Enronitis Dampens Loan Market

A STOCK-MARKET DRUBBING and general business anxiety have finally made their presence felt on the market for commercial mortgage-backed securities (CMBS). A mortgage banker who is among the more than 30 market participants in the monthly Barron's/John B. Levy & Co. Commercial Mortgage Survey puts it this way: “Senior credit officers have a bad case of Enronitis; they're second guessing every decision.” Consequently, CMBS spreads have widened from their mid-July levels.

Selected CMBS Spreads*
To 10-year U.S. Treasuries
Rating 8/5/02 7/1/02
AAA 109-110 95-97
AA 119-120 105-107
A 129-130 115-117
BBB 177-180 158-163
BB 490-510 480-500
*in basis points, or hundredths of a percentage point

Whole Loans*
Term of loan Prime Mtge. Range 8/5/02 Prime Mtge. Rate Prime Mtge. Range 7/1/02
5 Years 5.20-5.40% 5.25% 5.92-6.02%
7 Years 5.63-5.68% 5.68% 6.24-6.40%
10 Years 6.25-6.30% 6.30% 6.67-6.77%
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

Despite the general market's recent turmoil, CMBS have turned in an extraordinary performance this year. According to Jeff Mudrick, a senior vice president at Lehman Brothers, CMBS garnered a total return for the first seven months of 8.61%, far outdistancing any other sector of the Lehman Brothers U.S. Aggregate Index. Treasuries, by comparison, returned 6.07% and corporate bonds weighed in at a modest 1.94%.

Individual loans performed much the same. The Giliberto-Levy Commercial Mortgage Performance Index showed individual loans registering a 6.36% total return in the second quarter. By comparison, triple-B corporate bonds of the same duration returned a sharply lower 1.98% during that span.

Restrained Reception

Underwriters led by J.P. Morgan and Wachovia Securities in late July sold a garden-variety $816 million offering made up of 129 fixed-rate loans. Although this was the first new offering from a conduit — a firm that buys and pools loans and then turns them into securities — in two weeks, the offering didn't sell quickly.

Street speculation figured the $410 million, 10-year, A-3 tranche, rated triple-A, would be priced at interest-rate swaps plus 45 to 46 basis points. (Interest-rate swaps are used for switching from a floating rate of interest into a fixed rate of interest, or vice versa.) It wound up selling at more than 47 basis points over swaps in order to attract sufficient buyers. If all goes according to plan, $10 billion to $12 billion in additional securitizations, both fixed and floating rate, should hit the market by the end of September.

Overall, CMBS originations in the U.S. were down 16% in the first six months of 2002. The lower origination volume is clearly helping to keep a lid on spreads. Triple-A spreads, which were at swaps plus 42 basis points in mid-July, could widen beyond the levels of the J.P. Morgan-Wachovia offering if general business anxiety continues.

But most buyers think a near-term ceiling is approaching. Says Peter Horos, a regional manager at Allstate: “There will be a lot of investor demand if triple-A spreads go as wide as interest-rate swaps plus 50 basis points.”

On a positive note, conduit delinquencies, according to Trepp LLC, have been virtually unchanged for more than six months. July conduit delinquencies were 1.69% while those in January were only a tad lower, at 1.55%.

Troubled Office Market

In the latest update of its Red-Yellow-Green report, Moody's Investors Service gave the market more than a few reasons to continue its cautious approach.

The report categorizes property market strength. Of the 53 office markets that Moody's follows, none are ranked green, or healthy, and 15 are classified as red, or in big trouble. Overall, office vacancies are now listed at 16% nationwide, and this number is sure to increase.

The retail sector is faring surprisingly well despite the widespread view that there's a glut of strip shopping centers. The overall sector warrants a Moody's green light, with 26 markets shown as green and only three depicted as red.

The lack of terrorism insurance continues to weigh on the market. Federal legislation is now before a House-Senate conference committee. Despite the hopeful sign, most major CMBS buyers aren't ready to say the problem is fixed, fearful that conferees may not be able to agree on satisfactory legislation.

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

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