A volatile Treasury gave commercial mortgage buyers and sellers a few Maalox moments during the past month, according to the Barron's/John B. Levy & Co. National Mortgage Survey of more than 30 institutional investors in both individual mortgages and commercial mortgage-backed securities (CMBS). The 10-year Treasury generally headed higher in May, but by the beginning of June was posting a modest rally into the 6.2% range, relatively unchanged from 30 days earlier.
On the whole-loan side of the ledger, insurance company buyers noted that loan demand continued to be fair at best, while most characterized their pending list of new transactions as "weak." Insurers who were finding a steady flow of mortgages were generally those whose spreads were remaining below those for the institutional market. Although a few lenders continued to keep their capital on sale, their numbers greatly diminished.
Several insurers noted that corporate-wide cash flows were down, therefore they were under no pressure to put out a large amount of new loans. Adding to the lack of pressure for new originations, early prepayments of existing mortgages were dramatically off the pace set in both 1998 and 1999. Clearly, with today's higher interest rates, there isn't as much incentive to prepay as there had been during the past two years.
According to Maurice Moore of ING Investment Management, "early prepays are running only 20% to 25% of the level seen during the last two years." Because new originations are proceeding slowly, buyers are not worried about an explosion of new CMBS securitizations. In fact, despite the jitters in the general stock and corporate bond markets, some of the new CMBS originations are actually playing to rave reviews. For example, in late May, J.P. Morgan originated a $622 million floating-rate transaction that was significantly over-subscribed in each class. The triple-A tranche was four times oversubscribed, a level not seen in the CMBS arena in some time.
Earlier in the year, most CMBS players theorized that they would see a flurry of floating-rate loan business this year, which would help to keep them active. To be sure, some of this floating-rate business did materialize, but has dried up dramatically. The reason is that due to the inverted yield curve, short-term rates are now more expensive than long-term rates, causing borrowers to question whether they truly want to pay higher costs for taking the risk of a floating-rate loan.
The recent CMBS market has remained quiet due to a lack of new supply. There has been an active secondary market, which was formerly confined to the tranches rated triple-A and double-A. With a mature CMBS market, investors are finding that there is liquidity even for tranches that are below investment-grade. Recently, for example, Heller Financial put out a bid list of five separate bonds, four of which were rated double-B and single-B.
June's origination calendar began with a $729 million conduit transaction headed by Salomon Smith Barney and Greenwich Capital Markets. Prospective buyers noted that this was a well-diversified conduit composed of almost 270 loans that would draw significant buyer interest. Pricing for the $409 million A2 tranche rated triple-A was expected to be in the area of interest-rate swaps plus 0.40% - 0.42%, which converts to the 10-year Treasury plus 1.72% - 1.74%. The Class-F rated triple-B is expected to price in the 2.50% area.
Wall Street expected an active month for the CMBS market in June as nearly 11 fixed- and floating-rate securitizations totaling more than $8 billion were expected. Most commercial mortgage traders felt that some of this will slip into this month and that no more than $5 billion will realistically come to market. The pending deals include two separate billion dollar floating-rate transactions, one of which is being sponsored by Lehman Brothers while the other is coming from Deutsche Bank.