CMBS Issuance Strong Amidst Fed Rate Cut Uncertainty

CMBS Primary Markets

On the surface, April showers did little to slow the U.S. non agency CMBS markets as they continued their relatively strong start to 2024. April saw another roughly $6.5 billion issued in the month, bringing total annual issuance to almost $26 billion, more than 3.3 times what came to market in the first 4 months of 2023. For the optimists in the room, these are signs of May flowers to come. Indeed, a strong pipeline of deals is already in the queue and ready to market.

Source: Commercial Mortgage Alert, Morningstar Credit

Fed Rate Cuts

However, for the pessimists (or perhaps just realists) there is some potential for a slowdown. April’s meeting of the FOMC confirmed that the likely number and timing of the Fed’s rate cuts has shifted significantly.

Entering the year, markets were predicting the likelihood of at least 4, or possibly even 6, rate cuts in 2024 starting as soon as May. It seems that now there will likely only be 1 to 2 cuts at best, and these are expected to occur later in the fall. This shift is primarily driven by 3 months of disappointing inflation reports, which have stubbornly remained above 3%, significantly higher than the Fed’s 2% target. Despite this, many other economic indicators remain strong. The jobs report was also underwhelming, with only 375k jobs added (https://www.bls.gov/news.release/pdf/empsit.pdf). However, this could be a positive sign for inflation – a point that the market seems to have taken into account.

Impact on CMBS Issuance

This projection of sustained high interest rates has the potential to dampen issuance in the short term, as proceeds are reduced, making it harder for borrowers to meet underwriting criteria. With a significant number of loans across the universe coming to maturity over the remaining course of the year, this could exacerbate the impact.

It remains to be seen how these evolving market dynamics play out. In our interactions with various market participants, most seem to think this is more of a timing issue and will push out the broader resurgence of capital market activity towards the second half of the year, but barring unforeseen events, which are unlikely to derail the market.

The consensus is that the stability and predictability of the treasury markets and credit spreads are crucial for maintaining and increasing CMBS issuance. If these factors remain relatively stable and not overly volatile, the risk can be priced, ensuring that loans will be approved and issued.