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CMBS Volume Hits Record High

Perhaps it's time to sing a chorus of “Happy Days are Here Again.” Make that another chorus because the market for commercial real estate has been singing that tune for quite a while. According to the Barron's/John B. Levy & Co. National Mortgage Survey, securitizations of commercial mortgages ran at a record volume in June, continuing a pace that has prevailed all year. Monthly offerings totaled $23 billion in the U.S. market.

The previous record, $21 billion, was set just in March. In spite of rising short-term rates, long-term U.S. Treasury yields have gone the other way, hovering around 4%. Even the greediest real estate developer knows a bargain when he sees it, and Treasuries at today's levels qualify.

The buyers of commercial mortgage-backed securities (CMBS) continue to gripe about the lack of underwriting standards in new offerings, particularly the number of interest-only loans. Though there is sporadic talk of a “buyers' strike,” nothing has materialized. Referring to the lack of underwriting, senior portfolio manager Peter Horos of Allstate Investments laments, “I'm just numb!”

Capping off a whirwind of activity in June, Banc of America priced a $2.1 billion offering. For many buyers, the transaction illustrates what's wrong with the CMBS business. More than 60% of the loans were at leverage levels higher than 100% — that is, in amounts greater than the value of their underlying properties, reports Moody's Investors Service. Some 73% of the loans were interest-only for at least a portion of their terms.

Particularly galling to some vocal investors were the leverage levels of the largest loans, including 140% on the Woolworth Building in New York and 155% on the Pacific Arts Plaza in Costa Mesa, Calif. Despite the grousing, there were more than enough buyers to take down the offering. Some analysts are suggesting that the leverage levels in offerings scheduled for later this summer will make the latest Banc of America offering seem tame.

Second-half predictions

In January, we asked a dozen buyers and sellers of CMBS for their market forecasts for the first half of 2005. With respect to super-senior triple-A spreads to 10-year interest-rate swaps, their estimates were spot on, averaging 26 basis points, compared with the current spread of 26 to 27 basis points. Scott Stelzer, a vice president with Morgan Stanley, was closest to the pin with a forecast of 25 basis points.

Among CMBS issuers, forecasts were surprisingly anemic. They expected U.S. volume to total $51 billion for the first six months. It came in at $73 billion. John Scheurer, managing director at Allied Capital was closest, with his estimate of $57 billion. The group's average 10-year Treasury yield estimate came in at 4.66%, above the actual 3.97%.

We've convened a new group along with our two previous winners. The panel doesn't expect super-senior triple-A spreads to vary much, but it does look at issuance to continue at record levels. If projections of $135 billion in volume hold true, 2005 volume will demolish the record set just last year.

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


CMBS market forecasts for Dec. 31, 2005*
Name Company 10-Year Treasury Yield Triple-A Spreads To 10-Year Interest Rate Swaps* U.S. CMBS Issuance Volume ($Billions)
Richard Avidon Credit Suisse Asset Management 4.50% 23 $130
Haejin Baek Barclays Capital 4.50% 27 $175
Brian Baker JP Morgan 4.35% 23 $132
Ken Cohen Lehman Brothers 3.85% 23 $145
Larry Duggins ARCap REIT 3.95% 29 $120
Phil Evanski Nomura Securities 3.85% 21 $132
Eric Gould GE Asset Management 4.50% 27 $120
Peter Horos Allstate Insurance Co. 4.25% 27 $120
David Lehman Goldman Sachs 4.25% 32 $130
Andy Parower AIG Global Investments Group 4.45% 27 $140
John Scheurer Allied Capital 4.62% 29 $150
Scott Stelzer Morgan Stanley 4.75% 25 $128
Average 4.32% 26 $135
*In basis points, or hundredths of a percentage point.
Source: John B. Levy & Co.

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