CMBS Spreads Bring Demand for Subs: Not Enough Mezzanine to Go Around, Observers Say


As several commercial mortgage-backed deals priced at surprisingly tight spreads last week - one source even described the $225 million Houston Galleria CMBS deal as a blowout' - market players noticed a very strong interest on the part of investors in the mezzanine pieces of deals; so much so, in fact, that apparently there are not enough B-pieces to satiate investors' overwhelming demand for them.

"It appears to me that it doesn't matter if you're doing a single-asset transaction, a floating-rate transaction or a fixed-rate transaction - mezzanines are well oversubscribed," said one CMBS trader. "They've been tightening tremendously in these last couple of deals. There's been a flattening of the credit curve for quite some time now it is continuing, and could go a lot longer."

"There's been surprising interest from new buyers in double-B and single-B-rated classes," added Michael Youngblood, managing director of real estate at Banc of America Securities. "The shame is, those pieces present a very small portion of a deal and we don't have a lot of them to offer. In most cases the first-loss buyer, who is typically also the special servicer, buys them before anyone has a chance to see them."

These B-pieces are among the highest yielding and best call-protected transactions in the mortgage market, and a natural craving for yield that has struck the market since the last Fed tightening has seemed to play itself out.

For instance, the mezzanine pieces on both the $1 billion Deutsche Bank Alex. Brown/Salomon Smith Barney floating-rate deal, as well as the price guidance on the $888 million CMBS fixed-rate offering from Bear Stearns & Co. and Wells Fargo, have been very well oversubscribed - perhaps as much as five-times oversubscribed, some sources said.

"There is just so much interest in these bonds, in the triple-B and triple-B-minus," said another CMBS analyst. "It's the same way in floater land as well.

"The people on the Street in secondary inventory do not carry much mezzanine, and they don't trade that often, so if you want to buy something you get it from the new issue market," the source added. "If the new issues are coming and you have a lot of demand in whatever issues are out with that supply, the stuff has to tighten up."

Coming up in the CMBS pipeline: Salomon Smith Barney is slated to price its $452 million floater by Wednesday of next week. The company is also a co-manager on the upcoming Prudential Securities Inc./Heller conduit, which should price early next week. Additionally, an SSB no-lock deal in cahoots with Allied for $330 million will be launching in early March, and a Salomon-led fixed-rate conduit with an as-yet-unnamed partner for between $800 million and $1 billion is slated for late March.

According to a source close to Salomon, the investment bank will not bring another floater to market "until at least the middle part of the year."

Regulatory Issues Highlighted

On the residential side of the market, mortgage-backed securities have tightened in by as much as six basis points on an option-adjusted spread basis for the current coupon passthroughs, sources said.

"We think the Street has modest positions in passthroughs in prime and subprime non-agency and in CMBS and if anything, we are heavily stocked with agency Remic's or CMO's," said Banc of America's Youngblood. "We think the Street can prudently build up large inventories in late 1999, as they were expecting massive buying by banks in early 2000. Since that hasn't materialized, it has left the Street heavy and therefore spreads have not been able to tighten."

Also popping up on MBS radar screens last week, a new proposal from federal banking and thrift regulators is supposed to include a ratings-based system that will treat all triple-A-rated private label MBS equally. This would mean that triple-A private label MBS would enjoy the same capital treatment as Fannie Mae MBS and make them a more attractive investment for banks. Currently, private label MBS are assigned a 50% risk weight.

Sources also say that a compliance with Financial Accounting Statute 133 - which requires the marking-to-market of servicing portfolios - is proving to be more troublesome than expected. Although compliance with FAS No.133 was postponed over a year ago, which would seem to give ample time for banks to prepare for its enactment, some top-ten mortgage bankers are rumored to be "grappling with the statute," sources say.