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Capital Markets Update Week of 11/19

November 19, 2024

Private-Label CMBS and CRE CLOs

New-issue activity slowed last week with only one transaction pricing:

• WFCM 2024-5C2, a $720 million conduit backed by 27 five-year loans secured by 138 properties from Wells, Goldman, JPMorgan, UBS, and Citi

According to Commercial Mortgage Alert, three transactions totaling over $3 billion are in various stages of marketing. In addition, CMA noted issuers were lining up transactions for an end-of-year push after near-record production in October (~$17 billion).

By the numbers: Year-to-date private-label CMBS and CRE CLO issuance totaled $101.5 billion, 154% ahead of the $39.9 billion for same-period last 2023.

Spreads Trend Tighter

• Conduit AAA and A-S spreads were unchanged at +85 and +115, respectively. YTD, AAA and A-S spreads are tighter by 31 bps and 50 bps, respectively.
• Conduit AA and A spreads were tighter by 5 bps at +145 and +175, respectively. YTD, AA and A spreads are tighter by 80 bps and 200 bps, respectively.
• Conduit BBB- spreads were tighter by 5 bps at +475. YTD, BBB- spreads have tightened by 425 bps.
• SASB AAA spreads were tighter by 5 bps to a range of +105 to +130, depending on property type. YTD, they have narrowed from a range of +143 to +212.
• CRE CLO AAA and BBB- spreads were unchanged at +160 / +165 (Static / Managed) and +450 / +475 (Static / Managed), respectively. YTD, AAAs have narrowed from +200 (Static / Managed) and BBB- bonds +600 (Static / Managed).

Agency CMBS

• Agency issuance totaled $4 billion last week, consisting of $2.1 billion in Fannie DUS, $1.7 billion in Freddie K, SBL, and Multi-PC transactions, and $230.9 million in Ginnie Mae transactions.
• Agency issuance for the year totaled $99.1 billion, 8% lower than the $107.9 billion for same-period 2023.

The Economy, the Fed, and Rates…

Economic Data

• Inflation Trends: October's inflation data highlighted the persistence of price pressures. The Consumer Price Index (CPI) rose to 2.6% in October, up from 2.4% in September, matching economists' expectations. Core CPI, which excludes volatile food and energy prices, held steady at 3.3% on an annual basis.
• Retail Sales: Retail sales grew by 0.4% in October, surpassing expectations of 0.3%. This came with significant upward revisions for September (from 0.4% to 0.8%), reflecting resilient discretionary spending, particularly in restaurants and autos.
• Small Business Optimism: The National Federation of Independent Business (NFIB) Small Business Optimism Index improved in October, exceeding expectations. Business owners are increasingly optimistic, partly due to anticipated policy changes under the incoming administration. Inflation remains a significant concern for small businesses, particularly regarding labor quality and taxes.
• Core PCE Projection: Using inputs from October CPI and PPI data, Bloomberg Economics estimates the Fed's preferred core PCE measure will accelerate to 2.8% year-over-year when released on November 27.

Fed Policy

• Interest Rate Trajectory: Fed Chair Jay Powell signaled a gradual approach to lowering interest rates, stating, "The economy is not sending any signals that we need to be in a hurry to lower rates." With the economy showing "remarkably good" performance and inflation gradually decreasing toward the 2% target, the Fed plans to approach future rate cuts cautiously. The Fed has reduced the benchmark rate by 75 basis points since September, bringing it to a range of 4.50% to 4.75%.
• Inflation Assessment: Policymakers highlighted the difficulty in wringing out the last bits of inflation. Powell described recent inflation data as "more of an upward bump than we had expected," though he maintained that the overall downward trend remains intact. He expects inflation to continue retreating, "albeit on a sometimes-bumpy path."
• Impact of Fiscal Policies: The incoming Trump administration's proposed policies, such as higher tariffs and tax cuts, introduce additional uncertainty to the economic outlook. While these policies could stimulate growth, they may also lead to higher inflation. Powell stated that the Fed would be careful in adjusting monetary policy until there is more clarity on the timing and impact of fiscal changes.
• December Rate Cut Uncertainty: Market participants are adjusting to the possibility of a slower pace of monetary easing. Elevated valuations in equity markets and rising bond yields suggest increased vulnerability to economic data and policy shifts. Futures markets now indicate about a 60% probability of a December rate cut, down from about 80% last month.

