Reonomy’s Debt Dive is a monthly recap of the debt markets, profiling the macroeconomic climate’s impact on debt, along with the state of balance sheet loans and securitizations. 

Key Takeaways

  • The yield curve continued to steepen at an increasing pace through the month of October – reflecting the expectations for positive economic growth, higher inflation, and expected future monetary tightening.
  • Demand for CRE mortgages remains high and lenders are ready to meet that demand, as credit conditions improve, loss reserves are released, and underwriting standards eased.
  • Multifamily and industrial properties continue to experience all around elevated levels of activity and optimism, as prices rise on sound operating fundamentals and robust demand. Office and retail recover, though remaining recovery laggards with mixed outlooks.
  • While the last year was dominated by agency issuance, 2021 looks to be the year of non-agency, and more specifically SASB and CRE CLO deals, which are up 199% and 388% year-on-year, respectively.

Macroeconomic Environment

The past month continued to see steepening across the entire yield curve, as the markets priced in higher inflation expectations along with the uncertain timing of anticipated monetary tightening. Shorter-term maturities experienced the most upward movement recently, though all maturities across the yield curve remain well above where they were one year ago. Since early August, the yield on the benchmark 10-year has steadily climbed higher; the current yield (1.64%) is +40 bps up from 6 months ago and nearly +100 bps from a year ago.

Short-term reference rates remain largely unchanged and still sit near their near-zero yields. Meanwhile, the steepening Treasury curve is beginning to show through the corporate bond market, as well. Corporate bond yields ticked higher over the month of October, with Aaa yields up approximately 18 bps on the month, while Baa yields moved up 9 bps. The spread between Moody’s Aaa and Moody’s Baa corporate bonds continued to grind incrementally tighter over the month to 67 bps, not too far from where it has been much of 2021, though well below where it was this time last year when yields on Baa reflected the elevated concern of default risk.

Positive economic growth, higher inflation, and future money tightening

Following the summer lull, as Delta fears and continued supply chain strains drove flattening, the yield curve continued to steepen at an increasing pace through the month of October – reflecting the expectations for positive economic growth, higher inflation, and expected future monetary tightening. Higher inflation expectations are apparent when looking at the 5- and 10-Year inflation breakeven spreads, which have continued to climb steadily for much of the past year and have picked up pace in the last month. The still-very-attractive low cost of credit is keeping borrower demand alive, and that’s a good thing because lenders are even more willing to lend now than they were before. The TED spread, which measures the difference between the cost of funds for the US government and that of banks, has continued to remain very low, reflecting the continued confidence in and solid economics for lenders.

Balance Sheet Lenders

The US commercial mortgage market was approximately $3.1 trillion, as of 1Q 2021, up 4% from a year ago. While banks continue to be the predominant lender for commercial mortgage financing, accounting for 61% of all US commercial mortgages, non-bank lenders are increasingly growing their share of the mortgage pie. ABS, REITs, & Financials have increased their commercial mortgage lending activity recently, growing their collective commercial mortgage portfolios by 7% over the past year. Most of this growth is attributable to REITs. Meanwhile, Insurers, another major segment of the lending market and also a non-bank lender type, have grown their commercial mortgage holdings and now account for a seventh of the aggregate US commercial mortgages, up from one-ninth a decade ago.

Turning attention to the recent bank lending data, we see that in aggregate, banks have significant capital to put to use and extend as credit. The loan-to-deposit ratio (LDR), a measure that captures the use of capital at a bank, fell sharply during the pandemic as stimulus and other pandemic emergency funds for many people and companies were deposited at banks and those same banks struggled to find enough opportunities to lend it out. With recent LDRs around 60%, significant loan growth will be necessary for banks to get their LDRs back in line with historical levels – around 70-75%. 

Supporting the situation for strong loan growth, banks have been reducing their loan loss reserves, money they set aside to offset expected losses on their credit book. This release means that they no longer are expecting as many or as severe losses on their existing loans. Banks currently have approximately $1.05 set aside as loss reserves for every $100 lent. A year ago, they had $1.21 in reserves for every $100 in credit extended. 

Bank lending on real estate, both residential and commercial, has modestly ticked up from 43% to 45% of all bank loans over the past year. This uptick is predominantly due to recent increases in commercial real estate (CRE) lending – particularly a return to lending on Construction & Development projects as well as continued strong lending on Multifamily properties.

