Despite the dormant issuance calendar and expected holiday-induced slowdown in activity, the CMBS market was subject to brisk investor selling toward the end of August. Spreads had been at the tight end of recent ranges and with a lull before the next supply wave, profit-taking surfaced and clean-up of inventories by way of bid lists was seen. In total some $1.2 billion of bid lists of investors hit the Street, most of which comprised of long-dated, triple-A-rated paper.

Despite the two-basis-point back- up in CMBS spreads, the sector is still viewed as rich with continued selling expected. Aside from better relative value being offered by agency debentures and residential pass-throughs, selling pressure is coming off of the convexity trades in swaps. If Treasurys continue to rally, RMBS investors will put on convexity receiving trades in the swaps market, drawing those spreads tighter and making CMBS tighter to Treasurys, prompting some sell trades, says Merrill Lynch's Roger Lehman. The only bright spot is that a continuing rally in the Treasury curve will likely have CMBS outperforming RMBS as the latter market is more exposed to call risk with lower yields.

Thinking outside the box

With the vanilla CMBS tranches looking a bit rich at current levels, investors will have to dig deeper for value. Continuing the theme of buying seasoned paper - Merrill Lynch advocated buying seasoned seven-year paper versus comparable new supply weeks ago - Bear Stearns' Peter Rubinstein is recommending that investors look closely at seasoned five-year triple-As. The old (10s issued four to six years ago) and new five-year paper is currently priced the same, but have different characteristics that make the seasoned paper essentially cheap.

What is traditionally a carve-out of the triple-A tranches of a CMBS deal, the 10-year (usually 9.7 WAL) is a "last cash flow" bond, protected by the sequential structure of the deal and prepayment restrictions, and in the case of an extension, are protected by 10-year balloon loans in the pools and repayment status ahead of subordinate tranches. This gives these bonds a bullet-like quality that can't be found in new five-year issues subject to the first prepayment hits. The result is better convexity in seasoned issues.

For additional support, Rubinstein notes that strength in the real estate markets in recent years has been formidable, making seasoned collateral a better credit risk now than when it was issued.

Also, any glaring problems with the underwriting or appraisal data would have surfaced, making an argument for better credit qualities than single-A corporates for only a minimal give-up in convexity.

Small Offerings

Set Up Calendar

To kick off the month, the $1.6 billion conduit coming from Deutsche Bank and Bank of America had yet to price as of press time but was scheduled to do so by early this week.

The issue is allowing for investors to buy either fixed- or floating-rate paper for the triple-A tranches and should increase investor interest. The deals to follow, however, will appeal to a selective audience.

A smorgasbord of single-asset deals are lining up for next week including the Freehold Raceway Mall $177 million offering via Morgan Stanley, a Lehman-led duo of hotel collateral for Swan and Dolphin Hotels totaling $300 million, and the Waikiki Beach Marriott for $130 million via Banc of America.

Behind that, promise of at least four fixed-rate conduits for a possible $4 billion in fresh supply has been earmarked for September business.

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