CMBS market players sing more favorable tune

If the commercial mortgage business was looking for a theme song these days, "Let the Good Times Roll" would do rather nicely. In fact, it is hard to believe that this is the same business that was literally dead in the water for most of the second half of 1998.

To be sure, interest rates rose last month based on Alan Greenspan's comments to Congress, so things were not all rosy. The Barron's/Levy 10-year prime mortgage rate soared to 7 3/8% from 6 7/8% on February 1. Nevertheless, the commercial mortgage business is in its best shape since before the August 1998 market crash, and players on both the commercial mortgage-backed securities (CMBS) and whole-loan sides are eager to take advantage of the market's firmness.

Two major securitizations priced last month, including a $1.3 billion offering from Deutsche Bank. The class A-2, rated triple-A priced at 1.2% over the 10-year Treasury while the class E rated triple-B was priced at 2.35% over the comparable Treasuries. The Deutsche Bank deal was fairly typical in that CMBS transactions this year are significantly smaller than last year as originators rush their supply of newly originated mortgages to market.

For the first quarter of 1999, it appears that some $20 billion in new CMBS will come to market, which is at the top of the previously estimated range. But for April and May, there will be a slowdown as the market takes a well-deserved breather. According to Gayle Scott at New York-based Standard & Poor's, "The April/May pipeline is not as full as it normally would be." With the coming respite in mind, some real estate buyers are suspecting that spreads will tighten.

Sure to add to the coming spread tightening is the recent announcement by Lehman Brothers, New York, that it is adding several CMBS indexes to its arsenal. One index will be devoted to investment grade bonds only, while the others will be devoted to below-investment grade and interest-only strips.

Last month, Lehman announced that the ERISA-eligible index would become part of the Lehman Brothers Aggregate Bond Index as of July 1 this year, which adds extra pressure on money managers to include CMBS as part of their buying profile. According to Howard Esaki at New York-based Morgan Stanley, "the Lehman CMBS Index could lead to spread tightening on the order of .05% to 0.10%."

Part of the "feel good" tone in the CMBS market is due to strong secondary trading. Secondary trades ensure that buyers will be able to sell their CMBS transactions in a liquid market, which entices them to allocate more funds into this relatively new asset class.

But despite the virtual lack of defaults and delinquencies in most insurer's portfolios, anticipated production volume for 1999 shows no increase at all for the most part and perhaps even a small decline overall. Insurers do not seem to be receiving an increasing flow of funds which is interested in being tied to fixed-income instruments like commercial mortgages. A significant exception to the rule is AEGON, USA, the American subsidiary of the Dutch multinational insurance company, which has announced that it has need for 50% more commercial mortgages in 1998 than it did last year, bringing its 1999 target to more than $2 billion.

The buzzword these days on the institutional side of the ledger is "club deals." In the past, life insurers and other institutions were reluctant to band together to take on commercial mortgages. But this year is different. Most insurers want to limit their exposure per transaction to no more than $75 million, and groups have banded together so that they can fund larger transactions and be competitive with Wall Street. These so-called "club deals" have each institution taking its pro rata share of the transaction being offered, which in many cases can be in excess of $200 million.

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