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Market takes insurance issue in stride

THE MARKET FOR COMMERCIAL MORTGAGES got off to a sluggish start in January, a typical performance for the month. Only $1 billion in commercial mortgage-backed securities came to market, according to the Barron's/John B. Levy & Co. National Mortgage Survey of CMBS issuers and other participants in the market for loans on income properties. The pace of loan originations wasn't much more robust.

One reason for sluggishness in the CMBS market was uncertainty over terrorism insurance, or the lack of it to be more precise. Late last year, industry leaders were confident that the federal government would enact a program to backstop terrorism losses. But lately, Washington appears to be losing interest, and this has put a crimp in the issuance of single-mortgage CMBS and so-called large-loan securities — CMBS backed by a few big loans. Lenders and buyers of such offerings have been reluctant to bring single-asset and large-loan offerings to market without knowing that terrorism insurance will be available.

But all that may be about to change. Underwriters led by Banc of America Securities and Wachovia Securities brought an $826 million large-loan CMBS to market in early February. The offering included seven properties in six states, ranging from a $178 million loan on the Starrett-Leigh Building in New York City to a $41 million loan on the elegant Windsor Court Hotel in New Orleans. Underwriters told prospective buyers that they weren't requiring terrorism insurance on the buildings. The offer, which priced in late February, could further reduce any remaining pressure on Congress to legislate a federal solution.

One trader notes that the secondary market for large-loan securities is “operating as if there is not a terrorism-insurance problem.” Significant blocks of single-asset deals on New York properties such as 245 Park Avenue, Rockefeller Center, 1285 Avenue of the Americas and 4 Times Square all traded at surprisingly tight spreads in late January.

For example, on 245 Park Avenue, a 2.3 million sq. ft. office building in Midtown, a $15 million block of the triple-B-rated tranche just sold at a spread overinterest-rate swaps of 132 basis points, or 1.32 percentage points. The building does not currently have terrorism insurance and the offering was priced to yield a scant 15 basis points over where it would have been priced if it had carried full coverage. Because of the lack of insurance, one trader observed, “these single-asset transactions are a great place to find yield.”

Selected CMBS Spreads (in basis points, or hundredths of a percentage point) Whole Loans (Interest rates)
To 10-year U.S. Treasuries Term of Loan Prime Mtge.
Range 02/04/02
Mtge. Rate
Prime Mtge.
Range 01/07/02
Rating 02/04/02 01/07/02
AAA 120 - 122 126 - 128 5 years 6.56 - 6.61% 6.56% 6.65 - 6.80%
AA 137 - 140 144 - 146 7 years 7.00 - 7.10 7.05 7.25 - 7.35
A 160 - 163 164 - 166 10 years 7.13 - 7.18 7.18 7.38 - 7.48
BBB 195 - 200 204 - 209 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.
BB 550 - 575 560 - 580

Attention Kmart shoppers

Many CMBS offerings have been affected by the Kmart bankruptcy filing, but most of the widening in spreads seem to be moderate because of the wide diversification that the securities offer. For example, CSFB 98-C1 is a $2.3 billion securitization that was offered in early 1998 and includes some $177 million worth of exposure to Kmart. After the bankruptcy filing, the large AAA, 10-year class A1B widened by a skimpy eight basis points.

Despite the diversification offered by CMBS, some analysts are beginning to question when the cumulative effects of numerous retail closings, including Charming Shoppes, Toys 'R' Us, Service Merchandise, Jacobson's and Kmart, will send delinquencies skyrocketing. Office buildings and hotels already are suffering their share of operating difficulties.

In a recently released research report, Credit Suisse First Boston examined 13 fixed-rate CMBS offerings, and found delinquencies rising from a modest 0.94% in October 2001 to 1.62% in November, and to 2.28% in December. Howard Esaki, principal at Morgan Stanley, believes delinquencies industry-wide could easily be in the 3% to 3.5% range by the end of this year.

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

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