Commercial mortgage rates continued their seemingly inexorable rise over the last 30 days, according to the Barron's/John B. Levy B Co. National Mortgage Survey of large institutional lenders who control a commercial mortgage portfolio in excess of $175 billion. Interest rates are up 1.2 in the last 90 days and over .8% in just the last two months.

Interest rates, which are at their high point for the year, have had a chilling effect on loan, demand. Commercial mortgage loan demand has been considered strong by most institutional lenders until now. Although some continued to view loan demand as "brisk," the majority note that their pipeline of pending business has shrunk considerably as borrowers move to the sidelines. The skyrocketing interest rates have clearly broken the momentum in the commercial mortgage business and have caught most borrowers "flat-footed" and demoralized. As a result, survey members expect the market to move at a slower pace for the remainder of the year.

Before rates moved dramatically higher, many institutional lenders were attempting to raise their commercial mortgage spreads, the difference between Treasuries and mortgages of the same maturity. But they have met with little success as the rising rate market has taken away any real chance to significantly increase spreads. Nevertheless, a few larger lenders have increased their spreads on the longer-term, 10-year money by 1/8% or less.

In candid conversations, a number of survey members agree that the deals they are now doing are "dicier" than those that they have seen for most of this decade. Several survey members were quite forthcoming with information about transactions where the competition offered significantly more money, 10% to 20%, than they were comfortable lending. There's a clear sense now that although all of the market is not "risky", there appreciably is more risk in the market.

In retrospect, 1995 was an incredible bull market for the commercial mortgage industry and numbers from the Department of Housing and Urban Development (HUD) strongly confirm that. According to HUD, 1995 multifamily originations totaled $38.4 billion, an 18% increase over the previous year. More to the point, it was the third-largest origination nation year ever, following behind 1987 and the record-setting 1986.

Innovation continues to abound in the commercial mortgage backed securities (CMBS) market. Earlier this year, in a deal thought by some analysts to be the "deal of the year," Lehman Brothers, for Host Marriott Corp., combined a CMBS transaction with a high yield transaction and raised a total of $537.6 million. Prohibited by the rating agencies from doing all of the transaction as CMBS, Lehman structured the CMBS portion into six tranches, which added to a combined total of 57% of the appraised value on the underlying 70 Courtyards by Marriott. Simultaneously, Lehman went to the high-yield market and offered Senior Secured Notes - rated "B" - for an additional $127 million, which pushed the total of the two financings up to 75% of the properties' value. The high-yield market reacted enthusiastically to this offering which went off at 5% over the Treasury curve. That spread has now tightened to 4.4% in trades. Industry sources indicate that Lehman and others are planning to use the combined CMBS and high-yield structure for other borrowers with large needs who want to maximize the available leverage.

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