The market for commercial mortgage-backed securities is expected to slow in 1999 as Wall Street firms curtail their real estate lending.
About $55 billion worth of commercial mortgage-backed bonds are expected to be issued next year, according to Donaldson, Lufkin & Jenrette Inc. That would be down from the $76 billion of such securities issued so far this year.
The commercial mortgage-backed market-a key source of long-term real estate financing-has never before seen a significant dip in volume. Despite a recent rebound, new-issue volume is not seen returning to the breakneck pace of the first half of this year anytime soon.
"Lenders clearly have more leverage than they used to. There are just fewer of them," said Stacey M. Berger, executive vice president at Midland Loan Services, a division of PNC Bank Corp. of Pittsburgh.
This autumn, several of Wall Street's so-called conduits-firms that originate real estate loans with securitization in mind-cut back on their lending as volatility in the fixed-income markets prevented them from selling their loans profitably.
Nomura Securities of Japan this month closed its Capital America unit, which had been the top originator and securitizer of U.S. commercial mortgages and a pioneer in the field.
For commercial banks, the more sober environment means an opportunity to pick up at least some of the slack left by Wall Street houses that left the conduit business this year, and to demand more conservative terms from real estate borrowers.
Executives like Mr. Berger say that 1999 will be the year that commercial banks as a group come to dominate conduit lending. They argue that banks' large balance sheets and networks of borrower relationships will give them an edge over Wall Street firms.
"Investment bankers will be less and less of a factor within the business, with the exception of distribution" of the securities, Mr. Berger said.
Some Wall Street competitors agree.
"If the bond market turns south, the banks have the ability to portfolio loans for a while," said Louis Colosimo, managing director of real estate capital markets at Morgan Stanley Dean Witter. "They're the lowest-cost providers because they were the traditional lenders and have existing lending networks and relationships. It would make sense that they take a larger share."
Others on Wall Street are more skeptical. Jim Titus, managing director of real estate research at Donaldson, Lufkin & Jenrette, said commercial banks are simply not as entrepreneurial as their investment banking peers.
"They have the financial might to be successful, but they lack some of the go-get-it attitude," Mr. Titus said.
He questioned banks' ability to keep loans on their books when the securities market is unfavorable.
"A commercial bank is kidding itself if it's not measuring its origination staff based on where loans could be sold in the secondary market," he said. "The rating agencies and bank regulators are going to come in and say, 'What's the market value of that collateral?'"
To be sure, the outlook for 1999 is not as bleak as it was early last month when analysts such as Mr. Titus were forecasting only $40 billion to $45 billion of commercial mortgage-backed bond issuance next year. At least $10.7 billion of new issues have been sold in the last two months, and spreads have tightened from the October peak.
Still, the sector remains significantly less exuberant than it was this year before the Russian debt crisis rocked the bond markets.
One trend that began this year and is expected to continue in 1999 is the use of minimum interest rates, or floors, when quoting conduit loans.
Traditional lenders such as insurance companies have always used this nomenclature. But until last August, conduits had quoted loans to borrowers in terms of a spread over U.S. Treasury securities. The market dislocation that bedeviled Nomura and others prompted the conduits to start quoting loans in terms of their absolute rate.
Floor pricing cushions conduits from falling interest rates and arguably makes loan underwriting more conservative. That is because the lender assumes that a real estate project will have to generate more cash flow to make the higher interest payments.
In the year leading up to last August, most commercial mortgage-backed offerings were in the $1 billion to $2 billion range. This year, securitizations are expected to be smaller, on average, in the $750 million to $1 billion range.
"People will try to turn inventory faster," Mr. Titus said. "People don't want to be stuck with several billion dollars worth of mortgages, only to have the market change course and be caught with fixed product in a different interest rate environment."
Having fewer participants in the conduit business will let those who remain underwrite loans more conservatively and require more equity from borrowers, said Stephen R. Blank, senior resident fellow for real estate finance at the Urban Land Institute in Washington. This might force borrowers to find additional sources of capital, such as mezzanine loans or third-party equity investors, he said.
"If you're buying" property, he said, "you're not going to be able to finance as much as you used to, and you may have to find a subordinated tranche of money."