As fall 1998 approached, the John Hancock Mutual Life Insurance Co. was sitting on a pool of loans it intended to securitize. Unfortunately for the big life insurer, as well as everyone else in the commercial mortgage-backed securities market, an international credit crisis spilled over into the U.S. bond markets and CMBS deals came to a screeching halt.

Unlike other companies running conduits, such as Wall Street's investment banks, this didn't pose much of a problem to John Hancock. It simply sold the pool of loans into its general account portfolio.

Investment banks, on the other hand, were caught with billions of dollars worth of loans that could not be securitized and were costing them immensely for every day they were held. Investment bank conduits instinctively pulled back from the market. Some stopped lending while others just priced themselves out of the game. Deals nearing completion were stopped cold. Transaction business died, and pricing pulled back.

Nine months later, at mid-year 1999, the remaining investment bank conduits are once again aggressively in the market, but the world has changed. Insurance companies, commercial banks, pension plans and agencies (i.e., Fannie Mae) quickly recut a niche for themselves. The market is again very liquid, and competition among the varied sources of capital has again become robust. Commercial real estate financing turned full circle. In June 1998, just about any deal could get done. By October, most transactions were stranded. In June 1999, just about any deal with good economics could find financing.

Historically, commercial real estate lending has always been dominated by commercial banks and insurance companies. For brief interludes other players have cut a path to the market, such as the savings & loans in the 1980s. They eventually fell out of the business with the real estate recession later in the decade. That situation combined with some extremely conservative lending practices by the banks and insurers created a vacuum which was eventually filled by Wall Street's investment banks pushing the formation of CMBS.

In 1990, CMBS production was less than $5 billion. Last year, it totaled a record $78 billion. And even with a hangover from the credit crisis the year before, CMBS volume reached $35 billion through the first half of this year, reports Commercial Mortgage Alert. (See CMA's 1st-half rankings of leading CMBS managers to the right.)

The life companies For the past few three years, John Hancock, based in Boston, allocated about a billion dollars annually for new investment. In addition, in 1997 the big life insurer began its own conduit.

1998 was a very good year for the company. On the general account portfolio, it originated just over $1 billion in new loans. This year, the company has allocated $950 million for loan origination and by mid-year had already done $507 million.

It should be noted, insurance companies operate on a calendar year basis and allocations are set at the beginning of the year. When insurers invest all of that allocation often they are done lending for the year. Obviously, insurers try to pace their investments so all the allocation is not run through in a short period of time. But, if there are a lot of opportunities out there, it is not uncommon for many life companies to run out of money by early fall. If the markets are just too hot to stay on the sideline, an insurer might make a new allocation.

"Our allocation usually changes throughout the year," says Sam Davis, senior investment officer for John Hancock. "We anticipate our final allocation for this year will be equal to or greater than the year before."

Life companies came out of the block this year with aggressive allocations to make sure they got their share of investment opportunities, Davis observes. Part of that was due to what happened to the conduit market mid-year 1998 when conduit spreads went lower than life company spreads. "Conduits had a pricing advantage for a good part of the middle of 1998 and many life companies were shocked because it was the first time the advantage went that way. The conduits ended up taking away a lot of high-quality life co mpany business."

This situation changed when the CMBS market blew up at the end of 1998 and conduits could not offer the same spreads as the life companies. Through first-half 1999, life companies regained the pricing advantage.

"That pricing advantage has again gone away to a certain degree, but many of the life companies seem to be in the same position that we are. They are ahead of their goals for investing for this year, based on a very strong first and second quarters," says Davis.

Since John Hancock also has a conduit operation, it has felt the pain on that side of market. "We were thinking we would have a $500 million year last year and we came pretty close. With the tumult in the fall, the pipeline for the conduit got shut down and we didn't quite make it to the $500 million goal." John Hancock's objective this year was to put out $750 million on the conduit side, but Davis admits at mid-year the company is less than 50% of where it needs to be to hit that target.

