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Commercial mortgage markets slowed a tad in mid-spring on the whole-loan and commercial mortgage-backed securities (CMBS) side. Bankers and traders used the long awaited slowdown to take a breather. Insurance company lenders noted that their pending list of loans had trended down, while the CMBS market had few new securitizations.

Although the market for new CMBS originations was quiet in April, secondary markets saw more activity - especially at the triple-A level - than at any time in the recent past. Wall Street firms used the opportunity to sell their inventory of CMBS bonds, leaving the street with precious little inventory to sell.

With few bonds being held by dealers, Merrill Lynch suggests that spreads could significantly contract, especially in the BBB- to BB range. At these lower levels, spreads have shown little tightening and could benefit from further spread tightening as investors look for opportunities to gain higher yields.

In the CMBS arena, three pricing levels exist: paper originated by banks, paper originated by finance companies and Nomura paper, with each tier being progressively more expensive. Bank paper continues to trade at the lowest yields, while paper offered by experienced conduit originators is trading at the triple-A level, .03% to .07% wider than bank paper. Securitizations originated by Nomura and its affiliate, Capital America, are priced at much richer levels, some 0.15% wider than similar bank paper rated triple-A.

Here, there may be less than meets the eye. Some Wall Street traders and analysts suggest that the spread difference between bank paper and Nomura paper cannot be justified by the fundamentals. According to Jim Higgins at Bear, Stearns, "levels on bonds are not necessarily reflective of underlying fundamentals but rather an aversion to perceived headline risk."

Other analysts point to two 1998 transactions as a prime example of this. Nomura Asset Securities Corporation 98-D6 and NationsLink Funding Corp. 98-1 are two CMBS securitizations that closed on March 30, 1998. Despite the link to NationsBank, the NationsLink Funding securitization has dramatically more defaults and specially serviced loans than does Nomura D6. Specially serviced loans indicate a current loan problem due to falling occupancy or lack of cash flow. The Nomura transaction shows no defaults or delinquencies in excess of 30 days, nor are any loans handled by special servicers. Conversely, the NationsBank transaction, which is less than one-third the size, has loans totaling $13.45 million that are 30 days or more delinquent and loans totaling an additional $14 million that are handled by a special servicer. Despite the underlying delinquency and servicing differences, similar Nomura tranches offer spreads at least 0.15% wider than corresponding NationsBank tranches. Investors and traders see this type of mispricing as a prime buying opportunity.

On the whole-loan side, insurance companies continue to sell reliability. They constantly remind borrowers that the conduit market left them in the lurch last fall. Generally, the borrowing market is buying their pitch. But, for loans of less than $25 million, several insurers say that they aren't seeing as many new offerings as they had hoped. Higher interest rates also haven't helped things, as Treasuries are up 5/8% since the beginning of 1999.

Several insurers are not only originating loans for their own accounts but are also originating loans for the securitized market, finding that accumulating loans for their own account is proving to be less difficult than for the securitized business. Most insurers are finding that their securitized loan production is well less than they predicted.

Commercial mortgages continued to perform well during the first quarter of 1999, according to the Giliberto-Levy Commercial Mortgage Performance IndexSM, which showed whole-loans in a virtual dead heat with duration-adjusted Baa bonds. Although the total return for the first quarter was only 0.5%, defaults and delinquency charges continued to drop. Credit losses for the year ending March 31 were a scant 0.19%, a lower level than most of today's investors have ever experienced.

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