As to the first two headlines, “It’s always the economy, stupid!” Readers should not need to be reminded that the global economy is fragile. While the United States may be the “cleanest dirty shirt in the closet,” Europe continues to struggle and China faces the possibility of a slowdown. The United States is not strong enough to carry the burden of economic growth by itself. We should expect to continue to “slog it out” for a considerable period of time.

As it relates to the third headline, we highlighted this issue in recent weeks with comments on “cov-lite” loans and the reported weakening of lender underwriting practices. Now, the regulators have stepped in and are grilling banks over lending standards and warning them about mounting risks in business loans. One should recall that it was lax lending practices across a wide array of industries that led to the recent crises.

Desperate for Yield

Nowhere is it more evident that institutional investors are desperate for yield than in the commercial mortgage–backed securities (CMBS) market. Given up for dead, the CMBS market has staged a Lazarus-like recovery, with 2013 year-to-date issuance of $20.5 billion, and prospects for total issuance for 2013 reaching $60 billion or more.

Investor demand and a flood of capital have led to lower-weighted-average loan coupons and spread compression, as indicated on the following chart:

Month

Weighted average loan coupon

AAA spread in basis points

June 2012

5.41%

143

November 2012

4.77%

94

May 2013

4.30%

75

There is no argument that borrowers have benefited from this “food fight,” with the all-in cost of CMBS borrowing increasingly competitive with that of insurance companies. But the worry is that to gain market share, CMBS originators have become too aggressive in their underwriting and that their lending and credit culture are suffering.

Monday’s Numbers

The Trepp survey for the period ending May 31 showed spreads widening slightly, with all-in costs remaining in the 4 percent range for top-tier assets and in the mid–4.0 percent area for less “pristine” assets and borrowers. While trying to outguess the Federal Reserve’s next move is giving the financial markets a headache, it’s “no harm, no foul” for the moment with capital available from many sources. We continue to believe we can take Chairman Bernanke at his word that the Fed will telegraph its next move well in advance.

Asking Spreads over U.S. Treasury Bonds in Basis Points
(Ten-Year Commercial and Multifamily Mortgage Loans
with 50% to 59% Loan-to-Value Ratios)

12/31/09

12/31/10

12/31/11

12/31/12

6/7/13

Month earlier

Office

342

214

210

210

174

185

Retail

326

207

207

192

163

174

Multifamily

318

188

202

182

151

164

Industrial

333

201

205

191

159

174

Average spread

330

203

205

194

162

174

10-Year Treasury

3.83%

3.29%

1.88%

1.64%

2.16%

1.70%

The Cushman & Wakefield Equity, Debt, and Structured Finance Group’s monthly survey of commercial real estate mortgage spreads for the one-month period ending June 3, 2013, showed spreads for ten-year, fixed-rate mortgages secured by Class A property widening as much as 40 basis points for Class A property, with spreads for Class B property widening 20+/- basis points. 

Ten-Year Fixed-Rate Commercial Real Estate Mortgages (as of May 2, 2013)

Property

Maximum
 loan-to-value

Class A

Class B

Multifamily (agency)

75–80%

T +195

T +200

Multifamily (Nonagency)

70–75%

T +190

T +195

Anchored retail

70–75%

T +210

T +220

Strip center

65–70%

T +230

T +240

Distribution/warehouse

65–70%

T +210

T +220

R & D/flex/industrial

65–70%

T +235

T +240

Office

65–75%

T +200

T +215

Full-service hotel

55–65%

T +265

T +290

Debt-service-coverage ratio assumed to be greater than 1.35 to 1.

Year-to-Date Public Equity Capital Markets

DJIA (1): +15.00%
S&P 500 (2): +14.06%
NASDAQ (3): +17.47%
Russell 2000 (4): +15.54%
Morgan Stanley U.S. REIT(5): +5.05%

 (1) Dow Jones Industrial Average; (2) Standard & Poor’s 500 Stock Index; (3) NASD Composite Index;
(4) Small capitalization segment of U.S. equity universe; and (5) Morgan Stanley REIT Index.

U.S. Treasury Yields

12/31/11

12/31/12

6/14/13

3-Month

0.01%

0.08%

0.05%

6-Month

0.06%

0.12%

0.08%

2-Year

0.24%

0.27%

0.29%

5-Year

0.83%

0.76%

1.04%

7-Year

1.35%

1.25%

1.53%

10-Year

1.88%

1.86%

2.14%

                                                  

Key Rates (in Percentages)

 

Current

1 Yr. Prior

Federal funds rate

0.09

0.18

Federal Reserve target rate

0.25

0.25

Prime rate

3.25

3.25

U.S. unemployment rate

7.60

8.70

1-Month LIBOR

0.19

0.24

3-Month LIBOR

0.27

0.47