Commercial mortgage interest rates declined slightly during January, according to the monthly Barron's/John B. Levy & Company National Mortgage Survey. Meanwhile, on the commercial mortgage-backed securities (CMBS) side, a sense of near normalcy returned as several transactions were well received by the market and more than a few other investment banks lined up to take advantage of the new positive tone among CMBS buyers.

Insurance companies greeted the new year with renewed allocations to the commercial mortgage market, although new allocation levels showed no striking increase. One market analyst sensed insurance company allocations at best would match 1998 levels. This is in spite of the fact that mortgage defaults and delinquency charges are literally at record-low levels and commercial mortgage spreads are historically wide.

Meanwhile, whole-loan borrowers appear to be playing a waiting game that whole-loan spreads will tighten. Their impulses may be misguided as insurance companies don't appear to be under any pressure to meet volume targets this year. In fact, insurance companies are holding their spreads at fairly wide levels in an attempt to keep the commercial mortgage arena profitable for them.

Commercial mortgages again whipped corporate bonds in the fourth quarter, according to the Giliberto-Levy Commercial Mortgage Performance Index. Commercial mortgages showed a total return of 0.71% vs. a meager 0.24% for bonds, as measured by the Lehman Bros. Baa duration-adjusted index. To no one's surprise, default and delinquency charges for 1998 continued their downward path and recorded a charge of 0.24% vs. 0.48% for the calendar year 1997. Commercial mortgage delinquencies are now at levels that were last seen in the very early 1980s.

On the CMBS side, spreads are "screaming in," according to one major buyer. Bear Stearns brought to market a $478 million securitization that was extraordinarily well received. The 10-year Class-A2 rated triple-A was priced at a surprisingly tight spread of 1.18%, while the Class-B rated triple-B was thinly priced at a spread of 2.45%, shocking most industry observers. Bear Stearns is becoming well known for its low-leverage transactions, and this reputation apparently attracted a number of security-conscience buyers. The market will be further tested by a $1.4 billion offering of mortgages from GMAC Commercial Mortgage Corporation. Price guidance for the triple-A rated Class-A2 is 1.20% to 1.23%, while the triple-B Class D is being discussed in the 2.55% to 2.65% range.

With spreads in the CMBS business tightening so significantly, conduit operators can now compete more effectively with their life company rivals. In the late third and fourth quarters, most conduits - if in the business at all - were pricing transactions from 0.50% to 0.75% higher than similar transactions offered by institutional lenders. But that advantage is disappearing quickly, and now conduits can offer prices within 0.25% of the institutional lending community.

The buzz around the commercial mortgage business was that the CMBS business would not return to normal until the "first loss" or unrated tranches attracted a new class of buyers. Before the fall 1998 capital markets crunch, the major buyers of these pieces were mortgage REITs, the most active of which was Criimi Mae, now in bankruptcy. Interestingly, the unrated or first loss pieces began to attract insurance company buyers, and within the last month at least two - Teachers Insurance and Annuities Association and the Traveler's Insurance Co. - stepped in to become part of the buying syndicate for these most risky pieces. The yield on these tranches is hefty, estimated to be in the 25%-28% range before losses. But the emergence of a new significant group of buyers has done much to cheer up the CMBS market.

In January, Lehman Bros. announced a new commercial mortgage-backed securities index that will increase the number of CMBS buyers. The index is made of several sub-indices, including one for investment-grade securities and one for the high-yield sector.

According to Howard Esaki at Morgan Stanley, if the Lehman CMBS index is included in the Lehman Bros.' aggregate bond index, it "could lead to CMBS tightening on the order of 0.05% to 0.10%."