Massachusetts Mutual Life Insurance Co. bragged a record year in 1998 with about $3 billion in origination. That basically breaks down into $1.3 billion in traditional commercial whole loans, about $400 million of residential pools of Fannie Mae and Ginnie Mae backed loans, and the remainder in non-traditional investments such as syndicated bank debt, unsecured REIT debt, CMBS and privately structured transactions.

Through the first half of 1999, Springfield, Mass.-based Mass Mutual completed about $1.4 billion in originations, on track to do the same kind of business as last year.

"The conduits left in the fourth quarter and didn't get back until well into the first quarter," says David Lauretti, a senior managing director with Mass Mutual. "Through the first quarter and to a lesser extent the second quarter, it has been a wonderful time for a portfolio lender. At this point, conduit pricing is not back to where it was last year, and I don't suspect it will be in the near future which means for quality properties, insurance company pricing is better."

Lauretti suspects, however, the good times could still be over rather quickly. "The second half will be harder, much harder than the first half. We are now at a point where the competition significantly is more robust. Conduit operators are staring at decreased volume so there are some that are buying market share. They have large infrastructures, large costs they have to cover, and they are seeing their hit rate drop so there is pressure on them, especially if they are close to a deal, to push the envelope. We expect more competition in the second half of the year from conduits."

In the fourth quarter of 1998, life insurance companies did about $6.38 billion in commercial mortgages, observers Gail Davis, staff vice president at the Mortgage Bankers Association in Washington, D.C. "Volume for life insurers in the first quarter was $7 billion, so it is about the same and it is preceding on the same track."

There is still a lot of capital out there, Davis adds. "And there is still a lot of competition. Even though rates have picked up, they are still favorable. The big question is, 'Are we at the precipice of the real estate cycle?'"

There also may not be a lot of upside in terms of refinancing opportunities, Davis cautions. From 1990 through 1992 the country was in a real estate downturn and there weren't a lot refinance deals being done, which means now, eight to 10 years later, fewer loans are coming due and needing to be refinanced again.

Conduit perspective While first-quarter CMBS volume looked good, "what you saw at the beginning of 1999 is all carryover from real estate loans originated in 1998 and not securitized until 1999," says Jeffrey Lenobel, a chairman of the Real Estate Group at the New York law firm of Schulte Roth & Zabel LLP. "People in the industry seem to think that CMBS over the last two quarters of 1999 could be a disaster because there is no pipeline of originated loans, but there will be a flurry of originations to build up the pipeline for early 2000."

Conduit lenders themselves are a bit more optimistic. "The second part of the year looks very good," says Greg Spevok, director of originations at Bear Stearns. "It certainly looks better than the first half."

This is not to say that Spevok views the market much different than Lenobel, but he does have a different spin. "There are indications that insurance companies are funding a lot larger percentage of their annual allocation in the first half of the year then they typically do - well in excess of 50% of their allocation - which would indicate they will be less aggressive in the second half and that should yield more volume for conduits."

Secondly, Spevok suggests, when interest rates spiked up many borrowers went to the sidelines hoping they would come back down again. But whether interest rates do fall back, borrowers can not wait for deals to happen. Deadlines have to be met and deals cannot be extended forever.

While volume is down at Bear Stearns this year, total aggregation is up because the company is funding larger deals then it did last year. "If you look at the $10 million loans, the standard conduit product, our volume is down and industry volume is down," says Spevok.

Bear Stearns was able to bring all the product to market in a February securitization. At mid-year it went to market again, contributing $400 million worth of product to a $1.1 billion joint transaction with Wells Fargo. Bear Stearns' conduit activity is running about $100 million a month, which Spevok says is a little behind "where we were last year."

Midland Commercial Funding in Kansas City, Mo., now part of PNC Bank in Pittsburgh, has been in the conduit business for about five years.

After years of growth, "the conduit business is not as strong as in 1998," says Jeffrey Johnson, executive vice president with Midland Commercial. "Volume is down about 25% to 30%."

