In more than one instance last week dealers used the word "stable" to describe the CMBS market after weeks of cheapening and uncertainty regarding collateral performance. With spreads now firm and in a narrow range, there can be meaningful discussion about where relative value lies and what sectors in which to focus. The larger story centers on an up-in-credit move, primarily targeting triple-A tranches, and there is increased vigilance regarding the hotel exposure shared by many issues.

According to Deutsche Banc estimates, the hotel sector accounts for fewer than 10% of the collateral in conduits, and within that percentage, there is reason to believe that the industry impact will be mitigated. Many of the loans in the conduits are secured by "limited service" or "economy" hotels, which have not seen the dropoff in demand compared to high-end hotels that began during the second quarter of 2001. As Salomon Smith Barney points out, the recent tragedy is going to hurt full-service hotels, especially those in tourist destinations, but travelers turning to auto travel will be looking for discounted lodging instead.

Nonetheless, it's hard to find a deal without some form of hotel exposure, and the uncertainty surrounding the industry is making a mark. The CSFB 2001-FL2 issue that priced on Oct. 3 had 38% of its loans backed by full-service hotels. The triple-A 1.7-year tranche came at 60 basis points to the one-month Libor, five basis points wide of revised guidance and 27 basis points wide of initial guidance.

Default rates are expected to reach annualized 10% to 15% levels for full-service hotels over the next 36 months, according to Salomon, but recoveries should be quicker than that, with a 30% loss severity over a 12-month horizon. Should the market price this uncertainty dramatically in the near-term, deals like the CSFB one should prove to be good values over the long haul. Prices for triple-A short floaters prior to the attacks would have been in the 30 to 32 basis points over Libor area, or 18 to 20 basis points behind two-year credit cards, so at 60 basis points, the CSFB deal looks cheap, especially with the 41% credit support.

A steepening curve

Pressure in the hotel sector, as well as in retail, recently pushed spreads to the widest levels since the credit crunch of late 1998, into the low sixties for triple-A 10-year paper versus swaps. This had CMBS trailing Treasurys, swaps, and agencies for the month of September.

The underperformance was made all the more apparent in the steepening curve environment, where, as Banc of America's Michael Youngblood notes, 80% of CMBS classes are priced relative to the 10-year, whereas only 20% are priced to the five-year. The BofA investment-grade CMBS index returned only 1.28% in September, versus 2.34% for Treasurys, 3.06% for agencies, and 3.73% for swaps in the 10-year tenors.

The curve is expected to continue a steepening posture into the end of the year, limiting CMBS performance in conjunction with some credit concerns, but overall the sector appears sound, with delinquencies up only marginally on the year.

CMBS pipeline

The new-issue calendar only provided one pricing so far in October - CSFB's $621million floater mentioned above. In the market now is a $716 million Greenwich Capital floater (which has 24% exposure to the hospitality/hotel sector), a $713 million Morgan Stanley issue with collateral provided by six insurance companies, and a $113 million JPMC issue.

Price discovery, while improving, is still lacking with the absence of a notable conduit. Bear Stearns, however, offers some insight as to where a marquee transaction should price.

The 10-year tranche of the $1.5 billion COMM 2001-J2 large-loan issue that came on September 26 priced at 77 basis points over swaps. This suggests to Bear that a "new issue, plain vanilla, market leverage, ten-year conduit should price in the low-to-mid 60s," on the condition that past pricing relationships between large-loans and conduits are still valid. This also means that a tier-one, lower leverage tranche would likely print in the high 50s to low 60s.

A marquee conduit remains elusive, however, but is within reach. Bank of America and First Union plan a $1.3 billion conduit this month, and Bear Stearns and Morgan Stanley are tapped to lead the TOP-4 issue sometime by the end of the month.

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