Talking to Mike Mazzei and Sheridan Schechner, you would never believe they work for competing companies. To say their investment banking firms - Goldman Sachs and Lehman Brothers - are competitive is an understatement. League tables consistently rank the two firms among the top five, and business, similar to the CMBS market, is booming.

In 1990, shortly after meeting, Mazzei and Schechner (known in the business as "Schechy") began to wonder if, together, their firms could yield more rewarding results - both for the client and themselves. Thus began a working relationship that has both men believing that the future looks bright and that two heads definitely work better than one.

NREI recently spoke with Mazzei and Schechner about their history, their views on CMBS-land and their winning combination.

Q: How did you two meet?

Mike Mazzei: We used to meet each other when he was done presenting to a client and I was on the way in.

Sheridan Schechner: Or vice versa.

Mike Mazzei: We would scorn each other. I can remember over many years sitting back at my desk saying, "What do I think I should be doing in the business? What are Schechy and Goldman [Sachs] doing in the business, and where are they going today?" I would try to think like them. I'd ask myself, "What is Lehman missing?" We were very competitive, and still are. Our firms still compete.

But I think over the course of the years, as the firms have committed more and more capital, and as an outgrowth of a couple of things like the fixed-income turmoil with long-term credit, the Russian default last year and the debacle in the CMBS market with spreads widening, coupled with the fact that more and more transactions use co-managers today than ever before, we thought that on a number of transactions, it would be good to share the risk. We decided to team up and compete for the larger transactions more aggressively by sharing the risk as opposed to doing fewer of them and splitting the risk.

Sheridan Schechner: It was back in 1990 on a transaction for Prudential where the two firms joined up for the first time - where [Prudential] asked us to jointly distribute a securitization of its portfolio. There was a second transaction in 1991 where the two of us were selected. That's where we started to run into each other.

And over the years, there were a notable number of transactions, such as Confederated Life, where we would work together. Also, it was clearly on the solicitations where the potential borrowers or issuers would run daily marathons where the firms would parade in. Clearly it would be Lehman coming in during the morning and Goldman in the afternoon, or vice versa. There were a lot of panels and speeches where Mike and I would be two out of the three speakers or two out of the four on the panels. That's how we got to know each other.

As to the question of joining up, two heads are better than one. From a client's perspective, getting two seasoned, reasoned judgments backed up by a tremendous track record on how to best structure a transaction and what pricing will be is clearly a major benefit. In our market today, the investors are requiring two firms to distribute securities. What better combination than two of the three largest firms in the industry? We're also able to be more competitive than other folks on pricing because we're sharing the risk.

Q: What is like to work as a team?

Mike Mazzei: On one particular transaction, we reached an agreement with the client at the very end of December - in between the two holidays - and closed the loan 20 days later. That would not have happened had we not had the underwriting staff and banking staff at both firms working night and day. That transaction freaked a couple of people in the market out. They began to say, "Hey, what are these two guys doing working together?" Similar to when I used to ask myself what Schechy and Goldman were doing that Lehman should be doing, I think a lot of competitors have the same reaction and say, "Why are they doing that?" We think we've broken down the barriers. You rarely see investment banking firms working together. We think we're the first to start doing this.

There were a number of situations where Goldman and Lehman did not work together - that Goldman had extended either credit to [the client] or advice or had a better relationship with - or vice versa. We went our separate ways on a number of transactions during the course of the year. We work together when it benefits the client and when the transactions are big enough where we think we'll need co-managers anyway. We have a good working relationship with [Goldman] and they with us where if we needed help withthe business we would look to each other, but there will continue to be transact ions in the future where no phone call occurs at all.

Sheridan Schechner: Other people have been trying to duplicate - without success - the relationship between Goldman Sachs and Lehman Brothers. The clients have definitely noticed. The clients are saying, "Is this a situation where the two firms are going to join up?" or "Would you mind if I put you with another firm?" However, if the client says, "We want Lehman or Goldman to be one of two, and we want to pick another firm for another reason," clearly we'll have to respect the client's wishes.

Q: Despite your similar tracks, you must have different strategies. What are they?

Mike Mazzei: [Our strategies] are very similar. One of the things we've done at Lehman - which we've been very successful at - is making highly-leveraged loans as the REIT equity market evolved. I think what we did a particularly good job at was, as the REIT market was opening up, we saw who the good operators were, and what the potential IPOs would be in the REIT market. We fed [the companies] with highly-leveraged loans or equity or bridge loans before they went public. We were able to procure probably five IPOs that were very successful by using the balance sheet of the firm as a bridge effect which is something that we're doing less of today but we were very successful at doing in the past.

