Offering pulled, breach of "quiet period" cited

The market for commercial mortgages - like the fixed-income markets in general - is experiencing new levels of volatility, according to the Barron's/John B. Levy & Co. National Mortgage Survey of investors and lenders. The gyrations are coming against a backdrop of slow loan originations and a ho-hum pace of new issues in the market for commercial mortgage-backed securities (CMBS).

As an example of volatility, interest rate swaps - instruments that convert floating rates to fixed rates - are currently priced at 1.25% for the 10-year market, vs. 1.02% only 30 days ago and 0.80% at year-end.

The biggest news concerned a scheduled $1.4 billion commercial mortgage securitization led by Lehman Brothers and UBS. It would have been the largest issue of CMBS so far this year - and perhaps the largest CMBS offering that would come to market all year. The mortgage pool consisted of 190 loans, including four large mortgages where the senior note portions were included in the securitization, and the subordinate notes were sold privately. Teachers Insurance & Annuity Association bought the subordinate notes of the two largest loans, Annapolis Mall in Maryland and Cherry Creek Mall in Denver.

Marketing of the offering was going well, especially given the volatile climate. In fact, all $700 million of the triple-A-rated A-2 Class was spoken for, and the shorter-term A-1 Class of almost $400 million, rated triple-A, was significantly oversubscribed. But hours before the offering's debut, the underwriters terminated the deal. Sources at Lehman Brothers attributed the deferral to an unauthorized statement to the press from an employee at Warburg Dillon Read, a UBS subsidiary. Because the offering was public, lawyers argued that the statement violated the "quiet period" mandated by securities regulations, and they suggested a cooling-off period of unspecified length before the deal could be revived. Nevertheless, the private sale of the most junior bonds is proceeding.

Deferrals, or cooling-off periods, for legal purposes are unusual in the CMBS arena, and several market analysts said they could not remember encountering one for a similar offering. Calls to UBS were not returned.

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 sector is "remarkably stable given choppiness across all fixed-income markets." She attributes this to a lack of new originations and the fact that the CMBS market has had "less bad news than other sectors."

Both the institutional and CMBS markets continue to suffer from a lack of 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 8.5%, we'll be back."

In order to cope with the distinctly lower level of originations, a number of conduits, or CMBS packagers, are busily pruning their ranks of originators to keep costs in line.

Insurance companies, big buyers of unsecuritized, or whole, loans, applaud the rough weather in the capital markets. As CMBS spreads - the gap between their yields and yields on Treasury securities of comparable maturities - have skyrocketed, some insurers have intentionally held their spreads on whole loans low in order to entice new borrowers.

On average, whole-loan spreads moved very little from where they stood earlier this year - 180 to 190 basis points over comparable Treasuries. This "spread stickiness" is despite the movement in AAA CMBS spreads, which have ballooned some 30 basis points over the same period. The difference between AAA CMBS spreads and whole-loan spreads has compressed to fewer than 20 basis points, a relatively razor-thin difference that will not be sustained.

Observers noted that institutional lenders who have mortgage production quotas are less likely to raise spreads dramatically than those who have to compete for allocations with their peers in the corporate bond market. Still, whole-loan spreads are clearly rising, assuming no fundamental change in the CMBS market.

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