The new year started off at a moderate pace, according to the Barron's/ John B. Levy & Co. National Mortgage Survey of whole-loan buyers and participants in the commercial mortgage-backed securities (CMBS) market. The 10-year prime mortgage rate was up just a tad to 6 3/4, but rates are still viewed as quite inexpensive by the borrowing community. February saw a dramatic increase in the number of new whole-loan commitments and securitizations.
At the end of January on the CMBS side, Nomura Securities International Inc. and Morgan Stanley priced a huge $2.052 billion FASIT (Financial Asset Securitization Investment Trust). This was only the second FASIT to come to market, and it included a mix of conventional conduit loans (18%) along with more exotic loans such as earn-outs (41%) which afford the borrower an opportunity to increase the loan amount when the property's income increases. The pool consisted of 260 loans, a third of which was hotel loans while another third was retail, leading some buyers to grouse about the mix of property types. But in spite of the complaining, this floating ratewas extraordinarily well received. The $1.2 billion triple-A tranche, which was initially scheduled to be offered in the LIBOR+ .30% range, went off at a slightly more aggressive LIBOR + .28%. According to one large money manager, the tranche offered strong relative value to other asset-backed securities, such as credit card transactions, where the price would have been in the LIBOR + .12% range. Another buyer noted that it was a transaction long on innovation and will certainly not be the last FASIT deal seen by the market this year.
In other CMBS, the market is awash in pending transactions. According to some analysts, up to $20 billion could flood the new issue market by the middle of this month. As of the end of 1997, CMBS total market capitalization stood at $130 billion, which puts it within sight of the total market capitalization for equity REITs of $140 billion, according to calculations by Morgan Stanley & Co. Clearly, given the pending volume in the CMBS market, its size will far surpass equity REITs this year.
The love affair with commercial mortgages continues on the whole-loan side as well as in the CMBS sector, and for good reason. According to the Giliberto-Levy Commercial Mortgage Performance Indexsm, whole loan returns for 1997 were 12.04%, as opposed to the duration-adjusted Lehman Brothers Baa Bond Index, which showed a total return of 9.58% for the same time frame. Corporate private placements, which sported a total return of 9.48% for the same 12 months, also strongly lagged commercial mortgages. Commercial mortgage losses were also down sharply to .51%, which was the lowest level since 1986. Although losses are a lagging indicator, nothing in the real estate market seems to indicate that loan losses should start trending up anytime soon.
Given the strong total return performance of whole loans, institutional lenders are anxious to set new volume records during 1998. But January, for the most part, was filled with a modest level of new commitments. Some institutional lenders are nervous about offering new 10-year fixed rate mortgages at rates below 7% and, as a result, have put a floor on new originations at 7% or higher. To be sure, this has stifled their origination efforts in many cases. Other lenders are trying to entice borrowers to take shorter term five-year mortgages and are offering them the ability to reset the rate at the end of the five-year period, based on then prevailing interest rate levels.
In order to bring in new transactions, a number of life insurers are offering to fix rates today for loans to be funded at the end of this year. By offering forward commitments, they hope to avoid direct competition with Wall Street as well as tie up some choice business early in the year.
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John B. Levy is president of John B. Levy & Co. Inc. in Richmond, Va.