Capital Market Liquidity

March 21, 2013

Two years ago I wrote an article for Western Real Estate Business discussing how increased capital market liquidity would drive a significant rebound in the commercial lending arena. What do we know now that we did not know back in February 2011 when this rally started?
Capital market liquidity is at its highest level in 5 years. Life Insurance Companies have met their 2012 production goals and have increased allocations for 2013. CMBS 2.0 is for real, and likely to outpace many of the experts’ total volume projections for 2013. And we know that after a few years of stockpiling cash and sitting on the sidelines, banks are back and committed to taking back their fair share of the commercial lending space.

Life Companies will continue to lend with cautious optimism, though it’s clear they are going to be resistant to getting into a foot race with other more aggressive lenders who have found their way back into the marketplace. Life Insurance Companies had a very solid 2012. According to industry wonks, total production was estimated at $47-$48B. Many feel 2013 is going to be another healthy year, pushing over $50B.

CMBS Issuance in 2012 soared almost 50% from 2011 when $32B was originated.  According to Commercial Mortgage Alert the activity was bolstered by approximately $18B of issuance in the last 3 months of the year—by far the largest quarterly volume of 2012. The momentum going into 2013 is strong and roughly $20B in transactions are slated to securitize within the first 90 days of the New Year.

The rally in CMBS is primarily due to the surge in bond market activity, which has driven down the cost of securitization programs. The lower cost has allowed CMBS lenders to compete with Portfolio lenders. Spreads have tightened, and in turn interest rates have declined to levels that are in line, and in some cases below, portfolio lenders’.

CMBS lenders have also become more aggressive with leverage. To the pleasant surprise of many owners and developers facing refinance in 2013-2014, the increasing appetite of CMBS shops combined with the low cost of capital provided by mezzanine financiers should allow owners to secure adequate leverage at a competitive rate to facilitate refinancing of maturing loans.

The banking landscape for the past two years has been dominated by the large national banks, and it is only now that we are starting to see local community banks and credit unions emerge as active players in the lending game. Although it is still a relationship game where banks are looking to secure primary relationships from borrowers, they are starting to show more interest in transactional business.

According to the January 2013 Federal Reserve commentary of current economic conditions, the reporting banks in the Western United States reported improvements in asset quality, and lenders were described as competing aggressively for highly qualified borrowers. Moreover, lenders may be heading toward loosening credit standards and increasing tolerance for risk.

We are in a rare period of alignment where most of the industry agrees about continued stability in the landscape over the short term. According to Barry Sternlicht, Starwood Capital’s Group Chairman and CEO, in an interview with “Squawk Box”, “You can finance them with positive leverage—meaning the cost of borrowing is much lower than the yield on the property.” Sternlicht went on to say, “This is the Goldilocks Period for real estate”.

What does all of this tell us? There is a lot of volatility in the market and a lot of eyes paying attention to rates, Wall Street, and of course action taken by the Federal Reserve.

This is a very important week for rates. Treasury rates have held at the key 2.00% level basis for the 10-year, but this week’s auctions will be an important indicator for the direction of rates for next month.

According to a few different bond traders, Wednesday’s $24 billion of 10-year and Thursday’s $16 billion of 30-year notes must be well bid by dealers (covering shorts set up in the past week) or the 10-year could blast through 2.00%, and jump quickly to 2.25%.

Inflation components are holding near their highs of the year at 2.54% for the 10-year, and 2.64% for the 30-year, which is tolerable by the Fed but further increase will push long term rates 20-25 basis points higher.

Mortgage and real estate professionals should carefully watch the action of the 30-year bond after Thursday’s auction results are announced at 10:01am (PST)—one of the most important in many months. If the auction stop price doesn’t hold by the end of the day it will be a sign of further rate increase to come in the next couple of weeks. If it does hold, the 10-year will probably rally back down to 1.80% by the end of February.

If the first 60-days are any indication as to a return to what some refer to as a normal market, we are in for a very busy and productive 2013. The market has lenders willing to lend and borrowers willing to borrow at historic lows. Sounds like a pretty good combination to me.

by Michael Kaplan, COO