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A Pleasant Surprise for CMBS Volume

In January, we asked a group of buyers and sellers of commercial mortgage-backed securities (CMBS) for their opinions on where triple-A spreads and issuance volume in the U.S. would be at the end of June.

On one hand, the group was a conservative lot, projecting issuance at $38 billion; the actual volume came in at $45 billion. On the other, they were way too optimistic on spreads from a borrower's point of view, predicting 29 basis points (0.29 of a percentage point). The actual number was 35 basis points.

Derrick Wulf, vice president at Dwight Asset Management, was right on the money, predicting spreads of 35 basis points and a volume of $45 billion. His forecast for the next six months is shown in the attached table.

Our panel senses that issuance will fall sharply from the first half to $37 billion in the second half. On average, the group expects spreads to widen slightly, to 36 basis points, but there is a big gap of almost 20 basis points between the high and the low estimates.

Frenzied Competition

In today's commercial property market, lenders are competing fiercely for business. In fact, most observers say that they have never seen such liquidity in the commercial real estate sector.

Heightening the frenzy are a host of either new or reborn competitors, including Barclays Capital, Country-wide Financial, EuroHypo Bank and Washington Mutual, that are hoping to cash in on the demand for mortgage securities. The competition has led securities buyers to fear a decline in underwriting discipline.

But is higher leverage driving spreads wider or is there just too much supply? Merrill Lynch Director Roger Lehman notes that commercial-mortgage “issuance for the first six months of this year is ahead of every full year, with the exception of 1998 and 2003.” If new issuance continues at the first half's strong pace for the rest of the year, we could well see spreads continue to tick upward.

No Alarm Bells over Fed Rate Hike

The Federal Reserve's decision in late June to raise the federal funds rate to 1.25% should have little impact on the commercial-mortgage market. Says Sally Gordon, vice president of Moody's Investors Service: “Rates would have to increase some 150 to 200 basis points for us to see a meaningful strain on performance.”

Currently, lenders are competing fiercely for business, leading to fears about loan quality.

John B. Levy is president of John B. Levy & Co. Inc. in Richmond, Va. © Dow Jones & Co. Inc., 2004.


CMBS market forecasts for Dec. 31, 2004*
Name Company Triple-A Spreads To 10-Year Interest Rate Swaps* U.S. CMBS Issuance Volume ($Billions)
Haejin Baek Barclays Capital 47 $85
Brian J. Baker J.P. Morgan 33 $85
Kent D. Born PPM America 30 $80
Mike Buchholz Northern Mutual Life 34 $82
Larry Duggins Arcap REIT 37 $70
Phillip Evanski Nomura Securities 32 $70
Tom Graf Wachovia Bank 42 $80
Michael P. Higgins CIBC World Markets 40 $88
David Lehman Goldman Sachs 29 $80
Greg Matthews AIG Global Investments 41 $80
Marc Peterson Principal Global Investors 28 $80
Craig Sedmak Bear Stearns 42 $85
Derrick Wulf Dwight Asset Management 39 $99
Average 36 $82
*In basis points, or hundredths of a percentage point.
Source: John B. Levy & Co.

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