The passing of the historic tax reform bill, known as the Tax Cuts and Jobs Act, in December 2017 marked the largest change to U.S. tax policy in decades by reforming both individual and corporate income taxes.
Intent of the Tax Plan
The pro-growth tax plan intends to, among other things, drive GDP growth while simplifying the tax code and broadening the tax base. Along the way it is expected to create new jobs, increase federal revenues, lower tax rates on wages, and reduce the corporate income tax rate. Although the merits of the tax reform and its consequences on the U.S. economy will likely be measured over the years to come, many of these changes became effective January 1, 2018, raising questions about whether or not the new tax legislation will translate into reductions in the cost of debt.
Current Pricing Trends
While there has been recent evidence of price compression in the market for select transactions when compared against similar transactions in 2017, it’s difficult to attribute this solely to tax reform. Rather, current pricing trends are more likely a function of several factors converging at the beginning of 2018: lower corporate tax rates, new lender production goals for the year, an increase in short-term rates since late 2015, favorable economic conditions, and an overall competitive lending environment.
Whatever the reason, the combination of these items should provide a positive back-drop for borrowers and the potential cost of financing. So, why does the feedback from borrowers suggest a wide range of quotes from lenders in the market?
1) Historic Growth
Many lenders experienced significant growth in their commercial real estate portfolios over the last five to seven years, and there may be less pressure from senior management to continue growing at a similar pace. As a result, lenders may not feel compelled to “chase” deals and will quote at levels that comfortably satisfy their return objectives.
2) Economic View
Despite a lot of positive economic indicators, there is sentiment that the market is in a late-stage lending cycle. And volatility in the broader economy has created uncertainty. Moreover, lenders are focused on industry-specific headwinds including the retail sector and over-supplied markets. Lenders tend to have long memories from issues of past cycles and will approach deals cautiously.
3) Structure
Some lenders trade structure for price; others are more yield-sensitive and would rather provide a less restrictive structure to satisfy their return models. Either way, pricing tends to be the last input of a proposal after structure has been determined.
4) Hold Levels
In the past, we have discussed the dynamics of a syndicated loan and its impacts on pricing. Depending on appetite for a loan and the corresponding commitment amount (i.e., will a lender hold the entire loan or need to sell), lenders may price their deals very differently. Even some of the recent declines in pricing expectations of the market don’t always translate to a broader or cheaper syndicated market. Lenders may need to price the deal to clear market, and that could impact the competitiveness of a quote.
5) Transparency
Unlike corporate debt issuance for public companies, details of secured asset-level financing is not typically available to market participants, creating a situation where the feedback for a winning “bid” may be anecdotal, at best. Thus, lenders don’t always get the benefit of learning where competitors may be pricing risk to help them revise their quotes for future opportunities.
6) Relative Value
Traditional unsecured corporate-level REIT facilities often represent an artificial “floor” on pricing for lenders given the size and credit quality of the borrower as well as the restrictive covenant structure. Each lender has differing views on the appropriate premium above this “floor” to price secured property-specific transactions.
Lenders in a period of price discovery
Given these considerations and recognizing that each deal is unique, lenders find themselves in a period of price discovery to determine an appropriate return to balance risk, competitiveness and market-clearing levels for syndicated transactions. Therefore, the best place to start evaluating your specific financing needs and the associated costs is with your PNC Real Estate Relationship Manager. Your Relationship Manager can help answer preliminary questions and, if necessary, connect you with a Loan Syndications Specialist who will look more deeply at your needs.
PNC is consistently ranked in the top five real estate loan syndication businesses in the U.S.[1] and manages, as Administrative Agent, more than 400 syndicated lending relationships totaling approximately $70 billion in commitments.[2] We look forward to the opportunity to work with you on your next large loan.
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