Treasury Yields

• Yield Movements: Treasury yields climbed sharply last week, with the 10-year yield reaching 4.50% at one point (the highest since May 31). This surge followed strong retail sales data and Powell's cautious remarks on rate cuts. The 10-year yield ended the week up 14 bps at 4.44%, while the 2-year yield rose 5 bps to 4.30%.
• Yield Curve: The yield curve steepened as long-term yields outpaced short-term gains, reflecting concerns over fiscal sustainability and inflation risks tied to the incoming administration’s potential policies.

You can download CREFC’s one-page MarketMetrics with statistics covering the economy and the CRE debt capital markets here.

Contact Raj Aidasani (raidasani@crefc.org) with any questions.

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ULI and Heitman Publish Report on CRE Property Insurance

November 19, 2024

In October, the Urban Land Institute (ULI) and Heitman published a detailed report on CRE property insurance trends, entitled "Insurance on the Rise: Climate Risk and Real Estate Investment Decisions.”

The report notes that the difficult CRE insurance market, characterized by escalating premiums, tightening coverage, and heightened underwriting scrutiny, stems from the following issues:

• Increasing frequency and severity of natural disasters, particularly secondary perils like hail and severe convective storms;
• Lower reinsurance capacity and rising costs, which boost primary insurance rates;
• Inflation, coupled with soaring construction costs, contributing to higher replacement values;
• Rising litigation costs and legal system abuse that amplify claim payouts; and
• Regulations in some jurisdictions that cap insurance rate increases.

Rising insurance costs are squeezing net operating income (NOI), particularly in the multifamily sector, hindering affordability, impacting investment returns, and sometimes threatening deal execution.

Investors are becoming increasingly cautious about investing in high-risk areas, exploring alternative markets, and incorporating climate risk into their decision-making. According to an investor interviewed by ULI and Heitman:

"Physical climate risk is a clear component and maybe I would argue one of the primary drivers of how we’re thinking about where we go next from a geographic perspective.”

What’s next: Investors are tapping sophisticated insurance programs involving multiple layers of coverage from various carriers to manage risk and secure more competitive pricing. Other strategies include the use of:

• Higher deductibles, aggregate deductibles, and self-insurance strategies to balance risk retention and premium savings;
• Event-based parametric insurance policies for specific perils like windstorms, offering a clear-cut payout mechanism;
• Greater portfolio size and diversification across geographic regions and asset types to reduce insurer risk; and
• Investment in resilient structures.

CREFC continues to focus on property insurance issues and potential policy solutions. Please see here for insurance-related presentations.

• CREFC’s Miami Conference will feature a panel on CRE financing risk amid skyrocketing insurance costs.

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Forum Spotlight: IG Bondholders

November 19, 2024

The IG Bondholders Forum’s Leadership Working Group, which includes Rajesh Bansal (Forum Chair), Adam J. Smith (Chair-Elect), and Richard Razza (Past Chair), sets agendas and priorities for the Forum and represents investors on CREFC’s Policy Committee.

Key Investment-Grade Bondholder Focus Areas:

• CRE CLO Surveillance: The CRE CLO Surveillance template is being developed to provide standardized information to investors in a usable Excel-based format. CREFC will host a meeting at the January conference in Miami to solicit additional feedback from all constituents. We aim to have the first draft of the surveillance file ready for use by Q1 2025.
• Ongoing dialogue with stakeholders of the forum (IG investors) to understand their concerns and identify solutions.
• The Leadership Group is concerned with loan extension risk due to higher interest rates. Notably, corporate single-A rated bonds continue to outperform AAA-rated CMBS.

Looking ahead, leaders are focused on working with servicers and trustees to improve responsiveness and access to loan and deal information in a timely manner.

What’s next: Forum leaders look forward to presenting CREFC members with an update on their market sectors in Miami. As June 2025 approaches, the chairs will seek nominations for the next Chair-Elect to join their leadership slate.

To join the IG Bondholders Forum, please register here.

For any forum-related questions, please contact Rohit Narayanan (RNarayanan@crefc.org).

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Fall 2024

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