Commercial mortgage investors started the new millennium with a wide-open checkbook, according to the Barron's/John B. Levy & Co. National Mortgage Survey of more than 30 whole-loan providers and participants in the commercial mortgage-backed securities (CMBS) market. Investors are fortified with new allocations and a search for higher yields, which puts CMBS and commercial mortgages squarely in the crosshairs. Treasuries remained high, forcing many lenders to offer floating-rate mortgages to entice borrowers.
Late in January, three major CMBS transactions came to market, and each was warmly greeted. The largest CMBS transaction was a $1 billion floating-rate transaction from Deutsche Bank. The $700 million Class-A rated triple-A was strongly over-subscribed and was priced at LIBOR plus 0.30%. An $888 million transaction offered by Bear Stearns and Wells Fargo also was priced at the time. The two have partnered before, and the offering was expected to attract extremely thin spreads because of its relatively low leverage and the Bear/Wells brand name. Not surprisingly, investors flocked to the transaction, and the actual spreads were dramatically lower than those which had been bantered about during "price talk." The Class-E rated triple-B, which had been expected to price in the 1.80% to 1.85% range, in fact priced at a surprisingly thin spread of 1.65%, while all of the other classes were priced either at the tight end of the price talk or were priced at lower spreads than had been anticipated. The $454 million Class A-2, rated triple-A, priced at a spread of 1.05%.
The Houston Galleria, a single-asset transaction, also gathered quite a bit of chatter. This premier 1.7 million sq. ft. mall attracted many insurance company buyers who want to be able to "kick the tires" and underwrite the transaction themselves. To no one's surprise, Morgan Stanley priced the Class-E rated triple-B at a tight spread of 1.60%. In the words of Allmerica Asset Management's John Nunley, it was "a food fight" for the transaction. Investors over-subscribed the triple-B tranche by 10 times, a level that has not been seen since well before the long-term credit capital debacle in the summer of 1998.
In addition to the new securitizations that took place at the end of January, trading in the secondary market was on a tear. According to one major Wall Street trader, approximately $2 billion in secondary market transactions - mostly triple-A paper - traded hands within the last two weeks of January alone. Many Wall Street houses were short on CMBS paper and bought the offered items for their trading inventory. Industry analysts were quick to cite the strong secondary market volume as another indication of the mature market and the liquidity that CMBS offers to its participants.
Insurance companies in the whole-loan market are confronting loan demand that is at best modest for fixed-rate loans. Borrowers are not accustomed to today's high rates, and, as a result, a number of insurance companies are offering floating rates as well. In fact, several companies have specific programs that allow borrowers to elect a floating-rate loan now and switch to a fixed-rate loan during the next 12 months. Interestingly, one survey member commented that all of his January production consisted of floating-rate mortgages. Insurers have a new threat to loan production. Because of new, low CMBS spreads, conduit lenders can now price mortgages as inexpensively as the life insurers. In the past, conduits have been at least 0.25% wider.
Last year was the worst year for fixed-income investors since 1994, and whole-loans were not exempt. According to the Giliberto-Levy Commercial Mortgage Performance Index, whole-loans generated a total return of 1.61% for all of 1999. The only good news was that mortgages outperformed the Lehman Brothers' Baa duration-adjusted corporate bond index, which registered an even more lackluster 0.61% for the same time period. Credit losses for commercial mortgage loans remained exceptionally low with the multifamily sector, for example, showing a virtually non-existent 0.03% of total loss for the past 12 months.