By all accounts, the deluge of CMBS supply in July was a force to be reckoned with - or at least bad enough to hurt spread levels, sources say. But as many an analyst noted last week, the resiliency of the sector to fight off the concession is something to behold, and only reemphasizes the love affair with the product sector going forward.
July totals were near $7 billion and the final week of the month brought $3.4 billion (the week of June 15 saw $3.5 billion), making it the second largest weekly issuance of the year, according to Bank of America. Over the month, spreads for the 10-year triple-A classes widened two to three basis points, with the peak at +49 basis points coinciding with the Salomon Smith Barney conduit - SBM7 2001-C1- that priced on July 25. Since, spreads have come in to +46 bps, marking the GE Capital issue that printed on July 30. Both credit subordination and low loan-to-value ratios had something to do with the rather range-bound spread movement, but it was good old-fashioned demand that takes credit for most of the return to the tights.
According to SSB, demand for paper is coming from a number of investors, including life companies. Traditionally considered more "credit-sensitive" participants, their contribution adds credibility to the sector despite some indications of slowly rising delinquencies. Demand in mezzanine classes was also seen by some vanilla investors, rather than just CDO-type buying, which kept the credit curve between triple-Bs and As unchanged at +83 bps.
Certainly a big factor in the demand during July was a result of FAS 140-induced slowdown in June, which saw only $4.4 billion CMBS price. And while July brought a bit of levity to the spread levels, expectation of a more "orderly" supply market bodes for even tighter levels - SSB is predicting a "normal pace of two or three deals a month." Credit Suisse First Boston adds that with dealer inventories well below Q1 highs and their feeling that real spreads have reached their peak, they are recommending that "investors looking to take advantage of this relative outperformance should begin to add to positions...before the bandwagon gets crowded."
Dynamic changes in
preference and structure
Supply of late has contributed some new twists to the way deals were structured in the past based on current expectations. For one, recent issues have been structured with short-maturity classes under five-years. This was to head off some prepayment concerns surrounding that average-life class. The change was well received by investors who used short tranches to wait out interest rate risk. Their success aside, SSB notes that five-year paper cheapened to attractive +43-47 bp levels, far wider than their average +32 bps spread over swaps.
In a similar effort to fend off the negative convexity penalty that first-pay bonds have suffered, newer conduits are placing seven-year WAL tranches in the structure. Merrill Lynch, however, sees better value in seasoned seven-year issues. They cite better liquidity due to tranche size, a tighter payment window, and better call protection as some of the reasons to opt for 1998 triple-As.
Current issues are also sticking to the PAC/support IO structure despite the overall decline in IO production. According to Merrill, the structure has been better for the issuer and in most cases is pricing as well as single-IO class deals. And while the PAC IOs are approaching fair value, says SSB, the support tranche has good value because it is being penalized as a "carve-out" of the PAC class.
Deals on the horizon include: Lehman Brothers $1.3 billion large-loan floater, LB 01-Large Loan FRN C4; Lehman/UBS $800 million single-borrower Westfield Mall Trust, LB-UBS Westfield Trust 2001-WM; First Union 2001-C3 $818 million conduit; CSFB 2001-SPG1 $277 million pooled floating-rate issue.