The war, a lingering recession, a roller-coaster ride on Treasuries and impressive commercial mortgage volume all showed up in March, according to the Barron's/John B. Levy & Co. National Mortgage Survey. There was even a role for SARS (severe acute respiratory syndrome) as some global banks took steps to disperse CMBS trading operations in the event of a quarantine.

Talk about the war has been at the forefront in April, as more than a few industry observers flipped between their trading screens and the news from the front. One analyst noted that in addition to weakness in the hotel sector, he expects retail sales to decline as a result of the “CNN effect” — people glued to their televisions as opposed to their normal shopping routine.

Despite the war and an ongoing recession, new securitizations were at levels not seen since the go-go days of 1998. According to Darrell Wheeler, director and head of CMBS research at Salomon Smith Barney, CMBS volume in the first quarter was just short of $18 billion, up from $14.7 billion during the same period last year. And the pipeline of pending deals is not over, especially on the floating-rate side. By the end of June, floating-rate securitizations in the U.S. market will total $9.3 billion vs. $8.9 billion for all of 2002.

Tepid Interest in ‘Directed Class’

In early April, underwriters led by Wachovia Securities and Nomura Securities brought an $891 million securitization to the market of which $704 million was rated triple-A. The $250 million A-1A tranche — one of three triple-A rated tranches — had cash flow directed solely from 56 multifamily properties and was purchased by Freddie Mac. In the past, Freddie Mac has generally participated in securitizations that are composed of at least 30% multifamily loans.

This so-called “directed class” was thought to assist Freddie in meeting its mandate to provide liquidity to the multifamily housing market. But the market didn't seem to be enthralled with the structure. “They've skimmed off the cream,” opined one large triple-A buyer who declined to participate. Wachovia, which had estimated that the triple-A rated class A-2 would price in the area of interest-rate swaps plus 0.43%, had to widen it to 0.45% to attract sufficient buyers. Despite the widening, underwriters might be pleased with the execution as the directed class spread was priced 0.03% to 0.04% tighter than the other triple-A tranches.

Action in the triple-B and triple-B-minus classes has been sparse. Buyers hoping to put these tranches into collateralized debt obligations have disappeared, and insurers, who previously bought heavily in this range, have been going up in quality to the single-A and double-A tranches. Though triple-Bs are now priced in the area of interest-rate swaps plus 1.35%, some traders suspect that could widen by 0.15% before stabilizing.

Unfazed By Warning Signs

Real estate fundamentals continue to weaken, yet there continues to be no shortage of investors in the securitized arena and in the whole-loan market. In fact, Northwestern Mutual Senior Vice President John Schlifske says the competition for new deals is so severe that “our success ratio is only a third of normal.”

Many CMBS observers note with pride that loan delinquencies have been relatively stable over the last year, even as rental rates have declined and vacancies have increased. But Roger Lehman, director with Merrill Lynch, is less sanguine. He notes that merely looking at delinquencies could mislead investors as he believes that CMBS credit has continued to weaken. Current delinquency numbers are only a snapshot and ignore collateral liquidations of foreclosed properties, which have increased over the past year.

As a result, Lehman suggests that investors look at a so-called “credit-impaired rate,” which includes both liquidations and delinquencies. Far from being stable, this rate has increased from just over 2% at year-end to 2.17% in February. While March numbers are not final, estimates suggest that the rate has continued to increase to 2.30%.

Perhaps just as troubling is that the loss rate on liquidated loans has skyrocketed as well. Lehman notes that while the long-term average has been in the 35% to 40% range, based on first-quarter numbers, the average loss rate is now approximately 50% of the original loan balance.

John B. Levy is president of John B. Levy & Co. Inc. in Richmond, Va. © Dow Jones & Co. Inc., 2003.

BARRON'S/JOHN B. LEVY & CO. NATIONAL MORTGAGE SURVEY

Selected CMBS Spreads*
To 10-year U.S. Treasuries
Rating 4/07/03 3/03/03
AAA 87-88 84-86
AA 97-98 94-96
A 107-110 104-107
BBB 174-179 171-176
BB 450-475 450-475


Whole Loans*
Term of loan Prime Mtge. Range 4/07/03 Prime Mtge. Rate Prime Mtge. Range 3/03/03
5 Years 4.61-4.66% 4.61% 4.56-4.66%
7 Years 4.99-5.04 4.99 5.12-5.22
10 Years 5.60-5.65 5.60 5.49-5.59
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.


*in basis points, or hundredths of a percentage point