The strong level of new U.S. CMBS issuance of about $75 billion last year is expected to flatten or more likely dip in 2004, said Standard & Poor's in a report released today.

“Interest rates will likely rise modestly, but probably not until the latter part of the year,” said Kim Diamond, a managing director at S&P’s structured finance ratings group.

She added that issuance volume will be benefiting not only from sustained low rates, but also from the refinancing of first generation conduit loans that mature or reach the expiration of prepayment lockout periods.

To put 2003’s issuance in perspective, CMBS issuance was roughly $60 billion in 2002 and $74 billion in 2001. But as volume remains robust, stressed real estate fundamentals have been slowly rebounding as the U.S. economy recovers.

S&P also reported that depressed fundamentals in 2003 caused a record number of CMBS downgrades and defaults. Analysts stated that the primary reason for the stress on real estate fundamentals was that, even with economic recovery accelerating, only a few jobs were created. “The vitality of the job market is fundamentally important to the strength of commercial real estate activities,” said the report.

Further, a weak job market limits the demand for offices, apartments, industrial spaces, lodging facilities, and retail sales.

However, even with the depressed fundamentals and record number of downgrades and defaults, the classes that were upgraded remained higher than those that were downgraded — 301 to 215, with 29 defaults. The considerable number of upgrades shows the resiliency of CMBS structures, said S&P.

Meanwhile, Managing Director Roy Chun said that S&P doesn’t expect 2004 to be as active as 2003 in terms of ratings actions. But he expects the number of delinquencies to grow through the middle of this year. He said that there’s still pressure in certain real estate sectors and markets expected to precipitate increased delinquencies. However, delinquencies should level off in the second half of 2004 and remain more moderate afterwards.

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