Buyers Get Leverage Jitters

OK, so maybe trees — or their real estate equivalent, leverage — don't grow to the sky. But for a while there, it sure looked to the commercial real estate gang as if leverage had no natural limits, according to the Barron's/John B. Levy & Co. National Mortgage Survey. In early May, buyers decided that they had finally had enough, causing bankers and traders to sit up and take notice.

The transaction getting all the attention was a $1.4 billion securitization sponsored by Wachovia Bank. The collateral included 72 loans on a variety of commercial and multifamily properties. Initially, the transaction was structured with the normal “super-senior” class of triple-A securities with 20% of the securitization in the subordinate, or junior classes. The super-senior structure has been quite the rage since last fall and has been widely accepted by both institutional buyers and originators of commercial mortgage loans.

Early in the road show for the securitization, Wachovia changed the structure to include a “super-duper” triple-A class with a 30% subordination level. A number of institutional buyers thought that given the leverage of the securitization, a 20% subordination level just wasn't adequate.

Indeed, the leverage on the Wachovia deal, dubbed C-18, caused more than a few observers to suffer from high-altitude sickness. For example, some 88% of the loans were interest-only for part or all of the term, a record high. Contrast this with an average of 55% for securitizations originated during the first quarter of this year. Additionally, excluding the loans that weren't shadow-rated, Moody's showed the loan-to-value of the pool at 103% — well above the 95% average loan-to-value also in the first quarter of this year.

Buyers, sensing blood in the streets, demanded and got higher spreads. For example, the super-duper senior class A-4 priced at interest-rate swaps plus 27 basis points while the more standard super-senior class priced at interest-rate swaps plus 30 basis points — some three to four basis points wider than a normal super-senior class.

Lower-rated classes priced wide as well with the triple-B priced at interest-rate swaps plus 110 basis points, some 10 basis points wide of normal transaction levels.

Record first quarter

New loan originations and new securitizations are on a tear these days. First-quarter securitizations set a world record at $40.7 billion, while volume for the second quarter is expected to set yet another quarterly record. For example, there are two deals in the queue, which combined, will bring over $8 billion in new volume to the market.

Hotels continue to be the hot property class. Both hotel occupancies and revenues are rising steadily, while hotel spreads are heading down precipitously. Dan Sheehan, senior vice president of Genworth Financial, noted that “hotel spread compression is out of control.” Another institutional lender suggested that hotel spreads are now trading only 10 basis points wider than office building spreads with similar quality.

Trophy deal in the works

In a deal sure to attract international attention, Rockefeller Center is being re-securitized. The $1.65 billion offering is being led by Goldman Sachs and RBS Greenwich Capital. It's viewed as a deal with low leverage and high visibility. The underwriters are looking to price a 20-year, interest-only loan on the entire transaction.

Although there is no official price guidance as yet, industry sources are suggesting that the class-A rated triple-A will price in the area of interest-rate swaps plus 35 basis points. The extra spread is thought to compensate buyers for the single-asset nature of the transaction as well as a much longer term. Large trophy deals are generally bought by insurance companies, which need to purchase long-term obligations as opposed to money managers who have a shorter-term horizon.

John B. Levy is president of John B. Levy & Co. Inc. in Richmond, Va. © Dow Jones & Co. Inc., 2004.


Selected CMBS Spreads*
To 10-year
U.S. Treasuries
Rating 5/9/05 4/18/05
AAA 70-71 72-73
AA 82-83 82-83
A 91-93 93-94
BBB 138-143 135-140
BB 280-295 285-300

*in basis points, or hundredths of a percentage point

Whole Loans*
Prime Mtge. Range Prime Mtge. Prime Mtge. Range
Term of loan 5/9/05 Rate 4/18/05
5 Years 4.97-5.07% 5.07% 5.10-5.20%
7 Years 5.11-5.21% 5.21% 5.25-5.35%
10 Years 5.31-5.41% 5.41% 5.47-5.57%

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.

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