In 1998, Midland did about $1.7 billion in originations. At mid-year, it was running about $750 million. "Our pipeline is fairly strong," says Johnson. "However, people are reluctant to pull the trigger. They get everything ready, but then the 6%, 10-year bothers them. They got used to a much lower 10-year Treasury. They think rates are going to go back down. If they pulled the trigger like they did last year, we would probably be 25% to 30% busier."

Johnson expects demand to pick up in the fall as people decide what to do about interest rates.

Mezzanine position According to John Petrovski, group president of Heller Real Estate in Chicago, his company is having a profitable year, but that's probably because it has shifted focus away from fixed-rate CMBS loans. Heller Real Estate did contribute $400 million in loans to a joint securitization with Prudential Securities back in May and it will probably do another joint securitization with Prudential in the early fall.

"We are busier on our mezzanine, our floating-rate debt, specialty products, vacation ownership finance and affordable housing, but we are slower on fixed-rate debt," says Petrovski. "Last year, fixed-rate debt was our primary product. In the first half of 1998, we did $1.5 billion in origination and we will be well below that this year. Given the tumult in the third and fourth quarter of 1998, we decided to target and warehouse smaller loans."

Sometime just before the end of 1999, Boston Financial will celebrate 30 years as a multifamily investor. Last year, the company acquired Schroder Real Estate Associates which invested in office and retail. Boston Financial. The company is not a lender but it does have a mezzanine fund where it issues mezzanine debt on behalf of institutional players. "When investors around the country take control of a piece of property or a development opportunity," explains Vince Costantini, president of Boston Financial's Investment Management Division, they may put up 5% or 10% and they can get financing for 60% or 65%, leaving a gap of maybe 25%. Mezzanine financing fills that gap. We have already done two deals at the beginning of summer where we brought in institutional players to fill that gap."

Also into mezzanine are Heller and GE Capital, says Costantini. Other players include some opportunity funds but they prefer to put out bigger chunks of money than a $15 million or $20 million multifamily deal. "On the smaller deals there are just not a whole lot of people in the market," Costantini maintains, which is why some firms like Heller that are looking for niches have moved there.

Of agencies, banks & pensions This a good time to be a buyer, especially on the private side, says Costantini. "The market is strong and stable and if you have equity it's even better because institutions do not want to invest at high loan-to-value. A developer or owner could find 50% loan-to-value money while sleeping. At higher levels it becomes more complicated, but there are real opportunities even though there is less competition then there was a year ago."

Hendricks & Partners calls itself the nation's largest multifamily marketing advisor. Based in Phoenix, it currently boasts 17 offices covering the western United States and is in the process of opening 16 offices in the Southeast and Midwest. Don Hendricks, president and chief executive officer says Hendricks has seen very little conduit activity.

Hendricks reports more than $1 billion of apartments in escrow throughout the United States and is marketing another billion dollars. "The second half of the year is shaping up to being more active then the second half of last year and probably the best trading environment that we have seen in the last 10 to 15 years," Hendricks says.

Demand is there, says James Easler, managing director and group leader for TIAA-CREF, formerly known as the Teachers Insurance Annuity Association-College Retirement Equities Fund, but he says the rise in interest rates has created a lot of uncertainty and volatility which, in turn, "has caused many potential borrowers who do have transaction financing to sit on the sidelines waiting to see of Treasuries go up or if spreads come in. There has been a lot of fence sitting."

Easler is optimistic TIAA-CREF will achieve last year's volume, but it will be more challenging. "We are at a pretty good point in our program now, but not yet where we want to be. At mid-year we are probably behind a bit where we were at the same time the year before."

Last year, New York-based TIAA-CREF was into the market for about $7 billion, of which $4 billion was allocated to conventional mortgage lending, $2 billion to CMBS and the remainder to other programs such as unsecured debt and preferred and common stock for REITs. This year's allocation is in-line with the year before.

"This year, the market is more challenging," reiterates Easler, "even though we see the market fundamentals to be very good with low vacancy rates and rents up. This year, we are looking at a reduced pipeline, reduced opportunities as well as more lenders in the market."

