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The second rate quote is based on the lender's spread plus the Treasury rate. The lender's spread is fixed at the time of application. The Treasury rate (based on a like-term Treasury note), however, floats until the rate-lock deposit is paid or the loan is closed.
So where does the lender's spread come from, and what is included in that spread? We now know that the lender's spread includes its own credit spread plus the swap spread. Depending on the lender, other components that could increase the lender's spread may include:
Longer amortization period
Reduced upfront costs to the borrower
The third rate quote, which can be formulated two ways, is the newest method. Using the first method, lenders will quote rates based upon the Treasury rate plus the effective lender's spread (credit spread plus the swap spread). With the second method, lenders will quote rates based upon the swap rate (the Treasury rate plus the swap spread) plus the lender's credit spread.
So what is the difference? None. Both methods basically use the same components; they're just grouped differently. The fact is that the swap rate is just the combination of the swap spread and the corresponding Treasury. Therefore, in reality, both methods have the same three parts, of which two parts continue to move prior to rate lock or loan closing.
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With credit-risk concerns today, many lenders are hesitant even to quote deals unless the spread is significant. Commercial-mortgage-backed-securities (CMBS) originations, especially, are becoming increasingly difficult, if not impossible to get done. Loans are actively retraded, causing an increase in interest rates and a decrease in loan proceeds. In many cases, the deals are either put on hold or killed altogether.
The only good news is that, as of press time, the 10-year Treasury rate has been dropping recently. This has offset some of the spread increase.
Have we finally hit the bottom of the rate tree? That remains anyone's guess, though there should be no further surprises looming -- that is, until some young Wall Street genius cross pollinates a couple of rate trees and comes up with a new hybrid.
Craig C. Johnson is president and CEO of Aries Capital Inc. and a director of Aries Real Estate Fund. His responsibilities include loan origination, servicing and developing new lending sources.
Johnson has held many positions within commercial real estate, including finance, development, construction and property management. He is a member of the Arizona Commercial Mortgage Lenders Association, International Council of Shopping Centers and the Mortgage Bankers Association. Reach him at firstname.lastname@example.org or (602) 952-9952, ext. 2.
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