The Federal Reserve's sixth interest-rate cut of the year was met with a yawn in the market for commercial mortgages and securities backed by them, according to the Barron's/John B. Levy & Co. National Mortgage Survey of lenders and other market participants. The quarter-point rate cut in late June, contrasted with the five previous half-point cuts, was interpreted as confirmation that the economy was beginning to right itself. Ten-year mortgages, though not directly connected to the move, did trend down in June by between one-tenth and one-quarter of a percentage point.
The Fed's easing reduced the cost of floating-rate loans. With the most common floating-rate index, based on the one-month London Interbank Offered Rate (LIBOR), of 3.75%, adjustable-rate loans for terms of three to five years are now available at 5.25% to 5.75%. Even so, institutional lenders didn't notice a rush of new floating-rate borrowers. In fact, they found greater interest in 10-year rates, even though those loans were commanding comparatively higher rates of 1.5% or higher.
In early January, we assembled a group of traders and investors in commercial-mortgage-backed securities and asked for their views of the market at the end of June. On the interest-rate side, Michael Hoeh, a senior REIT portfolio manager at the Dreyfus Group, wound up closest to the pin with his forecast of triple-A spreads to 10-year interest-rate swaps of 50 basis points, or a half percentage point, vs. the actual spread of 47 basis points. On issuance volume, the group turned out to be timid, forecasting on average $30 billion for the first six months, vs. the actual volume of $40 billion — a blistering $10 billion ahead of last year's pace. Brian Harris, an executive director at UBS Warburg, with a volume estimate of $35 billion, is joining Hoeh and a group of new participants for their year-end forecast.
On average, the group is taking an optimistic approach and is expecting triple-A spreads to tighten, albeit modestly. But when it comes to volume, there are a wide variety of opinions. Some forecasters are estimating that CMBS volume for the year will break the 1998 record of $78 billion, while others suggest that the year will end with only modest volume.
In the CMBS arena, Goldman Sachs and Deutsche Bank last week began marketing a $783 million securitization from GMAC Commercial Mortgage. Multifamily loans account for 27% of the issue, less than the 30% minimum that generally would attract Freddie Mac — one of the largest triple-A CMBS buyers. Late last week there were whispers in the industry that Freddie would break its self-imposed limit and buy a major portion of the triple-A rated collateral.
Secondary market trading in CMBS securities is clearly taking on a life of its own. It is not unheard of for the market to trade $1.5 billion to $2 billion a week in secondary offerings alone. In late June, one large money manager acquired upwards of $500 million in just one week. The buyer noted that CMBS looked good “relative to corporates, which have performed well to date” and seemed less vulnerable to the economic downturn, as CMBS is more diversified.
Although the economic slowdown has surely affected real estate, both commercial mortgage whole-loans and CMBS securitizations have seen only a modest increase in delinquencies. Nevertheless, the rating agencies have materially tightened their underwriting standards. According to Janet Price, a group managing director at the Fitch rating agency, “the sky is not falling, but we're underwriting virtually all office buildings with a 10% vacancy factor, regardless of whether total market conditions are better.”
John B. Levy is president of John B. Levy & Co. Inc. (www.jblevyco.com), Richmond, Va. © Dow Jones & Co. Inc. 2001.
Barron's/John B. Levy & Co. National Mortgage Survey
|To 10-year U.S. Treasuries|
|AAA||132 - 133||127 - 128|
|AA||147 - 149||142 - 144|
|A||164 - 168||160 - 162|
|BBB||216 - 221||209 - 214|
|BB||515 - 525||515 - 540|
|Term of Loan||Prime Mtge. |
|Prime Mtge. |
|5 years||6.89 - 6.99||6.94||7.06 - 7.16|
|7 years||7.25 - 7.35||7.30||7.37 - 7.47|
|10 years||7.35 - 7.50||7.45||7.62 - 7.72|
|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.|