Commercial mortgage rates showed little change though the holiday season, according to the Barron's/John B. Levy & Co. National Mortgage Survey. Spreads -- the difference between mortgages and Treasuries of the same maturity -- continued to be under pressure and declined again in December. The 10-year Barron's/Levy prime mortgage spread has now declined to 1.4% ... a far cry from only one year ago when it was a more robust 1 7/8%.

As we reported last month, the National Association of Insurance Commissioners (NAIC) -- whose decisions are generally accepted by state insurance regulators -- is in the process of reviewing its classifications for a significant part of the commercial mortgage-backed securities' (CMBS) market. The NAIC has tentatively agreed that large diversified pools of commercial mortgages should be treated as bonds and, therefore, carry lower reserve requirements. But it has yet to define what qualifies as a "large pool." It is equally unclear to many industry analysts how the remaining parts of the CMBS market will be treated. These would include credit-tenant leases and single-asset transactions, such as Taubman Realty Group's Lakeside Mall, which we detailed last month. The NAIC is believed to have a number of additional transactions under review, including the $287.5 million Danbury Buildings, which are home base to Union Carbide, as well as the $120 million Crabtree Valley Mall in Raleigh, N.C., and 1211 Avenue of the Americas, a $155 million loan on a Rockefeller Center office building.

Although the NAIC had not answered our request for clarification at press time, industry players have confirmed that these transactions can be treated as bonds for 1994 as long as they carry a suffix of "Z" -- indicating that they may be moved back to the mortgage side at some time in the future. Since insurance companies must set aside 10 times more capital for a commercial mortgage than they would for an "A"-rated bond or better,the treatment of these transactions is of no small consequence. Deals approximating $4.5 billion in 1994 alone could be affected. Additionally, the NAIC has yet to indicate whether securitized mortgages to single borrowers, such as REITs, will be treated as mortgages or as bonds, leaving the market further confused. As one survey member put it, the NAIC is "dancing" around the issue and is not giving clear guidance. Until they do, some insurers are widening their minimum spreads for selective CMBS transactions in order to take into account the potential risk that they may be eventually scheduled as mortgages. The NAIC has told insurers that it expects to have answers on single-asset transactions and credit-tenant lease deals by June 1995. For deals where a ruling has already been requested, including the four previously listed, a decision may come even sooner.

In the conventional commercial mortgage market, declining spreads and deteriorating underwriting have forced several large survey members to cut back their 1995 allocation by 20% to 25%. They argue that the commercial mortgage market is rapidly losing "value" relative to alternative investments and that the costs and risks of commercial mortgage programs cannot be justified based on today's market conditions.

The majority of survey participants, however, are not downsizing their 1995 mortgage program, but are realistically looking for loan volume this year to be approximately equal to the volume in 1994. Since the commercial market is not experiencing a great deal of new construction, lenders are being conservative about their chances to grow production. Certain institutions see the previously ignored office building market as offering real value due to reasonable underwriting standards and modestly higher spreads. In the view of several survey participants, apartment deals are so tightly contested that they, in fact, probably offer the least value in the commercial mortgage arena today.

To the surprise of many, survey members are actually projecting rates to decline over the coming year ... albeit modestly. Lenders are, to no surprise, a conservative lot and normally view rates as only headed up. But, when asked where the 10-year Treasury would be on the first business day of 1996, the majority felt that rates would be approximately 50 basis points lower. They reason that the Federal Reserve's rate increases were beginning to take hold and would slow the economy. They also pointed out that they expected rates to rise further this year before they declined by the end of the year.