Financing Today

Decline in mortgage rates motivates many borrowers Commercial mortgage rates declined during July, according to the Barron's/John B. Levy & Co. National Mortgage Survey of institutional lenders and players in the commercial mortgage-backed securities market. The continued drop in mortgage rates has motivated a large number of borrowers to take on new debt at levels historically viewed as cheap. Several survey members stated that their pipelines had increased from 25% to 50% in just the last 30 days.

After record activity levels in June, the CMBS market was relatively quiet during July, and all indications were that the fireworks wouldn't begin again until after Labor Day. The one exception was Goldman Sachs' first large loan securitization -- known as Grande Loan 1 -- which was expected to price the first week of August. Following in the tracks set by Nomura Securities' MEGA loan program, Goldman has assembled a $942 million pool of eight large loans and pools of loans made to a sparkling cast of characters, including pension funds advised by J.P. Morgan Investment Management, Cadillac Fairview and two real estate investment funds managed by Lazard Freres. Four of the eight loans come with levels of mezzanine debt which has made some buyers in previous securitizations uncomfortable. But in Goldman's case, the mezzanine levels are on top of relatively low loans-to-value which range from 40% to 60%, causing most buyers to greet the added debt with a yawn. These glitzy loans and their equally high-profile borrowers are expected to be warmly received by the market. There is a vacuum of new CMBS offerings, which will surely lead to oversubscriptions from many classes. Notwithstanding the vacuum, buyers note that the price talk for most of the 12 tranches is in line with spreads which were previously achieved in other securitizations. This indicates that the well-documented collapse in CMBS spreads may well have come to a halt.

As we've noted before, tight CMBS spreads have enabled the conduits to battle institutional lenders for Class-A deals by offering spreads equal to or less than those found in the pension fund and life insurance company markets. But life insurers are calling foul as of late and note that interest calculations are different for conduits from the whole-loan market. Conduit providers, for the most part, calculate interest based on a 360-day year vs. a 365-day year for the whole loan market. This seemingly minor difference leads to conduit loans charging 0.10% to 0.12% more for the same quoted spread and thus perhaps misleading some unsophisticated borrowers.

Both the whole loan and CMBS markets continue to be awash with liquidity. As one observer noted, "This is a great time to be a user of capital." But it's not only good for borrowers but lenders as well. Commercial mortgages continue to show returns in excess of those offered by alternative investments. For the quarter ending June 30, 1997, commercial mortgages, with a total return of 4.20%, outperformed the Lehman Brothers duration-adjusted Baa bond index, which showed a total return of 3.76%. This was also the case for the past 12 months when commercial mortgages showed a total return of 10.78% compared to 9.11%, according to the Giliberto-Levy Commercial Mortgage Performance Indexsm.

There can be no doubt that the current lending euphoria exists in no small part because of the continued stellar performance of mortgage loan defaults and delinquencies. Default and delinquency costs for the 12 months ending June 30, 1997, declined to 0.61% -- a level not seen since 1986. More to the point, default and delinquency costs are now down 75% from their peak just four years ago.

In an effort to entice new borrowers, both Wall Street and institutional lenders are taking a serious look at weakening their prepayment protection.

Comments and questions are welcomed at our World Wide Web site:

John B. Levy is president of John B. Levy & Co. Inc. in Richmond, Va.

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