The market for securities backed by commercial mortgages has begun to resemble that old Four Tops standard, “It's the Same Old Song.” Invariably, spreads between the securities' yields and those on interest-rate swaps widen in anticipation of new issuance and fall in the aftermath. According to the Barron's/John B. Levy & Co. National Mortgage Survey, spreads on long-maturity, triple-A securities began the month of September in the area of swaps plus 40 basis points, or four-tenths of a percentage point, and by the end of the month they had fallen off a cliff to 33 basis points over swaps.

To be sure, at the beginning of September the pending list of new issues was daunting. Bank of America's $1.7 billion offering, for example, would have been the largest of the year. Buyers reasoned that spreads would have to widen in order to absorb the new supply. And they were almost right, except for two developments.

Freddie Mac, the largest single acquirer of commercial mortgage-backed securities, went on a shopping spree in September to the tune of almost $1 billion. Then the Bank of America CMBS deal ran afoul of disclosure rules and was put off at least 30 days. J.P. Morgan had been struggling in its efforts to sell a $1.25 billion offering, but once buyers were given notice of the Bank of America delay, the Morgan deal quickly oversold.

Factors at Work

Despite continuing weak real estate fundamentals, triple-A spreads are now as tight as they've been in over five years. Contributing to the tightening was the presence of several large institutions in the market buying CMBS. In the Midwest, Fifth Third Bank was described as especially acquisitive, and a recent newcomer to the CMBS market, Vanguard Funds, reportedly bought some $300 million in CMBS in a matter of days.

Also benefiting from the tight spread levels was a $1.2 billion offering led by Morgan Stanley and Bear Stearns, referred to as TOP12. The long triple-A tranche originally was thought to price in the area of interest-rate swaps plus 35 basis points, but it tightened to 33 basis points over swaps upon execution.

While TOP12 was in the market, Manulife of Canada announced its acquisition of John Hancock, the largest tenant in Boston's John Hancock Tower. One of TOP12's largest loans is a $50 million participation in a $180 million loan on the building. Buyers didn't seem concerned whether Hancock would be likely to renew its lease when it becomes part of Manulife.

Hotels: Potential Opportunity or Headache?

Hotels have been the weakest link in the real estate chain, thanks to the events of 9/11 and the subsequent decline in business and consumer travel. According to Li Chang, manager of finance for Trepp LLC, some 6.81% of hotel loans are currently delinquent, more than three times the level of the real estate industry in general.

Yet Darrell Wheeler, managing director at Smith Barney, suggests that it's time for buyers to buy distressed hotel-debt offerings. He notes that hotel revenues recovered smartly over the summer and that they are now down only 2.5% from the heady times before 9/11.

Wheeler observes that major cities continue to see significant weaknesses, with New Orleans down almost 30%, Boston off by more than 21% and Oahu, Hawaii, down 21% from their peaks just before 9/11. Limited-service hotels outside major cities have done well.

Wheeler is advising investors to focus on issues that have been already downgraded. Three issues supported only by hotels include the Opryland Hotel Trust, the Times Square Hotel Trust and the Hilton Hotels Pool Trust.

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

Selected CMBS Spreads*

	To 10-year U.S. Treasuries
Rating	10/6/03	9/8/03
AAA	77-79	89-90
AA	86-88	99-100
A	96-98	109-110
BBB	139-144	158-163
BB	415-440	425-440

Whole Loans*

	Prime Mtge. Range	Prime Mtge.	Prime Mtge. Range
Term of loan	10/6/03	Rate	9/8/03
5 Years	4.51-4.61%	4.61%	5.17-5.27%
7 Years	4.95-5.05	5.05	5.60-5.67
10 Years	5.52-5.62	5.62	6.10-6.20
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

John B. Levy is president of John B. Levy & Co. Inc. in Richmond, Va. © Dow Jones & Co. Inc., 2003.