CMBS spreads continue to drift wider in 2016, following a pattern of wider spreads that began in the summer of 2015. Three CMBS deals in the market have released pricing guidance in the range of 155-158 basis points (bp) over swaps for the benchmark AAA-rated senior CMBS class. That level is up from the 136-140 bp range from three CMBS deals that priced in December 2015. Equivalent CMBS spreads for the AAA-rated senior class were 100-110 bp last summer. Market professionals are pointing to economic concerns in China and plunging oil prices creating volatility in debt markets, including CMBS. As a rough rule of thumb, every 1 bp increase in AAA-rated senior class CMBS means lenders must obtain a 1 bp increase in loan spread from borrowers to maintain the same level of profit. This would imply an increase in loan spreads to borrowers of 15-20 bp in January.
The pace and magnitude of spread increases in 2015 were such that borrowers did not experience much re-trading of loan spreads presented in their Term Sheets. For the most part CMBS lenders accepted lower profit margins in the hopes of making better margins on subsequent deals based on newly executed Term Sheets at higher spreads. But the higher margins never materialized as wider spreads on CMBS deals that priced through fall 2015 simply wiped out the additional spread on newly executed Term Sheets. Lenders hoped that for at least some period spreads would stabilize, but they have not.
“With spreads increasing at a quicker pace and at a larger magnitude in January, lenders are advising commercial mortgage brokers to educate their borrowers on market conditions; this way, in the event that the borrower receives a spread adjustment prior to closing, they don’t feel they are being cheated,” commented Michael D. Sneden, Executive Vice President at ValueXpress. “Whether a spread adjustment is warranted depends on a lot of factors, including the interest rate floor in the Term Sheet, whether the interest rate index is the higher of swap or U.S. Treasury and the initial spread level.”
“A spread adjustment is not a forgone conclusion. This is just ‘heads-up’ market intelligence for borrowers just in case,” said Sneden.