Record Issuance Seen For CMBS Amid Weak Market
July 26, 1999
Despite market volatility, recent weak performance and widening swap spreads, commercial mortgage-backed securities experts predict that the sector is becoming more popular than ever, with a hearty supply of significant deals slated for the remainder of the year and record issuance levels for the second quarter.
According to Michael Youngblood, managing director of real estate for Banc of America Securities, July 1999 issuance represents the third-highest monthly issuance ever for CMBS, and the issuance of $20.9 billion for the second quarter is the third- highest quarterly issuance ever.
"The slug of supply that has come and is expected to come to market in July exceeded everyone's expectations," Youngblood said. "Most participants had confidently expected a steep falloff in issuance after we cleared June, but we cleared June and ran into this huge supply in July, and a decent August and September calendar. After that, because of Y2K, there is only one more month remaining to do anything, by most accounts."
According to one CMBS researcher, the Street is expecting approximately $20 billion in supply for the second half of 1999, with $14 billion slated for the third quarter.
In August, there will be nine deals totaling $7.1 billion, and for September, there will be six deals totaling more than $3 billion, the source said.
"Relative to the earlier part of this year, there are good technicals for CMBS in terms of supply," said Patrick Corcoran, director of CMBS at J.P. Morgan. "Though our market has had some underperformance against corporate industrials this month and we've been tied to the backup in swap spreads, we fundamentally continue to have good value against corporates, despite what the market is telling us.
"I liked that view a month ago, and I like it even better today."
Swap Spreads Impacting Market
Unfortunately, this large volume in issuance and a noticeable absence of Tier 1 conduits has caused CMBS spreads to widen disproportionately, sources say.
When swap spreads widen, it makes it more difficult for floating-rate investors to jump in, and there has been a lukewarm reaction to current offerings.
Last week, the benchmark 10-year triple-A spread widened by 11 basis points to 132 over the curve; the 10-year swap spread widened by only five basis points.
"But both issues that came to market last week represent very difficult births indeed and the transaction working this week is not having any better luck," Youngblood said.
Morgan Stanley's $733.8 million offering by Midland Loan Services, Residential Funding Corp. and CIBC priced at 138 basis points over Treasurys, which was wider than price talk.
Similarly, late last week the $874.5 million Greenwich Capital, National Realty Funding and Bridger Commercial Realty Finance deal led by Prudential Securities priced at 150 over, which was also much wider than the price talk prediction of 125 over.
Because of this weak performance, some market players say that money market investors have become rattled, especially investors who live or die by their monthly mark.
"A period like this can cause some shuffling around," Corcoran said. "Tiering continues for future transactions, and you can basically have a flight to liquid bonds in the sector."
Most market participants, however, say that there will be a significant slowdown in supply come October, mainly due to Y2K fears, a tightening of technical factors, a slowed velocity of real estate transactions, and less property appreciation.
Tiering Continues In The Market
Market players note that there will be even more tiering in the pricing of future transactions, and a predilection for more traditional types of collateral.
Investors have shown a preference for transactions from Tier 1 issuers, mainly because of the superior underwriting up front and the higher quality servicing over time, market sources noted.
Additionally, Tier 1 issuers characteristically have deep pockets and are perceived to have a permanent commitment to the CMBS business.
"One can show that in periods of distress, Tier 1 spreads widen proportionately less than tier 2, 3 or 4 spreads," said Banc of America's Youngblood. "Also, as information about the market becomes more widespread...participants are now able to make the kind of discrimination between issues and issuers that corporate bond investors have traditionally been able to do."
Sources also mention that tiering by underlying collateral is also a common practice, in addition to tiering by issuers.
"You might have a good name, but if your deal is 20% hotels, the market would take that into account when pricing bonds," said Loy Saguil, head CMBS trader at CIBC Oppenheimer. "There are now many different factors taken into account."
Where Is The Value?
In a year largely considered to be a retrenchment for the CMBS market, participants still see nuggets of value in the sector.
"We see the momentum continuing in CMBS in terms of greater interest and inquiries about the market, especially in regard to investors who haven't participated in it before," said J.P. Morgan's Corcoran. "I get the indication that investors are looking to be back in the U.S. economy, and they are looking for something relatively conservative but priced on the cheap side.
"CMBS is great for investors who want a no-brainer type strategy to enhance your current income."
According to Corcoran, the long triple-A CMBS bonds pricing in the 130's comprise some of the best value around today in the fixed-income sector. Additionally, there was no value like that in previous years, he says, with the exception of 1998.
Corcoran also mentioned that other great values exist mainly at the top and bottoms of the deal structures, as well as in the interest-only strips. - AT