The commercial mortgage-backed securities market was a hotbed of activity in July, as some $7 billion in CMBS came to market, according to the Barron's/John B. Levy & Co. National Mortgage Survey. The torrent caused spreads at the triple-A level to widen modestly, which came as no real surprise to industry players. At the current pace, securitization volume for the year may well surpass the previous record of $78 billion set in 1998. Low interest rates continued to attract new borrowers, assuring a steady stream of coming business for both CMBS and whole-loan players.
In the week of July 23-27 alone, there were no fewer than eight deals for almost $3 billion in various stages of marketing, with two major transactions in the pricing stage.Salomon Brothers led a $956 million conduit securitization, and J.P. Morgan Chase priced a separate $996 million transaction as well.
Although the smaller, lower-rated tranches seemed to sell well, CMBS buyers indicated that the 10-year, triple-A tranches moved somewhat sluggishly. Evidence of the oversupply came from several insurance companies and money managers who noted that they had been asked to buy some of these bonds “on swap” — swapping the new bonds for others in the buyer's inventory — as opposed to cash payments.
The triple-A, A3 tranche on the J.P. Morgan Chase deal priced at interest-rate swaps plus 0.48%, while the similar Salomon Brothers tranche priced at interest-rate swaps plus 0.49%. Major buyers indicated that at LIBOR plus 0.50%, they would become significant buyers, suggesting that the spread widening has virtually reached its peak.
Defaults on the rise
Despite the generally positive tone in the CMBS market, defaults are rising. Gail Lee, director at CS/First Boston, said that at the end of last year, some 0.7% of the conduit/fusion universe was 30 days or more delinquent. By the end of the second quarter, that number had ballooned to 0.94%. On the whole-loan side of the ledger, the story is the same.
According to the Giliberto-Levy Commercial Mortgage Performance Index, whole-loan delinquency costs hit a record low of 0.09% per annum late last fall. By the end of the second quarter, that number had increased to 0.12%. Retail loans, with a delinquency cost of 0.20%, had the highest costs. True, whole-loan delinquency costs have merely gone from imperceptible to barely visible. But real-estate delinquencies are a lagging indicator, so the worst is surely yet to come.
Leverage on CMBS loans also seems to be climbing. According to the Fitch rating agency, 8.9% of CMBS loans in the fourth quarter last year had loan-to-value percentages above 90%. By the end of this year's second quarter, that number had ballooned to 19.42%. CMBS buyers have been voicing their concerns, especially in light of the economic slowdown. To counter higher leverage, subordination levels are up a tad. “The general leverage creep is putting a halt to declining subordination levels,” stated Janet Price, group managing director at Fitch Commercial Mortgage Group.
During the second quarter, commercial mortgage whole loans produced a total return of 0.39%, according to the Giliberto-Levy Index. Although this beat the 0.28% return on CMBS investment-grade bonds, it severely lagged Lehman Brothers' duration-adjusted Baa bond index, which sported a total return of 0.96%. Commercial mortgages also lagged private placements, which had a 1.17% return.
Institutional lenders noted that whole-loan demand was slowing, despite attractive rates. One reason could be the summer doldrums, while another might be the more conservative attitude of institutional lenders. Life companies and pension funds are less interested in “full loans” — those with 75% to 80% leverage. They are showing a strong preference for loans in the 65% to 70% range. But their conservatism doesn't seem to spring from delinquency problems. One lender with a $9 billion portfolio says his firm has only $5.2 million in loans delinquent 30 days or more.
John B. Levy is president of John B. Levy & Co. in Richmond, Va., www.jblevyco.com ©2001 Dow Jones & Co. Inc.
Barron's/John B. Levy & Co. National Mortgage Survey
|To 10-year U.S. Treasuries|
|AAA||129 - 130||132 - 133|
|AA||144 - 145||147 - 149|
|A||159 - 161||164 - 168|
|BBB||230 - 235||216 - 221|
|BB||520 - 540||515 - 525|
|Term of Loan||Prime Mtge. |
|Prime Mtge. |
|5 years||6.71 - 6.81||6.76||6.89 - 6.99|
|7 years||7.10 - 7.20||7.15||7.25 - 7.35|
|10 years||7.30 - 7.40||7.35||7.35 - 7.50|
|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.|