Y2K marks brisk end of '99 CMBS market

The commercial mortgage market ended 1999 with a bang, according to the Barron's/John B. Levy & Co. National Mortgage Survey of more than 30 industry participants. In stark contrast to the Y2K Armageddon forecast of just a short while ago, the market frantically tried to close additional transactions at the end of the year on both the whole-loan and CMBS sides.

To be sure, a few Y2K naysayers sat on the sidelines husbanding cash, but they appeared to be in the minority. Many mortgage originators were willing to close new transactions up until December 31.

The tone in the CMBS market has dramatically improved and, as a result, spreads, especially for the senior tranches, have tightened significantly. Additionally, late in December and early in November the market was surprisingly strong in the mezzanine tranches - those rated AA through BBB. These tranches, where demand was soft all year, suddenly saw an influx of buyers who sensed that those securities were undervalued.

The market's strong positive tone pushed two more transactions into December, both of which were previously thought to be coming to market in January. The first and largest was a $1 billion offering led by First Union Securities and Merrill Lynch. Toward the end of 1999, First Union's Wes Jones noted that they were "pushing to bring it to marketthis year," but also noted that a last minute delay was possible. Wall Street sources noted that an inquiry from a large agency buyer of the triple-A tranche, reported to be Freddie Mac, helped First Union in its decision to accelerate the timing of this transaction. First Union's Jones denied the rumor, while Freddie Mac officials declined to comment.

Another transaction that attempted to beat the year-end deadline was an $800 million transaction being shepherded through by J.P. Morgan and ABN/AMRO. As of early December, sources for the underwriters indicated that there was a 50-50 chance that the transaction would go by the end of the year.

Part of the market's positive tone is due to the fact that CMBS buyers finally recognized that this year's origination volume will be down significantly. Both whole-loan and conduit originators are continuing to note a lack of new transactions. In the words of one life insurance company executive, loan demand is "tepid." The theory goes that the lack of new originations will force spreads to tighten, with much of the tightening expected in the first quarter.

In a long-awaited event, the Bond Market Association, an industry trade group, recently filed an application with the Department of Labor to allow pension funds to buy lower rated tranches of CMBS and other asset-backed securities. Heretofore, ERISA - the Employment Retirement Income Security Act - has essentially limited pension fund purchases to those issues rated triple-A.

The application asks for permission to allow pension funds to buy tranches rated as low as triple-B. The possible expansion of the buying market for these mezzanine-class securities has excited many a Wall Street trader. It's thought that a positive ruling could tighten spreads in these tranches by perhaps .05% to .10% or more. While there is no fixed time frame for the Department of Labor to respond, Barbara Klippert, an attorney at New York law firm Stroock, Stroock & Lavan who wrote the application, was hopeful an answer would be forthcoming by the second quarter of 2000.

Although higher fixed rates have surely had a negative impact on loan demand, they have spawned a renewed interest in floating rate transactions from both Wall Street and the insurance industry. A number of insurance companies are now offering floating- rate transactions, which are priced at LIBOR plus 1.75% and up depending on the leverage requirements and the term of the loan. Most of these loan terms run a fairly short three to five years. Conduit issuers have also joined the floating rate party and are offering floaters in an attempt to entice some fence-sitting borrowers who have been waiting for rates to decline.

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