The party in the commercial-mortgage market just keeps getting livelier. The Barron's/John B. Levy & Co. National Mortgage Survey shows whole-loan originators and participants in the commercial mortgage-backed securities arena are still whooping it up.

About $11 billion of commercial mortgage-backed securities came to market in November, and another $7 billion is expected in December. The fourth quarter may well be the busiest quarter ever, with issuance of more than $28 billion. Domestic CMBS issuance is running 36% above last year's level and, assuming December turns out as planned, 2003 will set a record for domestic volume, eclipsing the previous record of $78 billion set in 1998.

Good economic news has pushed borrowers into the market seeking new loans, as they reason that a healthy economy will lead to higher interest rates. As a result, the first quarter of 2004, generally a slow period for new issuance, may be stronger than most analysts anticipated.

Credit Curve Tightens

Despite record volume, CMBS spreads have remained remarkably stable. In fact, the credit curve (the difference between triple-A-rated and triple-B securities) at 57 basis points, or 0.57 percentage point, is at its tightest level since 1997. That suggests buyers are betting on an economic recovery that would lessen real estate defaults and delinquencies.

But Lisa Pendergast, managing director at RBS Greenwich, suggests the curve is so tight that “buyers aren't being sufficiently compensated for moving down the CMBS credit curve.”

Others sense that CMBS spreads may be in for significant tightening. Relative-value investors note that they can pick up 23 basis points in additional yield by selling their double-A corporate bonds and investing in triple-A CMBS. A more typical pickup in spreads is four basis points.

But the real wild card in predicting CMBS spreads is Freddie Mac. In 2003, it was far and away the largest single buyer, but industry buzz is that the federally chartered company will be scaling back its appetite in 2004.

Some investors argue that could cause triple-A CMBS spreads to widen by five to seven basis points, but Ken Cohen, managing director with Lehman Brothers, is more sanguine. He suspects that “even if Freddie stops buying, triple-As will widen only two to three basis points, and then only temporarily.”

Chock-Full of Offerings

The CMBS market was chock a block with offerings in early December, including $1 billion-plus offerings from Wachovia Securities, Morgan Stanley, RBS Greenwich and GMAC. The deal to watch is the Greenwich transaction, a $1.8 billion offering backed by 81 loans. The 10 largest loans make up 46% of the pool, and 58% of the pool consists of office-building loans. The deal has less than 4% multifamily loans, so Freddie Mac isn't a potential buyer. Greenwich estimates the A4 class, rated triple-A, will price at interest-rate swaps plus 34 to 35 basis points.

Now that the CMBS market exceeds a half-trillion dollars, analysts are looking at loan performance to see which originators have been naughty or nice. There is no agreement, however, on the correct way to compute delinquencies, and most originators calculate the number in a way that puts them in the best light. Newer originators have an advantage because their loans aren't seasoned enough to hit the period of maximum default.

Credit Suisse First Boston, arguably the largest conduit originator, has analyzed conduit and fusion deals from 1997 through the third quarter of this year, and says the lowest delinquency rates belong to Key Bank, UBS and Bear Stearns. Key Bank's 60-day delinquency rate is a scant 0.0026%.

At the bottom of the heap: Merrill Lynch, Nomura and Citicorp's Salomon Smith Barney/Citibank. Merrill Lynch's comparable 60-day delinquency rate is 3.20%.

John B. Levy is president of John B. Levy & Co. Inc. in Richmond, Va. © Dow Jones & Co. Inc., 2004.

BARRON'S/JOHN B. LEVY & CO. NATIONAL MORTGAGE SURVEY

Selected CMBS Spreads*
To 10-year U.S. Treasuries
Rating 12/8/03 11/10/03
AAA 72-73 74-75
AA 80-83 82-84
A 89-92 91-93
BBB 125-130 132-137
BB 415-425 415-440


Whole Loans*
Prime Mtge. Range Prime Mtge. Prime Mtge. Range
Term of loan 12/8/03 Rate 11/10/03
5 Years 5.01-5.11% 5.06% 5.01-5.11%
7 Years 5.41-5.51 5.46 5.40-5.50
10 Years 5.89-5.99 5.99 5.92-6.02
For loans of $5 million and up, on amortization schedules of 25-30 years that can be funded in 60-120 days with 0-1 point.


*in basis points, or hundredths of a percentage point