According to the Avison Young’s Debt Market report, economic volatility will not slow and naturally it will impact loan spreads in 2019.
Loan spreads widen in times of economic distress and narrow while the economy is improving, the report stated.
According to the report, the biggest increase in loan spreads took place during the recession of 2009 and capital flowed rapidly away from commercial real estate to safer assets.
‘The next significant increase in spreads was in 2011 when Standard & Poor’s downgraded the United States’ credit rating. In 2016, when oil prices fell materially, highyield bonds issued by energy companies cratered, pulling most fixed-income yields higher in sympathy.’
U.S treasury rate increase affects loan spreads
‘The spread increase in 2009 had a bigger impact than the widening that took place in 2011 or 2016 because the base U.S. treasury rate was much higher. An increase in spread of 150 to 200 basis points is substantial; however, when the 10-year treasury yield is offering less than 2% and the growing spread results in loan rates increasing from 3.5% to 5%, the effect is not as shocking as when the 10-year treasury yield was closer to 5% itself. ‘
According to the report, the spread increase in 2009 had a bigger impact than the widening that took place in 2011 or 2016 because the base U.S. treasury rate was much higher.
‘When the 10-year treasury yield is offering less than 2% and the growing spread results in loan rates increasing from 3.5% to 5%, the effect is not as shocking as when the 10-year treasury yield was closer to 5% itself.’
‘ What do rising interest rates mean for loan rates? Simply that loan rates will increase, as will debt-service burdens. The more complex answer is that loan spreads widen out further – approximately 65% higher, on average – when the 10-year U.S. treasury yield is above 4%. That is to say that higher interest rates have dictated higher spreads in the past. Once the line of an acceptable debt-service coverage is crossed, the amount of equity required to restore the necessary cash-flow cushion beyond that needed just to service the debt will increase. As spreads widen, we are starting to see some situations where debt-service coverage issues create constraints on the amount of leverage that can be obtained. ‘ stated in the report.
