The market for commercial mortgage-backed securities (CMBS) has become a bit crowded. No fewer than six separate offerings totaling more than $6 billion were due in late December. Some Wall Street houses were eager to clean up their loan inventories, while others focused on maintaining their dominant positions as underwriters. After all, rankings by total dollar volume as compiled by trade publications are all-important to these big players.
Morgan Stanley priced the first, a $909 million transaction known as IQ3, in early December. The issue included 239 loans primarily from insurance companies, which investors find attractive because of their reputation as conservative underwriters. The long triple-A tranche A-4 priced at 49 basis points over interest-rate swaps while the Class-F tranche, rated triple-B, came at a surprisingly tight 135 basis points over swaps.
Some analysts think spreads must widen to absorb the remaining deals. Darrell Wheeler, director and head of CMBS research at Salomon Smith Barney, says it will take “triple-A levels of swaps plus 52 to 53 basis points to clear the year-end market.” Ken Cohen, senior vice president at Lehman Brothers, argues that triple-A spreads will “hit 45 [basis points over swaps] in mid-January.”
Meanwhile, loan delinquencies declined modestly in November, but CMBS nevertheless failed to keep pace with the corporate-bond rally. Single-A corporate bonds outperformed similarly rated CMBS by 2.78 percentage points last month, while the gap for triple-B credits was a severe 4.38 percentage points.
Liquidity in the CMBS market also has slipped, according to a major money manager. Some investors rotated out of CMBS, which had been viewed as a safe haven, and returned to corporates. The heavy supply of new issues also continues to soak up liquidity, he adds.
Impact of Terrorism Insurance Legislation Still Unclear
President George W. Bush in November signed into law the Terrorism Risk Insurance Act, for which the commercial real estate industry had lobbied long and hard. So far, the impact of the bill, which was supposed to jump-start new construction, has been limited.
The bill requires insurers to offer terrorism coverage, but so far no one knows the cost of the additional insurance. Since the bill allows borrowers to decline the terrorism coverage, it also isn't clear how many property owners will avail themselves of the new coverage.
Single-asset CMBS transactions, which were affected the most by the lack of a terrorism-insurance bill, have continued to trade in very modest amounts and with no appreciable spread tightening.
Mezzanine Activity Heats Up
Most first mortgages have covenants forbidding borrowers from adding subordinated debt without the lender's express consent. But borrowers don't want to prepay first mortgages with today's low rates, along with stringent penalties, if they later want to obtain more financing.
So they are pressing lenders to permit future “mezzanine debt” on the property. Mezzanine debt, while not a recorded mortgage, is secured by the borrower's ownership interest in the properties. Generally, about 5% to 10% of the loans in a generic securitization have this provision included.
One mezzanine lender that has received rating-agency approval for its debt is Chatham, N.J.-based CBA Mezzanine Capital Finance. Its mezzanine loans offer conduit borrowers 5% in addition to its first-mortgage proceeds.
Susan Merrick, group managing director of CMBS for Fitch Ratings, noted that “although mezzanine debt isn't as good from a credit perspective as no additional debt, in a competitive market lenders need to be more flexible. As a result, we expect to see more of this in the future.”
John B. Levy is president of John B. Levy & Co. Inc. in Richmond, Va. © Dow Jones & Co. Inc., 2002.
BARRON'S/JOHN B. LEVY & CO. NATIONAL MORTGAGE SURVEY
|Selected CMBS Spreads*|
|To 10-year U.S. Treasuries|
|Term of loan||Prime Mtge. Range 12/09/02||Prime Mtge. Rate||Prime Mtge. Range 11/11/02|
|For loans of $5 million and up, on amortization schedules of 25-30 years that can be funded in 60-120 days with 0-1 point.|
*in basis points, or hundredths of a percentage point