It's hard to imagine the commercial-mortgage business getting any more competitive, but the latest Barron's/John B. Levy & Co. National Mortgage Survey indicates that it is. Lenders and originators have both noted a marked step-up in the rivalry for new transactions. In addition, most institutions report that their pipeline of pending business is spotty — making each new loan opportunity increasingly important.

A Telltale Sign

To be sure, judging the market's strength is somewhat subjective. But one indicator that the number of applicants is dropping off is the apparent relaxation of escrow requirements. Generally, lenders want borrowers to establish escrow accounts to ensure that tax and insurance bills are paid on time.

But a look at a recent $1.3 billion securitization from Bank of America reveals that, of the pool of loans, only 72% are escrowing for taxes and a mere 33% for insurance. The corresponding escrow numbers for a $1.1 billion offering from Bear Stearns were 67% for taxes, 59% for insurance.

Nonetheless, both transactions were well-received. Bank of America's class A-4, rated triple-A, priced at interest-rate swaps, plus 30 basis points. That's one or two basis points (each equal to 1/100th of a percentage point) lower than some analysts had predicted. Included in the transaction was a $297 million tranche bought by Freddie Mac.

Last year, Freddie was the largest single buyer of commercial mortgage-backed securities (CMBS), according to industry estimates, spending almost $10 billion. Although traders are expecting the company to be somewhat less acquisitive this year, Freddie has taken sizable positions in a number of new deals.

New securitizations in March and April combined are anticipated to be about $16 billion, including what will be one of the largest CMBS deals ever. Goldman Sachs and RBS Greenwich are teaming up to offer a $2.5 billion fixed-rate transaction that would become a trading benchmark.

Both the Bear Stearns and Bank of America deals priced two to three basis points lower than the previous transaction. But some of the bonds, especially those rated A and triple-B, didn't exactly fly off the shelf. As one trader put it, “The bids are real, but they're not that deep.” Another trader said he doubts that all of the mezzanine bonds — essentially convertible debt — in a number of the recent transactions had been sold. He suspects that more than a few remained on dealers' shelves.

Borrower's Paradise

Lenders are scratching their heads, trying to come up with new ways to become more competitive. Borrowers couldn't be happier, as most 10-year, fixed-rate mortgages now can be priced at 5.5% or less. But these historically cheap rates haven't exactly led to a surge of loan demand.

The borrowers willing to step into the market are being greeted with attractive terms they haven't seen before. In addition to the possibility that they won't have to put up escrow reserves for taxes and insurance, many borrowers find that several types of interest-only loans are now available.

The interest-only period generally is five years or less, but some interest-only loans for the entire 10-year term are available for those borrowers not seeking maximum leverage.

When it comes to pricing new transactions, less glitzy properties are benefiting from the increased competition. “The market does not differentiate between a really good deal and a mediocre deal,” says Kieran Quinn, president and CEO of Atlanta-based Column Financial, a subsidiary of Credit Suisse First Boston.

The competition for new mortgages is so pronounced for multifamily properties that spreads are often 100 or fewer basis points above the 10-year Treasury yield, which hovered near 3.75% in mid-March. But danger could lie ahead. Torto Wheaton Research recently concluded that there is a 50% chance that the value of the average U.S. apartment building will decline by about 12% in the next three years.

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 3/8/04 2/2/04
AAA 70-71 67-68
AA 77-78 74-76
A 86-88 82-84
BBB 120-125 120-125
BB 390-410 395-410


Whole Loans*
Prime Mtge. Range Prime Mtge. Prime Mtge. Range
Term of loan 3/8/04 Rate 2/2/04
5 Years 4.48-4.58% 4.53% 4.78-4.83%
7 Years 4.88-4.98 4.93 5.15-5.20
10 Years 5.45-5.55 5.50 5.70-5.75
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