Q1 2023 Commercial Mortgage Market Update

On March 22nd, the US Federal Reserve chair, Jerome Powell announced another 0.25% increase to the overnight rate while telling the market that there would likely be another rate hike before the end of the year and a pause. Having had enough of contradictory statements from Powell, the market doesn’t seem to believe it, with wide expectations that rate cuts are just beyond the horizon. One week prior, we saw the 16th largest bank in America collapse after a bank run, along with several other regional banks experiencing runs of their own. As a result, the US Government, through the Fed/FDIC, injected liquidity into the banking system that reversed months of quantitative tightening measures. The chart in the top right, is data provided by the US Federal Reserve, and shows credit extended to financial institutions over the past 20 year. There is a notable increase during 2007-2009 during the “Great Recession” and another blip during the early stages of the pandemic. The vertical line on the right is not a border… it is a sharp spike as result of the new Bank Term Funding program recently extended to the banks to shore up their liquidity. To further drive home this point, we’ve included the chart to the bottom right which outlines the quantum, of the Fed’s balance sheet, which further shows a reversal of months of Quantitative Tightening.

In other banking news, across the pond in Europe saw the forced marriage of Credit Suisse and UBS, along with fears of Deutsche Bank having issues as well. When refocusing on our own country, we have seen bond yields drop sharply from the peaks observed in early March – a drop close to 90 basis points (noted in the right side of the chart below). This is partly due to the government intervention in the U.S. and partly due to signaling of a dovish rate policy from the Fed. Needless to say, this is also aided with the Bank of Canada maintaining their overnight rates for the first time in a year. While the market is desperately hoping the stance on keeping rates steady holds through the rest of the year, the jury is still out.

As it relates to the Canadian commercial mortgage market, here is what we’ve observed in First Quarter of 2023:

• Spreads for Conventional Term Loans have increased from the start of the year, with a marked jump after the Fed announcement. This has been observed across all asset classes. Even for asset classes of choice, such as multifamily and industrial, strong deals are being quotes with a minimum spread of the 200 Bps over the GOC. Liquidity for 5-year term deals from the life insurance lenders is beginning to dry up, with preference for 7- and 10-year terms to match their longer-term liabilities.

• CMHC Insured Loans continue to be a hot commodity, however allocation capacity and lender quotas are beginning to be challenged. We expect that minimum deal sizes will increase along with spreads in the near term. A large spread divergence is now beginning to appear, with Oakbank receiving some quotes as high as the 80 Bps + over for deals under $3,000,000 while simultaneously being quoted in the low 40 Bps over for deals above $10,000,000.

• Jumbo Loans (i.e. loans $200M+) are proving to be challenging as lenders are stretched thin and bowing out of the role of syndication. We’ve heard from many institutions that they are happy to participate, however look for others to take the lead.

• As it relates to Land Loans, we will repeat our exact wording as our Q4 update as the landscape remains virtually unchanged. For unzoned parcels, valuations are being challenged with residual land value analysis now in question with end sales prices as a large question mark. For zoned multi-family/condo parcels, similar logic applies as projects may not “pencilout” to development margins acceptable to institutional lenders given the shift in sales prices on the end-user side. We expect some developers to take advantage of the CMHC MLI Select and RCFI programs and switch gears away from condo in an effort to preserve their investments.

• Overall, lender scrutiny and due diligence has tightened considerably for all non-income producing assets and Construction Financing. Spec industrial financing which was a hot ticket during the pandemic is now becoming increasingly difficult to finance as lenders are becoming concerned about interest rate volatility, exit lease rates, and with capital allocation requirements due to Basel III implementation this year.

There is potential for a significant change is on the horizon with the Canadian Federal Budget announcement on March 28th. The budget includes a proposal to consolidate the Canada Mortgage Bond (CMB) program into their regular borrowing program (GOC Bonds). What this means for the future of the securitization of CMHC insured loans is uncertain at this time but will be made clearer when the Federal government releases their fall fiscal policy update.

Although marked with uncertainty and a lot of volatility, there has also been an increase in market activity and positive lender sentiment in the marketplace. Even despite increased spreads, with bond yields dropping, overall borrowing rates have decreased which is now driving significant refinancing activity, especially in the multi-family sector. We continue to hold a positive outlook for next quarter and the remainder of the year as the market continues to stabilize.

To view a PDF version of the Q1 2023 Commercial Mortgage Market Update, click here.