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Once you have tasted it, you don't like to give it up." The observation by Shekar Narasimhan, chief executive of WMF Group, could have been about any tempting delight -- expensive wine or exotic food. But it wasn't. Narasimhan was referring to something more prosaic -- commercial mortgage-backed securities.

The Vienna, Va.-based WMF Group was one of the first conduit lenders burned by capital market turmoil. Near the close of summer 1998, the company announced it would take a $30 million pre-tax loss connected to loans originated by its conduit unit.

Did the painful and sudden loss cause Narasimhan to give up the conduit business? Not at all. The problem going forward for WMF Group was how to stay in the business because it didn't want to give up its $12.1 billion in loan servicing, $150 million of assets under management and roughly 3,200 customers. "We had to change our strategy," says Narasimhan.

"Right after the debacle, we said right away we can do anything [in the conduit business] except take the risk -- principal risk -- during the period of aggregation of the loans," explains Narasimhan. "We had to go find a partner with a balance sheet that could support that risk and the capacity to manage the balance sheet through an interest-rate cycle or two." WMF Group found that partner, Greenwich Capital, and the two formed an alliance.

Decade of decision

The 1990s had been an expansive decade for CMBS. From just $4.8 million annual production of CMBS in 1990, volume steadily rose through last year. CMBS

volume climbed to a record $44 billion in 1997, but that mark was nearly eclipsed at mid-year 1998 as the volume reached a staggering $78 billion for the full year.

All was not, however, copacetic. In fact, 1998 made for a very tumultuous year. The virtual collapse of Russia's capital markets touched off a global flight from financial risk of all kinds. The mad rush to dump almost any kind of risk investment brought down even the high-flying CMBS market. Big players such as Nomura dropped out of the business, some investment banks such as Credit Suisse First Boston have remained on the sidelines, mortgage REITs collapsed and the biggest non-investment grade buyer of CMBS, Criimi Mae Inc., filed Chapter 11.

Where some stumble, others find opportunity. As investment banks, which were pushing the conduit business heavily over the past three years, closed or slowed their lending at the end of 1998, others stepped up to the plate including commercial banks, insurance companies, credit companies and even pension funds.

LaSalle Partners Investment Banking Group works with clients arranging debt either on a portfolio or single-asset basis. The company currently is focusing on single-asset projects whether it is an existing property or new development. It works with a variety of capital sources.

"In the first half of 1998, the most aggressive sources out there were the conduits," says Michael Seifer, a vice president at LaSalle and head of its San Francisco-based Debt Capital Markets Group for the Western half of the United States. "Conduits were providing the best pricing, especially for the type of deals we were bringing to market." However, at the end of 1998, Seifer says, the conduits stayed on the sidelines and although several life companies stepped up and filled the void, "the transaction pace slowed and almost came to a halt."

For LaSalle, deals that didn't get done last year are now in this year's pipeline.

"There is a lot more balance in the market today," Seifer maintains. "Life companies have developed conduit operations themselves. Several companies like GMAC and GE Capital have plenty of capability that will get them market share. And there are folks like TIAA-CREF that are out there placing money as well."

A LaSalle Partners Investment Banking Update reports, "In 1999, the CMBS market will be characterized by transition. Already a number of conduit operators have drastically reduced origination volume or exited the business. Large issuance is also expected from a number of conduits that are coming under mounting pressure to reduce inventory and clean up their balance sheets."

Commercial banking stronghold

The commercial-banking community remains the largest lender in the industry. If there is a trillion-dollar market of commercial mortgage lending, banks have probably $400 billion to $450 billion of it, life insurers $150 billion to $200 billion, pensions a small $10 billion to $20 billion, and the rest to conduits, notes Paul Turovsky, a managing director at Bankers Trust (which is in the process of merging with Deutsche Bank). However, the lines get fuzzy because a number of commercial banks originate loans for their own conduits.

As Turovsky speculates, commercial bank lending for early 1999 will certainly take a dip, but in terms of market share commercial banks will still be the predominant lenders. He adds, "Conduits will definitely come back as people are starting to feel their legs again."

On the buy side, Turovsky says the investment-grade side of the marketplace has been flowing, "and it has moved at a more attractive price level than it did in the latter part of 1998. At the same time, the investment-grade side hasn't approached early-1998 price levels. On the non-investment and unrated side there is a lot of talk of aggressive buyers getting in there and seeking opportunities, but that is not really the case yet. People have sold investment-grade property in the latter part of 1998 and early 1999, but I'm not sure that non-investment grade inventory has moved."

Yaniv Tepper holds the title of real estate portfolio manager for Hartford, Conn.-based Altus Investment Management, a CMBS investor. Over the past three years, Altus' position in CMBS vaulted from $100 million to well over $1 billion. Most of its holdings are in higher quality AAA issues, although it does drop down to BBB and BB issues as well. Tepper likes the market.

"We still see a healthy amount of supply this year. To date, we are slightly ahead of last year's supply." Still there are some problems, especially in the non-investment grade issues. "Obviously the B-piece market is the most difficult to place, but it's also where the banks make the vast majority of profits on these deals. Until that market firms up, it will be a little touch and go," Tepper says.

As an investor, Altus was not put off by the turmoil in the markets. "We are longer term investors and we don't have the kind of inventory exposure that originators do. They are underwriting loans, putting it on their balance sheet and then trying to play the spread game between short borrowing in the bond market and lending long in the real estate market. Sometimes they get stuck with inventory when the market backs up. Origination is a different perspective. They are trying to originate loans and sell them into the public markets at tighter spreads, so when the spread reverses that can hurt them quite a bit."

The long-term future of the CMBS market is going to depend on the quality of the investments, adds Larry Melody, president of Dallas-based LJ Melody, a wholly owned subsidiary of CB Richard Ellis. "There has been a lot of B- and C-quality property in CMBS which was unusual in the marketplace. If there are delinquencies on some of the CMBS issues it is going to hurt business."

Melody adds, "Right now spreads are tightening across the board on CMBS paper and there are investors for almost all tranches with the exception of unrated pieces. It's hard to find buyers for unrated pieces, which means people are afraid of long-term real estate risk."

LJ Melody built a servicing portfolio of $11 billion. Last year, the company did about $7 billion in originations and $2 billion in CMBS. "We originated CMBS product for issuers for whom we are a known correspondent and they securitized," explains Melody. "We acted as a broker or mortgage banker for them. We originated business and they securitized which means we don't take securitization risk, we don't take accumulation risk."

Like the WMF Group, Dallas-based AMRESCO Inc. got roughed up by the capital markets turmoil and had to make adjustments. Last year, the company reported a net loss of $69.2 million, mostly due to unprecedented capital market conditions causing spreads on mortgage-backed securities and related instruments to widen significantly. During the fourth quarter, the company made a number of corporate adjustments, closing AMRESCO Residential Credit Corp., eliminating jobs, shutting down its bulk/correspondent home equity lending subsidiary and selling off loans.