CMBS Issuance in U.S. Breaks Another Record

Staggering volume, higher Treasury yields and bad news from Ford Motor Co. and General Motors didn't cause the wheels to fall off the commercial mortgage bus, but it certainly loosened a lug nut or two. First-quarter volume, normally a fairly quiet period, hit an astounding level of almost $33 billion, the largest domestic quarterly volume ever, according to the Barron's/John B. Levy & Co. National Mortgage Survey.

The first-quarter numbers were 18% higher than the previous record set in the fourth quarter of last year and an astonishing 70% ahead of the first quarter last year. Commercial real estate analysts expect the second quarter to proceed at an orderly pace until June, when another record is forecast. Assuming the second quarter stays on track, volume for the first six months will range between $60 and $70 billion, far ahead of our panelists' consensus forecast of $51 billion.

Wider spreads ahead

A general weakness in corporate bond yields, exacerbated by the performance of the auto sector led to sharply wider CMBS spreads. Long triple-A spreads are now in the range of interest-rate swaps plus 27 to 28 basis points, up some 7 to 8 basis points from their tight levels of early March.

The bad news is clearly not over. Investors smell blood in the water and seem reluctant to buy until spreads widen a bit further. Many traders wouldn't be surprised to find that triple-A spreads widen another 3 to 5 basis points in the process, while triple-B spreads are fully 15 basis points wider than their previous lows. As Managing Director Craig Sedmak of Bear Stearns remarks, “The market's soft, but defined.”

In addition to tracking real estate fundamentals, CMBS traders and analysts are keeping a close eye on something widely known as the CDX IG4, an arcane derivative of investment-grade corporate credits. Simply put, the higher the spread, the more likely corporate spreads are to increase in the future.

Right now, the IG4 is 10 basis points wider than the levels set a little more than a month ago, suggesting that higher corporate spreads are in the offing. Since CMBS spreads track corporates, although clearly not in lockstep, a higher IG4 series implies that CMBS spreads are on the move upward. Developers who are waiting to borrow money may be hit with both higher Treasuries as well as larger spreads.

Real estate recovery builds

Investors believe that real estate fundamentals are improving, although clearly at a measured pace. Bret Wilkerson, CEO of Property & Portfolio Research, notes that of the 54 apartment markets they track, 48 have a vacancy rate lower than a year ago, and vacancy rates in 45 markets fell again in the first quarter of this year.

But the multifamily news isn't all good: Condo construction in the first quarter is up a whopping 130%, and investors often turn condos into rental units, leading to possible vacancy problems down the road. Office properties are improving as well with vacancy rates now having fallen for five straight quarters for the first time since 1998.

Until now, condo conversions have been financed substantially through banks and specialty finance firms. But all that's about to change as Credit Suisse First Boston is bringing an eight-property, $1 billion securitization of condo conversions to the market. The properties are in the usual locales: New York City, Hawaii, Miami Beach and the metro Washington, D.C. area, among others.

To entice investors, the floating-rate spreads offered are 10 basis points wider than previously and are sure to attract a yield-hungry crowd. Credit Suisse First Boston has been an innovator of late; it also started the super senior triple-A craze late last year. There will likely be a large following of “me-too” condo conversion financings in the ensuing months.

Impact of Fannie Mae fallout

Fannie Mae is making headlines these days, and the news hasn't generally been good. Although Fannie Mae does not buy CMBS, it does purchase a monstrous amount of apartment loans through other programs. Some investors are pondering whether a leaner Fannie Mae could cause spreads in the multifamily markets to widen. Brian Schwartz, managing director at RBS Greenwich Capital, isn't particularly concerned about a smaller Fannie Mae and suggests, “It's a stretch to say that it will have an adverse effect on CMBS spreads.” Other investors are equally sure that spreads will widen to handle the additional loans that Fannie Mae is unable to purchase.

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 4/18/05 3/7/05
AAA 72-73 63-64
AA 82-83 71-72
A 93-94 81-82
BBB 135-140 125-127
BB 285-300 285-300

*in basis points, or hundredths of a percentage point

Whole Loans*
Prime Mtge. Range Prime Mtge. Prime Mtge. Range
Term of loan 4/18/05 Rate 3/7/05
5 Years 5.10-5.20% 5.15% 5.09-5.19%
7 Years 5.25-5.35% 5.30% 5.24-5.34%
10 Years 5.47-5.57% 5.52% 5.46-5.56%

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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