Smaller banks take the lead

Much of the recent increase in real estate lending activity has been driven by smaller banking institutions and community banks. Even though the large banks are not sitting on the sidelines, the smaller banks have accounted for more than half (51%) of all recent real estate lending, well above their 41% five years ago.  The smaller banks have also been much more aggressive in their return to underwriting CRE credit – accounting for 66% of all new CRE loans, recently. Small banks have historically been significant CRE lenders, but their recent market share is elevated. Foreign banks and branches operating in the US have also picked up their interest in CRE lending recently, but still represent a small fraction of the CRE lending market (3%).

Banks surveyed in the third quarter reported a strong resurgence of borrower demand for all segments of CRE loans through the second quarter of 2021. The bankers surveyed reported the strongest demand for Multifamily financing followed by Construction & Development financing. The number of bankers who reported robust demand for multifamily loans hit the highest level since the survey began asking about CRE financing, in the fourth quarter of 2013.

Eased underwriting standards

In addition to the strong borrower demand for CRE credit, the Federal Reserve’s July 2021 Senior Loan Officer Opinion Survey revealed that bankers were also ready to meet this demand and were easing underwriting standards for new applications for CRE credit from borrowers. The current trend of loosening of credit standards for CRE loans began a year ago in the third quarter of 2020 after the vast majority of bank lenders tightened amid market and outlook uncertainty related to the pandemic. Through the second quarter of 2021, over a fifth of bank respondents eased credit standards for Multifamily lending and nearly a tenth did the same for Construction & Development credit.

Credit quality improved through the second quarter of 2021, as both delinquency and charge-off rates declined across all bank loan portfolios – including Residential and Commercial Real Estate. Delinquency rates for all real estate fell below their pre-pandemic levels, driven by strong performance in Residential. While CRE delinquency rates remained approximately 20 bps above pre-pandemic levels, the second quarter average of 92 bps is well below the long-term quarterly average of 330 bps. Similarly, the charge-off rates improved for all of real estate through the second quarter. Charge-off rates for Residential real estate in the second quarter of 2021 turned negative, as banks released excess loss reserves. CRE charge-offs also improved, and fell to pre-pandemic levels, 5 bps. 

Commentary from the October Federal Reserve Beige Book helped to explain the improved CRE situation across the country. While market conditions and lender outlooks largely turned positive compared to a year ago during the depths of the pandemic, the CRE conditions and outlooks varied across regions and property types. Some of the notable trends across the commentary included:

  • Sales – Multifamily and industrial sales activity remained strong across the country, surpassing the pre-pandemic levels in the south, mid-west, and northeast. Meanwhile, office sales activity lagged across nearly all regions. However, a potential bright spot was noted by the Boston Fed, which noted that “some contacts forecasted an uptick in office sales in 2022.” 
  • Leasing and Rents – Leasing activity also improved across much of the country through October, but also varied by property type. The notable areas of weakness mentioned by multiple Federal Reserve Districts were office and retail. The Chicago Fed summed up what many other Districts reported, “leasing and sales activity within the office segment remained substantially below pre-pandemic levels. That said, office property showings increased in recent weeks, and some offices moved to new spaces to avoid the costs of reconfiguring to accommodate COVID-19 protocols.” Retail was another area of tepid recovery. The overall situation and outlook for retail continues to improve, as stores remain open and leasing activity picks up, but still below pre-pandemic levels. The Minneapolis Fed noted, “Retail contacts reported improved conditions; a mall contact noted an increase in store openings and overall leasing, though rent levels and lease terms ‘continue to be a challenge’.” A niche market, life sciences properties were called out by the Boston Fed, which reported these properties have maintained “near-zero vacancies”.
  • Construction – Across the country the construction pipeline improved through October, despite challenges presented by northeastern storms and high (but falling) material and labor costs. Again, multifamily and industrial pipelines are seeing the most robust development pipelines across the country. While construction activity picked up for many office projects, “the overall pipeline of new projects narrowed as uncertainty clouds the office market,” noted the Philadelphia Fed.


The securitization market for CRE debt has largely surpassed all expectations for the year. Total issuance of CRE-backed paper is nearly $263 billion year to date, up 44% over the same period last year. While the last year was dominated by agency issuance, 2021 looks to be the year of non-agency. Year to date issuance of non-agency paper accounts for roughly 45% of all 2021 issuance, well above the 28% that it represented in the same period last year. 

More specifically, single asset single borrower (SASB) and collateralized loan obligation (CLO) issuances are up 199% and 388%, respectively. This tremendous growth in issuance has driven non-agency issuance up 130% year-on-year. One of the key explanations for the rise in SASB and CRE CLO issuance is that these structures tend to have more concentrated credit exposure, which is easier for the market to understand and price. So long as the outlooks for different property types and regions continue to be so mixed, one can expect to see this trend continue.

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