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Falling Rates Spark Deals

Extraordinarily low Treasury rates and the largest offering of collateralized mortgage-backed securities in more than three years made for a vibrant August. Meanwhile, a new single-asset transaction marketed by Lehman Brothers may help allay buyers' concerns about terrorism insurance.

One of many financial casualties of Sept. 11 was the single-asset securitization market. Buyers became wary of any deal underpinned by one property that could be taken out by a single terrorist attack. In August, Lehman Brothers began marketing the first single-asset securitization in more than a year, which was expected to price in mid-September.

The property, 1166 Avenue of the Americas in Manhattan, was financed 15 months ago in a $215 million floating-rate transaction led by Banc of America Securities. Lehman plans to raise $240 million this time with $93 million going into an upcoming Lehman Brothers/UBS securitization and $147 million being sold privately.

The security is for a 560,000 sq. ft. condominium interest in the building, which is the world headquarters for the Marsh & McLennan insurance firm, and is also backed by a lease from J.P. Morgan Chase. The borrowers — Edward J. Minskoff and Louis R. Cappelli of 1166 LLC — are refinancing to take advantage of low interest rates.

The double set of investment-grade credits seems to have helped skeptical buyers, as did a new approach to terrorism insurance. Lehman's marketing data indicate the building will carry full “all-risk” insurance, including terrorism coverage. The borrower must continue to provide terrorism insurance, if it is commercially available, regardless of whether it is reasonably priced or not. In the unlikely event that neither the capital markets nor the rating agencies require terrorism insurance, the borrower will be allowed to let the insurance lapse.

Favorable Interest Rates Persist

Record-low Treasury rates have been the full-employment act for mortgage-loan producers. Borrowers are eager to take advantage of long-term rates, which on low-leverage transactions can be less than 6%. As a result of increased production, CMBS offerings should increase in the fourth quarter and early next year.

This spurt of originations has led market participants to sense that commercial-mortgage spreads will need to widen in order to absorb the increase. As Mike Marriott, managing director of commercial mortgage trading at Credit Suisse First Boston says: “I'm a bit of a bear. Spreads could widen significantly in the fall as investors rotate into corporate bonds and sell what's done best today, which is CMBS.”

In late August, Banc of America Securities brought to market a $1.7 billion securitization — the largest collaterized offering in three years — including about $1.4 billion in triple-A rated bonds. The nearly $1 billion triple-A class A-3 offering priced at interest-rate swaps plus 0.47 of a percentage point, at the tight end of early price guidance.

The securitization, which covered 168 multifamily and commercial properties, was aided by the voracious appetite of Freddie Mac, which reportedly gobbled $600 million of the three triple-A classes. Owing to the large number of triple-A securities offered, buyers sensed the transaction would trade well, and they proved to be right, as the long triple-A tightened to interest rate swaps plus 0.44 to 0.45 of a percentage point shortly after closing.

Loan Defaults on the Rise

According to Fitch Ratings' 2002 CMBS conduit loan-default study, annual defaults more than doubled from 2000 to 2001, with the highest default rates for loans secured by hotels and health-care properties. The greatest number of defaults, however, was within the retail sector. In fact, the bankruptcy of furniture retailer Heilig-Meyers was responsible for 31% of all retail defaults in 2001 alone.

The rating agency noted if the annual number of defaulted loans doubled in 2002 and sustained that high rate for the next five years, the default rate wouldn't be great enough to impact the principal on investment-grade CMBS rated triple-B-minus or higher. However, non-investment grade CMBS tranches could suffer severe loses.

John B. Levy is president of John B. Levy & Co. Inc. in Richmond, Va. ¤ Dow Jones & Co. Inc., 2002.


Selected CMBS Spreads*
To 10-year U.S. Treasuries
Rating 9/2/02 8/5/02
AAA 97-99 109-110
AA 108-111 119-120
A 120-123 129-130
BBB 172-177 177-180
BB 450-475 490-510
*in basis points, or hundredths of a percentage point

Whole Loans*
Term of loan Prime Mtge. Range 9/2/02 Prime Mtge. Rate Prime Mtge. Range 8/5/02
5 Years 5.21-5.31% 5.21% 5.20-5.40%
7 Years 5.61-5.71% 5.61% 5.63-5.68%
10 Years 5.99-6.14% 6.04% 6.25-6.30%
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.
*Interest rates

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