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Lower rates lure institutional borrowers back into the market

Commercial mortgage borrowers are beingwarmly greeted by a market with gently declining interest rates and increasingly aggressive underwriting practices, according to the Barron's/John B. Levy & Co. National Mortgage Survey. The Barron's/Levy Survey's 10-year benchmark prime rate is now at 7 3/4%, a level sure to entice even the most upbeat borrowers.

The recent downturn in rates has persuaded a number of large institutional borrowers to jump into the market. Pension funds tend to borrow against their real estate equities only when rates are quite low, assuring them of positive leverage. The latest rate decline has been enough to entice several large state pension funds to raise some debt capital. Generally, pension fund borrowers are only looking for loans of 50% or less of the property's value which attracts extraordinarily thin spreads from the institutional lending community. Although it is rare, spreads for these transactions, the difference between mortgages and Treasuries of the same maturity, have been as low as .90% to .95%.

Generally by November, most borrowers and lenders are focused more on closing year-end transactions than on starting new deals. But this year there is an incredible press of new business currently in the market. This business is not just on the whole-loan side but on the securitized side as well. Private label conduits, once thought to be a dying breed, have shown that they can be extraordinarily aggressive players. Institutional lending types tend to downplay their efforts and assert that, for the most part, conduits are involved in `B'and `C'quality lending. But less biased analysts are unwilling to agree and, in fact, find that conduits are beginning to compete directly with life insurance companies and other institutions.

Apartment buildings continue to be the "darling" of both the whole-loan and CMBS markets. And there's clearly good reason for that. According to the Giliberto-Levy Commercial Mortgage Performance [], apartments for the 12 months ending September 1996 showed a total default and delinquency cost of only .30%, less than half the .76% recorded by the aggregate $150 billion index. Even more positively, based on the third quarter numbers alone, it's entirely possible that delinquency costs will be in the .20% to .25% annual range within the very near future.

Commercial mortgage-backed securities spreads continue to decline in almost a free fall, which is the major reason that conduits are able to price their money so much more aggressively. In an attempt to capitalize on these aggressive new spread levels, the pipeline of upcoming CMBS deals is literally filled to the brim. Leading the charge are two huge deals from Nomura and Merrill Lynch/First Union, each of which will be over $1 billion. The Nomura deal will be its sixth so called "mega deal", while the Merrill Lynch/First Union deal is a securitization of their conduit transactions. Some market watchers expect that spreads may actually widen as much as .15% as the market tries to absorb the incredibly heavy amount of new business. But a more realistic view is that the current tidal wave of business will merely delay further spread tightening.

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

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