Rates on commercial mortgages declined significantly over the last 30 days, according to the Barron's/John B. Levy & Co. National Mortgage Survey of institutional investors and participants in the market for commercial mortgage-backed securities (). Commercial mortgage rates were below 7% for the first time since the 1960s. Naturally, real estate borrowers are swarming to take advantage of the unprecedented low rates.
The CMBS market has been relatively quiet for the last couple of weeks, but an incredible supply of new transactions is just about to hit the market. According to James F. Titus, senior vice president at Donaldson, Lufkin & Jenrette, the first quarter should see new offerings in the range of $16 billion to $18 billion, compared with the slightly more than $17 billion which was securitized in the fourth quarter of 1997. CMBS issuance in 1997 hit yet another record of $42.8 billion, more than 40% above the previous record set just last year. Amazingly, this relatively young market managed to absorb 11 transactions, each in excess of $1 billion, with the largestbeing the $2.2 billion transaction underwritten by Lehman Brothers and First Union in November.
Wall Street forecasters are, not surprisingly, calling for another very good year. Conservative analysts expect that the market will duplicate its 1997 production with a second $40+ billion year, while some of the more aggressive types are calling for new originations to peak in the $50 billion to $55 billion range. Looking forward, expect to see more floating rate transactions in the market. There were relatively few adjustable rate CMBS transactions in 1997, but firms including Lehman Brothers, Nomura and Credit Suisse First Boston, to name just a few, are all gearing up to offer more floating rate securitizations. Additionally, in the second half of this year, Wall Street bankers are planning to offer securitizations involving European and Canadian properties.
On the institutional lending side, investors are rightly concerned about the growing intrusion into their market by Wall Street types. Hoping to increase marketshare, more than a few institutions are now offering prepayment penalties, which are less onerous than the traditional yield maintenance penalties. They reason that the chances of rates going substantially lower are slim and, therefore, prepayment penalties can be modified with relatively little risk to the lending institution.
Wall Street doesn't seem to agree with this view and, with the exception of CRIIMI MAE, the big NYSE-listed REIT, few investment bankers sense a large market for deals with less than air-tight prepayment penalties. Wall Street and the institutional lending community do seem to agree on one thing: Underwriting has clearly deteriorated. To be sure, most won't admit this for the record but, in the words of one survey member, "we're pushing the envelope." A more concerned Wall Street analyst noted that loans-to-value were now "out of control." In either event, the theme of "too much leverage" is being heard more and more, and apparently the ratings agencies may be listening. Toward the end of last year, conduit operators noted an ever so slight tightening in rating agency standards, but it's too early to know whether this was a fluke or a long-term trend.
Spreads on the whole-loan side have tightened a bit as institutional lenders are now hoping to start off 1998 with a bang. CMBS spreads have acted in a similar manner. For example, triple-A spreads, which peaked in late November at .83% over the curve, have now tightened to .75%. The triple-B tranche is still showing some signs of sponginess, with spreads now in the 1.40% range, down barely .05% from the levels reached during the Lehman/First Union transaction. CMBS buyers are eagerly awaiting the coming onslaught of new offerings, and more than a few money managers are trying to buy large amounts early in the year before spreads decline even further.
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John B. Levy is president of John B. Levy & Co. In. in Richmond, Va.