Typically, Swap Rates are more than the equivalent Treasury Rate, but recently the relationship has reversed: The Swap Rate is currently lower than the equivalent Treasury Rate. This relationship is important to CMBS conduit loan borrowers because the Swap Rate is the index used to set the interest rate on CMBS conduit loans. The lower the Swap Rate, the lower the interest rate that the borrower receives.
Historically, the 10-Year Swap Rate (the rate used to fix the rate for CMBS conduit loans with a 10-year term) has traded roughly 10 basis points (bp) more than the 10-Year Treasury rate. But in September, the 10-Year Swap Rate went below the 10-Year Treasury rate for the first time in five years and is roughly 10 bp lower than the 10-Year Treasury rate. This has turned out to be a bonus for borrowers. For example, a month ago with the 10-Year Treasury hypothetically at 2.0%, the Swap Rate would have been 2.10%; add a loan spread of say 250 bp, and the interest rate would have been 4.60% (2.10% + 2.50%). Today, the hypothetical Swap Rate is 1.90%, 10 bp below the 10-Year Treasury rate. This results in an interest rate of 4.40% (1.90% + 2.50%), a significant 20 bp swing in favor of the borrower.
This phenomenon is not lost on CMBS issuers as the inversion is reducing profits. Market pros are wondering if it’s time to go back to using the Treasury rates as the basis for pricing loans instead of swap rates. The idea increasingly has been discussed among the CMBS bankers. It seems that the root of the inversion is relatively low demand for Treasuries and corresponding increased demand for swaps. If the imbalance fades, it is likely the discussion to switch to Treasury-based pricing will disappear, but if the gap widens, dealers may take action.