Fixed-income markets ride out choppy seas

The commercial mortgage business in March can best be described as slow. According to the Barron's/John B. Levy & Company National Mortgage Survey of investors in both the whole-loan and commercial mortgage-backed securities (CMBS) side, new loan originations have slowed to a snail's pace, while the level of new CMBS securitizations was clearly nothing to write home about.

The fixed-income markets in general, and commercial mortgages in particular, seem to be experiencing new levels of volatility. As an example, interest rate swaps - a derivative that converts floating rates to fixed rates -are presently at 1.25% for the 10-year market vs. 1.02% only 30 days ago, and 0.80% at year-end.

CMBS securitization terminated The biggest news in March concerned a scheduled $1.4 billion CMBS securitization led by Lehman Brothers and UBS. The securitization was to be the largest transaction year-to-date, and in the minds of some analysts, probably the largest CMBS transaction that would come to market all year.

The mortgage pool consisted of 190 loans, including four large mortgage loans where the senior note portions of the loans were included in the securitization, and the subordinate notes were sold in a private sale. In the case of the two largest loans - Annapolis Mall and Cherry Creek Mall - the subordinate piece had already been sold to Teachers Insurance and Annuity Association (TIAA).

According to informed sources, marketing of the deal was going extraordinarily well, especially given the volatility in all fixed-income markets. In fact, all $700 million of the A-2 class, rated triple-A, was spoken for and the shorter term A-1 class of almost $400 million, rated triple-A, was significantly oversubscribed.

But just hours before the transaction was to be officially launched, underwriters abruptly terminated the launch. Sources at Lehman Brothers attribute the deferral to an unauthorized statement to the press from an employee at Warburg Dillon Read, a UBS subsidiary. Because this was a public deal, lawyers argued that such statements are not permissible during the "quiet period" and suggested a "cooling off period" of unspecified length before the deal could be relaunched.

Nevertheless, the sale of the most junior bonds, which is being handled on a private basis, is proceeding with Lennar Partners Inc. Deferrals, or cooling off periods for legal purposes, are unusual in the CMBS arena, and several market analysts could not remember a previous deal of similar size when this has occurred. Calls to UBS were not returned.

Lack of new originations evident Despite the Lehman/UBS cancellation, Laura Quigg of Sanford C. Bernstein & Co., a money manager and CMBS buyer, notes that the tone of the CMBS market is "remarkably stable given choppiness across all fixed-income markets." She attributes this to a lack of new originations and the fact that CMBS has had "less bad news than other sectors."

Both the institutional and CMBS markets continue to suffer from a lack of new originations. According to Kieran Quinn, president of Column Financial, "It's as slow as I've ever seen it, but as soon as borrowers accept interest rates at 8 %, we'll be back in business." In order to keep costs in line , a number of conduits are busily pruning their ranks of originators.

On the whole-loan side, insurers have greeted the rough weather in the capital markets with applause. As CMBS spreads have skyrocketed, some whole-loan lenders have intentionally held their spreads low to entice new borrowers. At some insurance companies, whole-loan spreads are in the 1.75% to 1.80% range, which is just 0.05% to 0.10% higher than triple-A rated CMBS paper.

Some observers note that institutional lenders who have a mortgage production quota are less likely to raise spreads dramatically than those who have to compete for an allocation with their corporate bond market counterparts. Nevertheless, whole-loan spreads will rise, assuming no fundamental change in the CMBS market.

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