Interest Rates: Eyeing the Spreads

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Industry Commentary from Serafino Tobia, Head of Capital Markets Trading, Greystone

The securities markets continue to reflect concerns that the coronavirus will effectively put the US and world economy under quarantine (if not in a coma) for weeks or longer. The S&P 500 was down some 25%-30% during the past month (as of 3/17/20) and the 10-year US Treasury rate is hovering at about 0.88%. The US Federal Reserve announced emergency measures, reducing the fed funds rate by 100 basis points, lowering the discount rate to 0.25%, committing to buy $500 billion in US Treasuries and $200 billion in agency MBS over the coming months, among other recent efforts.

One would think that this is the very best of times to be locking an interest rate to refinance or purchase a multifamily property. However, with the 10-year US Treasury dropping from about 1.50% to below 0.50% (now back at around 0.88%), mortgage spreads have widened, and Fannie Mae and Freddie Mac have both increased their fee spreads and established floor index rates.

US Treasuries benefit from the “rush to quality” buyers whereas mortgage securities and other spread product (corporates, asset-backed securities) are owned and purchased by securities dealers (for re-securitization into REMIC pools) and by end-user investors – insurance companies, banks and money managers. These mortgage securities investors aren’t so quick to follow US Treasury rates lower, particularly when there is a dramatic “rush to quality” move. Dealer investors have existing inventory and commitment pipelines that are hedged with swaps and futures contracts; they are experiencing losses on their asset and hedge positions, making them less interested in adding assets. We are seeing some REMIC dealers show bids with spreads that are way wide; some others are not bidding at all. Retail investors are comparing multifamily mortgage investments with other types of fixed income investments including CMBS, residential MBS, corporate debt and asset-backed debt. Spread widening has occurred across all spread products.

Certainly, interest rates are still quite low in the multifamily mortgage markets, but not as low as expected given the historically lower US Treasury rates. It’s still a very good time to be locking-in mortgage rates – FHA mortgage rates are below 3% (plus HUD Mortgage Insurance Premium) and Fannie Mae and Freddie Mac loan rates are about 3.50% for a 10-year loan with an 80% LTV. And who’s really to say that US Treasury rates will stay this low for any length of time – we saw how quickly US Treasury rates dropped; clearly they can go back up just as quickly as well.

I would argue it’s also a good time to be “getting ready” to lock-in mortgage rates – assessing your portfolio, applying for the mortgage and getting the underwriting to a point where the interest rate can be set. The Fed’s commitment to buy agency MBS will help reduce spreads once it starts in earnest. If mortgage spreads work like they have in the past with rush-to-quality moves in US Treasuries, and if we see US Treasuries stabilize below 1%, we should start to see mortgage spreads come in to their historical spread range which will result in even lower mortgage rates.

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