Commercial mortgage market takes a breather The commercial mortgage market took a well-deserved breather following an incredible November, which saw spreads, especially on the CMBS side, fall almost as fast as they had risen during September and October. According to the Barron's/John B. Levy & Co. National Mortgage Survey of major investors in the whole-loan and commercial mortgage-backed securities (CMBS) markets, triple-A spreads were at least .75% lower at the beginning of December than during the peak reached in mid-October.

The CMBS trading market appears to have stabilized and, in hindsight, several traders noted that the spread peak reached in October was clearly an overreaction, although at the time that certainly wasn't the majority opinion. Though the lowest spreads recorded in November were set by a $1.1 billion offering from Donaldson, Lufkin & Jenrette, the deal that seemingly changed the market's attitude was a $2 billion deal priced only several days earlier by Lehman Bros. That transaction, which included both large and small loans originated by Lehman's own conduit program, broke all the rules in the CMBS market up to that time in that it was thought to be too large to be efficiently priced, not originated by a bank conduit operation, and it was a so-called "fusion" deal due to the fact that six loans exceeded $50 million each. Nevertheless, buyers responded enthusiastically and the 10-year triple-A class was priced some .13% tighter than the previous transaction offered by the Chase Securities unit of Chase Manhattan.

Market analysts have now changed their tune from worrying about the huge overhang of CMBS supply to a concern about the dearth of upcoming buying opportunities. In December, only two conduit deals of any size were scheduled to come to market: a $1.1 billion offering sponsored by Goldman Sachs and a $750 million offering led by Merrill Lynch. With this relatively light calendar, many institutional buyers are now reverting to secondary market transactions in order to fill their needs. The new year should see a reasonable January schedule of new investment opportunities but, after that, the calendar is beginning to look thin at best. With the upcoming lack of new securitizations, a number of CMBS analysts are predicting that spreads will continue to tighten.

Michael Hoeh, Senior Portfolio Manager at Dreyfus Real Estate Funds, which holds some $2 billion in CMBS, noted that "lack of issuance and renewed investor confidence could push triple-A spreads to 100 over by the end of the year." To be sure, others weren't so sanguine, as the non-investment grade and non-rated tranches still aren't selling well, while others note that triple-A spreads have reached a "natural floor." But it is clear that there is a vigorous new tone to the CMBS buying market. Triple-A spreads have contracted so quickly that a number of firms are recommending that buyers look to the lower-rated tranches in order to find real value.

On the new loan origination side, conduits are finding that it's slow-going. Many borrowers were burned by conduits increasing their previously committed spreads and aren't quite ready to jump back into a relationship with them until spreads are a lot more stable. A number of conduits have also slashed their origination force so that no one has a sense that there will be a real heating up of new loan production anytime soon.

On the whole-loan side of the fence, life insurers are still finding the pickings to be good, but clearly no where near as good as they were at the beginning of November. The good news is that underwriting has stiffened on both the whole-loan and CMBS sides so that deals in the market now are much more conservative during the late spring and early summer.

Whole-loan originators are continuing to quote rates instead of spreads, which may provide them with a huge windfall.