After a slow start to the year, Pat Micka, a managing director and head of CMBS origination and servicing at Chase Manhattan in New York, feels her group, too, will come back. "First quarter securitization activity was slow in volume, but by the second quarter we are back on plan as we started to see a return of the market based on what was in our pipeline."

Last year, Chase did $2.5 billion in originations. "We are on track to do that again," says Micka. "Everybody's volume is down so the fact we have recovered in the second half to running at a rate to produce originations equivalent to last year is a good sign."

Chase pulled off a joint securitization in May for about $1.2 billion with First Union and it expects to repeat that size transaction later in the summer, again with First Union.

Today, says Micka, there is tremendous competition from the conduits, life insurers and even the agencies in regard to multifamily with Fannie Mae and Freddie Mac being more aggressive. With all the competition, she notes there is not as much demand for small loans - $3 million to $15 million - but there is still a lot of action for larger loans above $15 million.

Using capital Herb Miller, executive vice president of Lend Lease Real Estate Investment in New York, casually declares, "We borrow about $1.5 billion to $2 billion a year and that makes us one of the biggest borrowers in the marketplace." And Lend Lease doesn't discriminate, it utilizes products from all sources whether it be investment banks, money center banks or life companies. "We are diverse on the equity side," Miller notes, "and that means we utilize almost every debt product there is in the market." From Lend Lease's rarefied perspective, the lending market is in great shape, except for one facet - new construction and development.

"The fixed-rate loan has come back and is very liquid," Miller says. "We tend to be a conservative, leveraged borrower and we can get those 75% loan-to-value deals with various terms, short or long, from CMBS or life companies. That's a very liquid market."

However, Miller observes, for investment banks there is more emphasis on the syndication of deals which makes them more conservative in their underwriting, particularly on the construction side of the business. "Banks clearly pulled back on construction. We have several hotels that had difficulty finding financing."

Lend Lease, for example, is building a Ritz-Carlton just south of San Francisco that was very difficult to finance. Eventually financing came from Prudential Insurance, which isn't a typical provider for that kind of project.

There remains a lot of liquidity for fixed rate business even on smaller deals, Miller says, and there are a lot more mezzanine debt players as well. One thing he does caution - borrowers need to be aware of a repeat of last year when the life insurers were so aggressive in putting out capital by the time the second half of the year rolled in they ran out of money.

One of the primary focuses of The Staubach Co., Dallas, has been the sale-leaseback deal which has remained buoyant even after the capital crunch - although the company did have to make some serious adjustments, says Brett Landis, a senior vice president of the company and a partner in Wolverine Equities, Staubach's acquisition arm.

"The chosen route for us after the CMBS demise last fall was private placements. In the last three to four months, our sources of capital have been the private placement sector and life companies," says Landis. "Although we are beginning to see more of the old CMBS lenders get back into the marketplace."

For the sale-leaseback business, the lending community is as committed and as strong as ever, Landis notes. "We are doing much more than we have done in acquisitions for sale-leaseback financing. In terms of volume and number of transactions. 1998 was a record year for us and 1999 will exceed 1998."

Miami-based Terranova Corp. says it sold or financed $80 million worth of real estate last year and expects to do the same in 1999.

Paul Ahmed, who joined the company recently as director of Capital Markets, says he was brought on board mainly to do mortgage originations which has become important to a company like Terranova.

Rose amidst the thorns At mid-year 1998, the market was extremely overheated, observes Carl Kane, national practice leader for KPMG LLP's Real Estate Consulting Group in New York. "We had a surplus of capital with a deficit of borrowers. That is why capital was competing against capital and the only way to do that was to lower the cost capital and lower the underwriting standards to clear hurdles. That's what was happening at this time last year."

"The CMBS market is here to stay, and the crisis last fall demonstrated the effectiveness of the new brakes that we have adapted to this market. Whether it is the Russian bond market or overbuilding, we have the ability to influence the activity in that market immediately and directly through the pricing of bonds. We have never had that kind of direct control mechanism in the real estate market."