returned. The ADP employment report was significantly more bullish than expected. Note that the manufacturing sector has been lagging in recent months while employment and consumer metrics have been bullish. After Monday’s ISM Manufacturing Index report and yesterday’s Factory Orders report exceeded expectations, markets really took off. The 10 year T jumped to 1.65%. Various unconfirmed reports of potential treatments emerging for the coronavirus added to the rally. However, note that these reports are based on pre-virus data and Asian supply chains are critical to that sector. So there is some caution as the effects and scope of the virus is yet to be quantified. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
January 29, 2020
During today’s Fed statement and subsequent comments by Fed Chair Powell there was an expressed concern about the “uncertainties” involving the spread of the Coronavirus. Treasury yields dropped and the yield curve is nearly inverted. The 10 year T is at 1.58%, the lowest in months and just 22 bps above its all time low. With the 3 month at 1.55%, another inversion may be at hand. The Fed also indicated concern about inflation and is very concerned that the U.S. does not become another Japan (ultra low rates and growth for decades with no room to cut rates and stimulate). The statement stressed that the 2.0% “symmetrical inflation target” was not a goal to be “near” but needed to be “reached”. Powell noted that the recent PCE of 1.5% was way too low and many Fed board members have indicated a willingness to let inflation go above 2.0% without raising rates quickly, possibly letting inflation “run for a while” hopefully in conjunction with strong growth. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
January 15, 2020
After two years of uncertainty that roiled stock and bond markets, the Phase 1 trade deal has been signed. Now the details are being parsed. Market reaction is basically a “relief rally” as the week to week uncertainty and tensions between U.S. and China have lessened. However, tariffs will remain in place subject to a Phase 2 agreement after the November election. The initial agreement mostly requires China to buy U.S. goods and services (some uncertainty remains whether China can perform on those purchases). This should remove a source of market volatility in 2020 and should be favorable for credit spreads. Treasuries and equity markets rallied with the 10 year Treasury closing at 1.78%. The first CPI and PPI reports of 2020 indicate (surprise) extremely low inflation pressures. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
January 8, 2020
Today’s yield curve is striking for it’s “normality”, ie. it is uninverted and fairly steep. One year ago today, the 2, 5 and 10 year treasury yields were bunched together, all within about 10 bps (2.55%, 2.58% 2.67%). The yield curve then inverted in August as the 10 year dipped below the 2 year yield. Today’s yield curve (1.57%, 1.65%, 1.87%) indicates confidence in the economy (high 10 year yield) and in the Fed’s promise to stand pat with no rate increase this year (lower 2 year yield). So 2020 begins with lower rates and a healthier curve. With low delinquency rates, an active secondary market, large allocations from portfolio lenders, and overall solid fundamentals, 2020 looks like another big year for commercial mortgage loan volume. For example, the Mortgage Bankers Association predicts an all time high in multifamily lending in 2020. Commercial activity is also predicted to be strong, with the notable exception that lenders are cautious on retail. As the economic recovery goes into year 11, it’s noteworthy that markets basically shrugged off potential escalation of conflict in the mid-East and uncertainty about U.S. China trade resolution. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
December 18, 2019
Behind the impeachment drama, our divided government has been getting things done: new trade agreement with Mexico and Canada, major spending bills (with major deficit spending), an outline of a trade deal with China (some are calling it more of a “trade truce” with the heavy lifting set for next year). The Fed is doing their part by injecting liquidity into the short term markets almost daily, but don’t call it QE. All of these factors along with some positive economic news from Europe and hopes that next year’s Brexit will be orderly have buoyed the 2020 global growth outlook. Treasuries are selling on the sentiment with the 10 year hitting 1.92% today, the highest since July. Maybe those prognosticators that picked a 2.00% 10 year T at year end are pretty close. The rising treasury and relatively stable LIBOR index could return us to a more “normal” index relationship: a steeper yield curve and a 10 year T getting separation from 30 day LIBOR (as the Fed has indicated no rate increases in 2020). So floating loan rates should again be “cheaper” than perm rates. The good economic fundamentals should keep loan spreads tight. In a few weeks, the securitized lenders (CMBS, CLO, etc) will be ready to issue new paper to bond buyers flush with new allocations for the new year. Portfolio lenders will have to compete as the securitized markets often set the bar on spreads.
Signing off for 2019. It’s been a pleasure writing this column for you and I look forward to an exiting new decade.
By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
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