Commercial Loans & Mortgage News - October 30, 2001
Swap Spreads Explained
The events following September 11th have led to 100 bps decrease in the cost of Fed Funds, $200 billion in increased spending, and lowered finance costs overall. These factors combine to create a fairly significant stimulus package and the outlook for economic recovery in the second half of 2002 is looking more and more promising.
However, we feel pretty certain that the lending practices of the last twelve months will not be the same as those for the next twelve. The capital markets are adjusting in anticipation of how bond investors will perceive future CMBS issuance. These adjustments can be seen in the form of wider spreads and a second look at overall deal fundamentals that might give rating agencies reason to question the underwriting applied to a particular loan. Commercial investors should continue to enjoy an ample supply of lending capital and competitive interest rates, but should also be prepared for more conservative underwriting assumptions as they relate to items like rent concessions, overall vacancy, and line item expense increases such as insurance and utility costs.
Given the fluctuations in the marketplace, we're recommending an alternative approach to obtaining loan quotes that ensures the leanest quote a lender can offer. This method is known as quoting off "swap spreads". Simply stated, swap spreads are the cost of funds that bond investors incur to purchase securitized loans, or CMBS. Whether their cost of capital increases or decreases, they pass this difference along to the lender. Typically lenders quote an overall spread above Treasuries, and thus tend to pad their spreads for potential increases in swap spreads that are passed along to them from the bond investors. The traditional spread-above-treasuries method is good for the lender when "swaps" move down because their margins widened from when they first quoted the deal; however, if "swaps" move up, then lenders face the scenario of being in a loss position, and run the risk of not being able to sell that particular loan. This is where the infamous "re-trade" usually comes into play, and the lender has the option to stick to the original terms and incur a loss or renegotiate a higher quote with the borrower. Requesting a quote over swap spreads enables the lender to fix a spread over the moving variable, thus eliminating a potential loss position. It's rare that the lender will close a loan knowing they're "under water" on the loan, so approaching lenders on the "swap" quote basis ultimately translates to tighter pricing that is much more likely to stick. Although this approach has been traditionally reserved for loans over $10mm, its an approach we suggest for all loan requests because helps trim some of the "fat" off the more conventional method of quoting an "all-in" spread over Treasuries.
In this ever-changing economy, Steelhead Capital is here to keep you current with any and all shifts occurring within the capital markets in order to help you make prudent investment decisions.
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Chief Executive Officer Peter Slaugh founded Steelhead in 1999. In the relatively short period since its inception, Slaugh has built Steelhead into a leading resource for debt and equity placement nationwide. Slaugh is primarily engaged in growing the company and its lender relationships, as well as working on financings.
San Francisco Offices
With an extensive lender network, Steelhead Capital has built its reputation on structuring commercial loans requiring both debt and equity placement. Fluctuations in the capital markets present significant challenges for investors and we are pleased to provide financing as well as guide and advise clients through the process. Whether you are looking for apartment financing, commercial financing, mezzanine financing, or creative "out of the box" real estate loan alternatives, we can help.
For apartment loans below $2 million, we have a small apartment loan program with extremely competitive rates. For apartment loans and commercial mortgage loans above $2 million, we provide direct access to the country's most aggressive lenders. Make Steelhead Capital a part of your commercial real estate financing success. We look forward to hearing from you soon.
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