Commercial Real Estate loans say goodbye to T-Bills as a base rate
If you have been in the market lately for a CRE term-loan, you might have encountered a trend where the bank is selling you a fixed rate loan using the SWAP rate as the base instead of the T-Bill. There are a few reasons for this.
First, using the SWAP rate is more indicative of the cost of funds for your bank. Remember that the bank lender gets most of its funding from short-term deposits, but when it lends you money on a long-term basis there is a mismatch. This asset (your loan) and liability (short-term deposits) mismatch creates interest rate risk for the bank. If the bankers are smart they do mathematical analysis, and mitigate the risk by going to the market and entering into some swap arrangements. The other way of managing that risk is to limit exposures to interest rate risk by keeping loan maturities to ten years with a repricing event after the first five.
Of course there are commercial real estate loan programs with longer maturities. In those cases, the bank might decide to keep the risk in-house or securitize them. This is where the large national banks have an edge on the smaller competitors, they can allocate billions to these programs and move them off the balance sheet by turning them into CMBS much easier than the small community bank down the street.
The other and most important reason of course is your lender’s profitability. Someone took a look at the historical SWAP and T-Bill rates and figured out that if we started basing our loans on the SWAP, we would make more money. And of course, the fact that there is a sellable story behind it does help.