The highly touted addition of commercial mortgage-backed securities to Lehman Brothers' fixed income aggregate index on July 1 (MBSL 6/28/99) might not transform the CMBS market as significantly as predicted, some sources say.

Although investors and others anticipated the addition of CMBS to the leading bond index to have revolutionary implications for the market - some analysts foresaw a one-time gain of more than $10 billion in new investments - word on the Street is that both financially and for the long-term, those early predictions might have been exaggerated.

"I don't think there is a broad enough understanding of CMBS to warrant a huge move in the market," said an MBS expert. "A lot of people do not grasp the unique features of this market the way they do for residential and corporate securities. So I tend to think this factor might skew the original predictions for the effect this will have."

Though most players agree that the addition of CMBS will make investors more aware of this burgeoning market, several insiders doubted that medium-size money managers - those managing between $2.5 billion and $5 billion in securities - would expend much time, money or energy to figure out the intricacies of CMBS.

According to sources, an investor that characteristically operates in government bonds, residential mortgage paper and corporates would most likely tend to shy away from hiring somebody new that has enough expertise to trade CMBS for them.

"People fudged the impact all this would have on CMBS," said a portfolio manager. "It has truly been overstated, and I think that there will probably be less than a third of the predicted amount of new investments. Even long-term, I doubt that companies will shell out the money to hire CMBS experts, especially since commercial mortgages comprises perhaps only 1.3% of the index."

Additionally, the CMBS presence in Lehman's aggregate index will be selective, including only the ERISA-eligible top-rated CMBS, or about $65 billion in securities.

Not a Clear Consensus

Indeed, the small weighting of CMBS in the index might cause many investors to believe that researching these securities is just not worth the effort. However, other investors insist that the addition will cause a lot more liquidity to be focused into the market, which will ultimately make this mortgage credit product more popular.

According to Howard Esaki, head of commercial mortgage research at Morgan Stanley Dean Witter & Co., about $3 billion in new money is expected to enter the market. Approximately one-third of that amount will come from investors who closely follow the performance of the index, and the rest will come from other investors who use it as a benchmark.

"This is the next big step in the maturity of the CMBS market," said Michael Hoeh, senior portfolio manager at Dreyfus Corp. "Now there is going to be a whole new set of buyers in the market. We know that the duration of the commercial mortgage index is very long, and there is not a lot of runoff. So, I think it will grow as a percentage of the index going forward, because there is no attrition.

"There won't be a tremendous falloff on the CMBS side for at least four or five years."

Although several money managers say that overall, the inclusion of CMBS will not affect how they invest money, some traders said they did see some additional buying since the beginning of the month.

Since the majority of investors basically measure themselves against the Lehman aggregate index, some sources believe that investors will have to own the mortgage products that comprise the index, thereby forcing them to take a closer look at CMBS.

"There is no doubt that investors are going to have to start looking at CMBS for the first time," said Joseph Franzetti, a senior CMBS analyst at Duff & Phelps. "I met a number of investors at the Fabozzi conference who said that they were coming into CMBS because they had to.

"I thought that was very telling."

Despite the positive tone from some Wall Street players, however, the commercial mortgage-backed market faces other challenges besides its characteristic research-intensive nature.

Last year's market meltdown, for instance, caused losses for many of the market's largest players, and trading became a major obstacle - one that still scares some investors. - AT

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