A Light in the Tunnel

WHO KNOWS? Maybe this time it's different. Real estate and commercial mortgages, whipping boys for many an economic downturn and surefire areas to avoid in troubled times, are wearing white hats these days. WorldCom's recent announcement that it improperly accounted for $3.85 billion in expenses did nothing to change that perception, according to the Barron's/John B. Levy & Co. National Mortgage Survey. As Debbie McAneny, a senior vice president and real estate director at John Hancock noted, “This is the first time in my 25-year career that real estate has been on the receiving end of a flight to safety.”

Two major deals were priced the same day as WorldCom's staggering write-down, and they caused nary a ripple. The first was a $1 billion deal led by Merrill Lynch and Wachovia Securities. It included more than 100 separate loans, and an attractive 34% of the collateral came from the multifamily area. Freddie Mac, the largest single buyer of commercial mortgage-backed securities last year, reportedly bought $350 million from three of the four triple-A tranches.

Simultaneously, underwriters — led by Lehman Brothers and UBS — priced a $1.2 billion “fusion” transaction comprised of 121 loans. The triple-A tranche, dubbed A-4, priced at 0.42% over interest-rate swaps, while the triple-B tranche, J, priced at 1.05% over swaps, about 0.05% tighter than the similarly rated tranche in Merrill Lynch's transaction.

Will the Good Times Last?

Despite the robust tone of the market, analysts are wondering just how long these good times will last. Real estate fundamentals continue to weaken and, in the past, deteriorating fundamentals and excessive capital have delivered a lethal punch to real estate performance.

In January, we asked a group of CMBS buyers and sellers for their mid-year projections of triple-A spreads and CMBS issuance volume. On the spread side, our group was a bit timid, forecasting that triple-A spreads to 10-year swaps would average 0.46 of a percentage point, while the actual figure was 0.42.

On the volume side, the gang viewed things through rose-tinted glasses, expecting issuance of $38 billion; the actual volume was $34 billion. Perhaps the major factor creating the gap between our panel's volume projections and the actual results was the lack of single-asset activity in the first half of this year. In the first half of 2001, according to Salomon Smith Barney, the market priced 10 transactions for a total of $3.5 billion. This year, the total was zero for one reason — lack of terrorism insurance.

We've brought together a new group, including Julie Madnick, a director at Hyperion, and Steve Finkelstein, a director at UBS Warburg, who were closest to the pin last time. The accompanying table shows their year-end projections. The panel predicts stable spreads, while their volume estimates reflect a lack of new originations. Last year's global record volume of $93 billion is beyond even the most bullish forecast.

John B. Levy is president of John B. Levy & Co. Inc. in Richmond, Va. © Dow Jones & Co. Inc., 2002.

THE SPREADS AHEAD