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Sweet September

The commercial mortgage-backed securities market was in a hyperactive mode to close out the third quarter. Some $8 billion to $9 billion in domestic issues were planned for September alone, according to the Barron's/John B. Levy & Co. National Mortgage Survey. The market was poised to post its most active third-quarter ever — one in which about $12 billion in new deals would be completed, easily surpassing the record of slightly more than $10 billion set in 1998.

Eight CMBS transactions were scheduled in September, following an August when the buying tone soured a wee bit. The last two deals to price, an $850 million securitization led by Wachovia and a $1.15 billion issue co-led by J.P. Morgan and Merrill Lynch, seemed to struggle. Large institutional buyers say they were told that, rather than pay cash, they could purchase bonds by swapping them for others they already own.

A few investors speculated that certain bonds weren't sold at all, but instead were kept in dealer inventories. In any case, spreads widened, with those on the triple-A parts of the Wachovia and J.P. Morgan/Merrill deals in the range of interest-rate swaps plus 38-39 basis points, up some five basis points from the previous transaction. (A basis point is 1/100th of a percentage point.)

Noteworthy Deals

Even with the large pending list of new securitizations, Marielle Jan de Beur, vice president at Morgan Stanley, is optimistic that the triple-B rated classes will do well. She notes that triple-B CMBS have been trading some 20 basis points wider than similarly rated real estate investment trusts and almost 25 basis points wider than similarly rated corporate bonds. As a result, she adds, triple-B CMBS could be in for a basis-point tightening of five to 10 points.

Hitting the market in early September was Power 2, a $1 billion offering with collateral put up by Bear Stearns, Wells Fargo and Prudential. This securitization was originally scheduled to come in August, but was deferred until September. The deal consists of some 100 loans, with the largest being a $100 million mortgage on 3 Times Square in Manhattan. Dealers are expecting the triple-A to price in the range of interest-rate swaps plus 38-39 basis points and the triple-B to price around interest-rate swaps, plus 115 basis points.

Loan Delinquencies Tick Up

Although the economy is showing signs of life, CMBS delinquencies are still rising. According to Trepp LLC, a CMBS analytics firm, office-building delinquencies now amount to 0.74% of outstanding loans. Although this isn't earth-shattering, it's up markedly from 0.45% at the beginning of the year and 0.66% at the end of the second quarter.

Rather than focus on delinquent loans, some sophisticated investors concentrate on loans that, while current, may become delinquent due to factors such as a reduction in income or low occupancy rates. Based on data from Trepp, 12.33% of office loans are on this “watch list,” up from 11.5% in June.

On the low end of the list are warehouses at 7.59%, while health-care facilities, at almost 32%, and lodging, at just over 31%, are the worst offenders. True, the vast majority of watch-list loans don't become delinquent. Nevertheless, the high percentages have led some analysts to regard the CMBS market more warily.

Interest rates are up, with the 10-year Treasury yield about 150 basis points above its June low. The increase has led some investors to wonder when capitalization rates — the reciprocal of a price/earnings ratio — will rise, causing property values to fall.

But Real Capital Analytics President Robert White says that there has been no noticeable rise. Furthermore, he notes that since the difference between 10-year Treasury yields and capitalization rates — now some 500 basis points — is at a record high, this spread probably will narrow, and cap rates won't rise nearly as sharply as interest rates.

John B. Levy is president of John B. Levy & Co. Inc. in Richmond, Va. © Dow Jones & Co. Inc., 2003.


Selected CMBS Spreads*
To 10-year U.S. Treasuries
Rating 9/8/03 8/4/03
AAA 89-90 91-92
AA 99-100 98-99
A 109-110 105-107
BBB 158-163 151-156
BB 425-440 425-440
*in basis points, or hundredths of a percentage point

Whole Loans*
Prime Mtge. Range Prime Mtge. Prime Mtge. Range
Term of loan 9/8/03 Rate 8/4/03
5 Years 5.17-5.27% 5.27% 4.96-5.06%
7 Years 5.60-5.67 5.67 5.33-5.43
10 Years 6.10-6.20 6.20 6.03-6.13
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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