CMBS issuance riding high for first months of 1998

Commercial mortgage activity has returned to a feverish pace, according to the Barron's/John B. Levy & Co. National Mortgage Survey of more than 30 institutional lenders and players in the commercial mortgage-backed securities (CMBS) market. Mortgage rates have moved up a sliver - the 10-year prime mortgage rate is now at 7% - but that has seemingly had no effect on potential borrowers.

In the whole-loan market, commitment volume is up, and the pipeline of pending business has increased, according to survey members. In fact, business is so good that several survey participants indicated that they are raising their spreads .10-.15% and have no fear of losing business. Several institutions indicated that although they have a virtually limitless appetite for 5 and 7 year term mortgages, their appetite for the longer term 10-year mortgages is quite minor. Portfolio managers don't seem to want long-term commercial mortgages in the portfolio with coupon rates in the 7% range.

On the negative side, more than a few institutional lenders noted feeling as if they were paddling upstream. Even though new loan demand is high, payoffs of existing loans are at record levels. As a result, the payoffs and new loans will virtually cancel themselves out, leaving little total portfolio growth.

Put simply, supply in the CMBS market is exploding. CMBS issuance was up some 250% for the first month and a half of 1998 overthis time last year. In fact, during the last six weeks of the first quarter, some $15 billion to $16 billion is scheduled to come to market - more than 10% of the market's total capitalization! Late last week, Morgan Stanley priced a new $1.3 billion securitization consisting of collateral supplied by themselves, Wells Fargo and John Hancock. The class A-2 triple-A securities were priced at a lower than estimated .78%, again showing strong demand from major CMBS buyers. The Class D securities rated triple-B were priced at the tight end of the offering range at a 1.35% spread. The bonds were priced over the "new 10-year Treasury" which for technical reasons trades some .07% tighter than the "old Treasury."

Although the triple-A and double-A classes do well, money managers are increasingly seeing that the mezzanine classes of the current securitization crop - those rated A and BBB - are showing signs of weakness. As one money manager said, "It's not that the buyers have gone away, it's just that the supply has increased astronomically." Triple-B rated tranches have seemingly been stuck in the 1.4% range, with some industry observers indicating it will take upwards of 1.5% to clear the coming glut of new product.

According to Tad Philipp, Managing Director of Moody's, "Now is as good as it gets." At least, that is, from a borrower's point of view. But he notes that leverage is up dramatically and, according to Moody's, exceeds 90% loan-to-value in many of the newer transactions. Traditionally, loans-to-value have not exceeded 75%. This increasing leverage is coming relatively late in the credit cycle, which leads him to warn that the combination of high leverage and timing could be a double whammy for the market.

On the horizon next week is a $1 billion conduit securitization offering by NationsBank - the first time a commercial bank has been the sole underwriter of a transaction this size. The bank has gathered more than 200 loans for this new offering, with some 50% composed of multifamily collateral. In a highly unusual move, NationsBank has reportedly told its major clients that all of the triple-A tranches - some $700 million - will be sold to the Federal Home Loan Mortgage Corporation. Freddie Mac is "paying up" for the privilege of owning all of these bonds. NationsBank's normal clients don't seem to be too worried about being "shut out of the deal," since there are any number of alternative triple-A rated CMBS investments available to them. NationsBank has denied that it is pursuing this strategy.

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