Fierce competition makes for a crazy month Commercial mortgage rates were highly volatile in April, according to the Barron's/John B. Levy & Co. National Mortgage Survey. However, thanks to a strong month-end Treasury rally, mortgage rates as May began were down modestly from 30 days previous.
"It's crazy out there" was the universal quote from most survey participants this month. Institutional lenders noted repeatedly that the competition for new transactions was as fierce as they could ever remember, including the go-go days of the late-'80s. This competitive frenzy left borrowers in a euphoric mood as they were able to access more sources of capital and a wider variety of financial structures than perhaps ever experienced.
The institutional push for more commercial mortgages was no doubt partially caused by the strong total return performance of the industry. According to the Giliberto-Levy Commercial Mortgage Performance Indexsm, commercial mortgages trounced both publicly traded bonds and private placement bonds by 1% and 2.54%, respectively, during the previous 12 months ending March 31, 1997. In the first quarter, mortgages on office buildings -- with a total return of 1.85% for the quarter and 10.03% for the trailing 12 months -- were the leading performer while retail mortgages brought up the rear. Commercial mortgage performance was aided by a continuing decline in default and delinquency costs, which tumbled to .59% for the previous 12 months. While these default and delinquency numbers are quite good, astute analysts caution that industry losses were at almost identical levels in 1986, a time when credit losses had already started to ramp up.
A number of survey members indicated that pension fund borrowers were becoming a significant part of their loan programs. Public pension funds have been on a property buying rampage of late and are now seeking to place loans on the properties at levels which are generally 50% or less of the property's acquisition price.
Spread pressure is by no means limited to the whole-loan market. On the securitized side, spreads are continuing to tighten, even though corporate spreads have widened somewhat. In a $1.166 billion, which was priced in early May, First Union-Lehman Brothers is expected to price the 'BBB' tranche of this conduit transaction at a spread of .95%. Below-investment-grade tranches tightened considerably in April. 'B'-rated tranches, which in January were priced at spreads of 6.5% to 7% over the curve, are now in the 5% to 5.5% range.
Wall Street is continuing to lead the commercial mortgage market in innovation, and nowhere is that more apparent than in what some wags are calling the "leveraging of America." Some investment banks are now offering, in addition to standard 75% loans-to-value, an additional layer of debt generally styled as either mezzanine debt or preferred equity. This increases the leverage on properties from 75% to as high as 90% in some cases. Nomura Securities has been in the forefront of this trend, although they seem to have plenty of recent company from GE Capital, Heller and First Boston, to name just a few.
To be sure, borrowers are enthusiastic about their newfound ability to leverage their properties and, in fact, in Nomura's most recent CMBS transaction, D-4, some 26% of the loans had so-called preferred equity features. Forthcoming transactions underwritten by First Boston and by Merrill Lynch-GE will test how excited CMBS buyers are about buying loans that have this additional layer of debt attached.
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John B. Levy is president of John B. Levy & Co. Inc. in Richmond, Va.