Increasing Interest Rates and Spreads Are a 'Double Whammy'

Year 2022, thy name is volatility, at least according to a report from investment banking firm John B. Levy & Company. The publisher of the Giliberto-Levy mortgage indexes noted that “more than 60% of the time, a change in Treasury yields is accompanied by a credit spread move in the opposite direction.” But in the first quarter of 2022, both moved up, an event that happens only 16% of the time.

In February 2022, the firm noted that “if volatility is the style, then 2022 should fit perfectly!” 

The Giliberto-Levy Commercial Mortgage Performance Index, G-L 1, showed a total return of -4.41% for the first quarter of the year.

“We think that the ‘double whammy’ of both the Treasury yields and spread increases caused coupon rates on 10-year loans to rise by some 90 basis points from 2021 year-end to the end of Q1-2022,” they wrote. “Clearly, this will lead to a dampening of the pace of lending in Q2-2022.”

The G-L 2 High-Yield Index closed 2021 with a 7.51% total return, up from 5.56% of 2020. “These high-yield loans are mostly floating-rate and, in the past, have been priced over LIBOR,” the firm noted. “Of recent, Giliberto-Levy has noted a shift to SOFR as the ongoing benchmark, a trend expected to continue throughout the year.”

Transaction volume in Q1 was a first quarter-quarter record of $171 billion that was down from Q4 2021. That’s the first month-over-month fall since June 2020.

But there are good signs as well. “Industrial warehouses continue to be anything but dull, notwithstanding Amazon’s recent announcement,” wrote the firm, estimating that “for low-leverage industrial loans, spreads may even touch 100 basis points or less, a level previously unheard of.”

Multifamily also continues to do well between population shifts and millions unable to buy a place of their own because of high down payments and mortgage rates, so they need to rent.

“Additionally, multifamily continues to be on a tear,” they said.” To be sure, rates are up. At the beginning of the year, rates from the big GSEs were less than 3.50%, and while rates are up, at the end of April, spreads are lower than they were at year-end!

A surprise to them is the continuing popularity of retail, at least anchored by essential services like supermarkets. Big malls may still be on the outs, but investors are interested in small retail strip malls.