Despite sporadic investor interest, mortgage flows dried up last Thursday afternoon with Treasurys pulling firmly ahead of MBS for the first time in about a week.

Both 15s and 30s shared in the sector underperformance, with the lower coupons getting particularly hit. In 30s, 6s and 6.5s trailed Treasury hedges by 9/32 and 4.5/32, respectively, while in 15s, 6s and 6.5s were 5.5/32 and 4/32, respectively, lower. In the main, mortgages performed as expected, finally cheapening up since going gangbusters following the previous week's rate cut.

Spread performance was equally abysmal, with 6s through 7.5s anywhere from 4-7 bps cheaper in 30-year paper. Early CMO bids came into the market, as it has for days, to lift 6.5s and 7s from the Street, but as the session wore on, the trade lost sponsorship and Treasurys took to higher levels. Flattening trades accelerated in the afternoon, led by performance in the long bond. Ten-year notes got some residual lift and are now posting the best levels of the day.

Freddie Mac reported that 30-year fixed rates moderated somewhat and dropped to 7.12% from 7.14%. Market reception, however, was non-existent since rates were expected to hold in that area based on recent 10-year yield performance. This, and the MBA Refi Index below the 2000 mark as of Wednesday for the first time since January, will provide mortgages long-term technical support, sources said. Friday promised more muted flows.

CMBS: Still wringing out value during supply hiatus

Much of the activity in the commercial mortgage sector continued to be wrapped up in the FAS140 policy, whether directly or indirectly. It would seem that the underwriting community has found at least a short-term solution to the accounting discomfort caused by the measure as evidenced by a successful pricing of Credit Suisse First Boston's deal the week before last and last Tuesday's successful pricing of the GE Capital transaction. What remained to be seen was how the short-term dearth of paper can sustain tighter spreads before a supply wave puts it on the brakes.

GE's $1.2 billion conduit priced at the wide end of revised guidance levels. The A1 5-year tranche came at +46 bps, and the A2 10-year printed at +49 bps over swaps.

Still, deals have been slow to come to the market, which has been a primary reason for tighter spreads, but not the only reason. The Fed cut helped spread product find richer levels, but for CMBS, the tightening was especially favorable as the yield curve steepened and livened up the yield pick up in commercials.

Salomon Smith Barney noted that the rate cut followed a rather substantial cheapening in CMBS that occurred on the supply-laden Q1. Still, FAS 140 is leaving investors with few choices and have forced them to "pick dealers' inventories clean." The increase in Treasury yields has decreased mortgage origination volumes, says the firm, suggesting that spreads will continue to tighten once the backlog in expected issuance has priced.

There is a more cautious tone, however, to the short-term outlook. Both Merrill Lynch and Lehman Brothers expressed concern over a stressed real estate market that is only like to be exacerbated by a softening in the economy.

Delinquencies have been on the rise, and instead of flirting with possible disaster, both recommend a move up-in-credit. Merrill likes the sector versus residential mortgages, but warns that CMBS looks fairly valued versus agency debentures and credit-card backed ABS. Likewise, Lehman has recommended an increase in triple-A premium exposure versus MBS.

Meanwhile, the pipeline saw some deals coming. Goldman Sachs and Banc of America were pre-marketing a $455 million for Strategic Hotel.

Price talk for the A 5-year, $154.8 million part 28A+/1ML Libor while the B $105.5 tranche is 40A +/1ML.

Two conduit deals are lined up for May, a $1.2 billion deal from Wells Fargo, Bear Stearns, John Hancock and Morgan Stanley and a $1.5 billion deal from Lehman and UBS Warburg.

Goldman and Morgan Stanley are prepping a $1.4 billion deal for TrizecHahn Office Properties. BofA, JP Morgan, Deustche Banc Alex. Brown, and Lehman are co-managers.

The portfolio is made up of 28 Class A and B office properties with 66 buildings found in12 states. The mortgages in these properties are cross-collateralized and cross-defaulted.

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