Lower Yields Spark Buyers' Protest

THE COMMERCIAL MORTGAGE business ran at a distinctly slower pace in late April and early May, according to the Barron's/John B. Levy & Co. National Mortgage Survey of the market for loans on income properties. Spreads for commercial mortgage-backed securities (CMBS), which had been plummeting, finally met some buyer resistance.

Such spreads, which price mortgages in relation to interest-rate swaps, tightened severely in late April because of a sharp decline in swaps due to technical reasons wholly unrelated to performance of the real estate markets.

As a result, buyers of mortgage securities were suddenly seeing 10-year, triple-A issues priced to yield only slightly more than 6%, leading to what one survey participant called “somewhat of a buyers' protest” and a bulge in spreads at the triple-A level of 0.03% to 0.04%.

If the free-fall in swap spreads continues, buyers may well force sellers to price mortgage securities at a spread to Treasuries, which was the convention until 1998.

Borrowers, understandably, were ecstatic over the narrow spreads. Those looking to put a conservative 50% loan on a property were greeted with spreads as low as 1.3 to 1.5 percentage points over Treasuries, depending on the property type and financing specifics.

The combination of narrower spreads and a continued low level of defaults led CMBS to handily outperform individual — or whole — loans in the first quarter, according to the Giliberto-Levy Commercial Mortgage Performance Index. Investment-grade securities registered a total return of 0.84%, compared with a whole-loan loss of 0.56%.

Small Appetite for Loans

Despite the low rates, borrowers weren't motivated enough to spur loan production, which continues to range from quiet to dismal. Most institutions surveyed reported production lagging approximately 30% behind the pace necessary to meet their targets for commercial mortgages.

Underwriters led by Credit Suisse First Boston and Lehman Brothers brought a $918 million securitization to market in late April. Forty-one percent of the collateral consisted of multifamily loans, which are being well received by the market these days.

The offering sold well, but without what market participants perceived as the frothiness of many recent issues. As one buyer noted, “We've already priced in most of the good news.” The long triple-A class sold at interest-rate swaps plus 0.47 of a percentage point, while the triple-B class priced at swaps plus 1.1 percentage points.

Perhaps one reason for the more moderate response was the change in one large buyer's position. Last year, one large government-sponsored buyer of property loans, Freddie Mac, was generally regarded as the largest single buyer of CMBS. Now Freddie Mac has signaled the market that it expects its appetite to decline 30% to 40%.

Good and Bad Signs

Terrorism insurance continues to be a concern in the market, especially for those interested in buying large, high-profile properties. Insurance is becoming more available, and at lower costs. But the policies contain exclusions, including coverage for biological and chemical terrorism. Commenting on the holes in such policies, Sam Zell, chairman of Equity Office Properties, says the “policies make Swiss cheese look opaque.”

In Washington, D.C., it appears that legislation to provide some federal government backup to terrorism coverage is closer to reality. For property owners in Manhattan, such congressional action couldn't come a day too soon.

For example, insurance giant American International Group (AIG), probably the largest provider of terrorism coverage, is reported to have reached its self-imposed $1.5 billion limit on Manhattan coverage. AIG declined to comment.

John B. Levy is president of John B. Levy & Co. Inc. in Richmond, Va. © Dow Jones & Co. Inc., 2002.


Selected CMBS Spreads*
To 10-year U.S. Treasuries
Rating 5/6/02 4/1/02
AAA 102-103 112-113
AA 113-115 122-123
A 125-127 134-137
BBB 165-170 176-181
BB 515-540 525-550
*in basis points, or hundredths of a percentage point

Whole Loans*
Term of loan Prime Mtge. Range 5/6/02 Prime Mtge. Rate Prime Mtge. Range 4/1/02
5 Years 6.43-6.48% 6.48% 6.91-7.01%
7 Years 6.92-6.97% 6.97% 7.31-7.36%
10 Years 7.07-7.12% 7.12% 7.51-7.56%
For loans of $5 million and up, on amortization schedules of 25-30 years, that can be funded in 60-120 days with 0-1 point.
*Interest rates

Hide comments


  • Allowed HTML tags: <em> <strong> <blockquote> <br> <p>

Plain text

  • No HTML tags allowed.
  • Web page addresses and e-mail addresses turn into links automatically.
  • Lines and paragraphs break automatically.