'Squeaky clean' deals give way to increased competition

Commercial mortgage rates declined .25% in the last days of July and early August, according to the Barron's/John B. Levy B Co. National Mortgage Survey of large institutional lenders. The 10-year Treasury now stands at 6.65%, which puts the 10-year Barron's/Levy prime mortgage rate at 8%.

Loan demand is presently quite uneven. Some large institutions remark that their current level of commitments and pipeline is quite strong, especially given the fact that summer vacations are now in full swing. The majority, however, weren't as sanguine and found their pending book of business to range from slow to acceptable levels. Even those institutions which reported strong pipelines of loan applications noted that they are experiencing a fairly high degree of "washouts." The market has become increasingly competitive with borrowers often getting multiple loan applications simultaneously so that they can more effectively "shop" their transaction. Additionally, several survey members note that they are seeing more deals which required structuring or "BandAids" to make them acceptable.

The recent shockwaves that have gone through the stock market have actually brought some slight benefit to the fixed income markets in general and commercial mortgages in particular. Several institutions indicated that they were seeing less runoff from their guaranteed investment contract business into the stock market than previously.

One continuing allure of the commercial mortgage business is that it continues to outperform corporate alternatives. For example, according to the Giliber to Levy Commercial Mortgage Performance Index[sm], for the 12 months ended June 30, 1996, commercial mortgages outperformed the Baa intermediate term corporate bond component of the Lehman Brothers aggregate bond index 6.57% to 5.29%. Interestingly, the strong performance of the office building sector almost single-handedly accounted for the difference between mortgages and bonds.

With respect to commercial mortgage backed securities (CMBS), the new-issue market is relatively quiet now after a terrific first six months. Many portfolio lenders, to whom the absolute level of rates is critical, have decided not to securitize at this moment. Nevertheless, most observers expect that this will be a busy fall for this emerging market.

To be sure, the CMBS is drawing an increasing number of buyers, and that is clearly reflected in declining spreads. For example, earlier this year generic BBB tranches were priced at a spread of 1.75%-1.8%. That has now shrunk dramatically to 1.4%-1.5%. What's happened in the below investment grade tranches is even more impressive. The BB class early this year was traded at a spread of 5.25% to 5.35%, which has now shrunk to 4.75% to 5%. These decreasing spreads on the junior tranches have made conduits more able to compete with the insurance companies for so-called "Class A" transactions.

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

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