Sheridan Schechner: I think that, again, we may have certain substance differences. For example, we have as a separate division the whole equity investment area, but at the same time, Lehman has been making equity investments through another arm of Lehman. While they may be run by different people, there aren't too many differences when it comes to the world of loans between the two firms.

Q: How is your firms' strategy different from other firms? What are the benefits to your clients of bringing Lehman and Goldman together?

Mike Mazzei: We have a client-driven strategy in the sense that both firms - in the origination of loans, the commitment of principle and the balance sheet of the firms - have focused on their client bases. And their client bases are those in the real estate investment banking franchises.

We have leveraged the fact that we have real estate equity research. We've leveraged the fact that we've taken a number of the REITs public or have done other services for them like mergers and acquisitions, lines of credit and things of that nature. We leverage our real estate investment banking franchise to get product. We are full-service firms.

The full-service firms make up just a handful of the 30-odd firms that are out there ranked in CMBS. Seventy-five percent of those firms are not full service in that they just have one business, which is pretty much the conduit origination business. The risk in that is that you're not a full-service shop and if there is a downturn in the business, you don't have a diversified business to weather the storm.

Q: That being said, do you think a lot of businesses need to recognize the need to have a full-service firm?

Sheridan Schechner: We want to be the No. 1 firm to the premier companies - both public and private - in the real estate industry. That's our goal. To do that, we need to offer them a full range of services and product. From strategic dialogue with CEOs of the company to giving them money through the form of mortgage loans. From mergers to mortgages is a full-scale business. That makes Lehman and Goldman - and a small handful of other firms - different because we have the ability to do it all.

OVERMATTER: Mike Mazzei: Goldman and Lehman are full service RE finance firms. In almost all aspects of the market, the firms' basic business philosophies are pretty much the same. Different from a First Union National Bank that maybe only has fixed-rate conduit program or different from a very small investment banking firm that can't use their balance sheet. Lehman and Goldman both have full RE investment banking departments of which Schechy is one of the heads. We do a lot of client underwriting; in fact, there were almost 8 transactions this year which Lehman and Goldman were co-joint bookrunners on. So, we have overlapped together. When you look at the league table rankings, each one of us holds the No. 1 ranking. Lehman was the No. 1 U.S. underwriter in Commercial Mortgage Alert on Monday, and Goldman was the No. 1 underwriter for full credit given to co-managers. We both hold one, two or three slots in all the various tables - there is a lot of overlap. Schechy and I have been competing against each other for more than 10 years in the business. We've worked in transactions before like Confederation Life in 1996.

Does consolidation need to take place in CMBS-land?

MM: When you say CMBS-land, that doesn't necessarily pertain to the equity market. Generally, my feeling is that the origination landscape is very, very competitive right now. Yes, for the amount of loans that are up for refinance, that are available and given the trends in the REIT market, the mortgage market is way overrepresented in terms of originators - way overrepresented. There has been some small consolidation that has occurred, but not nearly enough. I do think that it's not going to be a major economic issue that causes further consolidation, but I think over the course of the year, profitability vs. the risk in the business is going to be too much for some to bear. And if you're not originating a minimum size of a billion-plus a year - at least - you're probably going to have really think hard about whether you want to be in this business. I do think that's going to occur this year.

SS: From my perspective, I think consolidation has occurred and will continue to occur. You have to think about the different subsegments of the market. First, on the origination side, as Mike just pointed out, we have had some firms leaving. Nomura left the business. On top of that this year, given that this has been set up as a volume business, with a low margin high volume strategy being the winning strategy, if you don't do north of a billion dollars this year, it's going to be tough to play. With respect to the larger loans, we think that consolidation has already occurred, and that we're down to, in terms of the Wall Street firms who compete on the larger properties, there is a small handful. With respect to distributors, it clearly has seemed like it's consolidated. Besides the two of us and Morgan Stanley, the three of us are now the dominant underwriters, and there seems to be a gap. By looking at the current league tables between us and the next which would be Donaldson and Lufkin. Lastly, and where it really is affecting the market greatly, is in the buyers of the subordinated bonds. That consolidation has occurred. Where there used to be 7 to 10 very active players for subordinated bonds, now we're down to 3 or 4.

MM: That's correct. It's 3 or 4 and a couple of tertiary players.

SS: In terms of whether consolidation needs to occur, it has already occurred, and it will continue. And it will continue in the segment that is probably the most visible which is the small loan origination segment.

MM: Schechy is right; I have the numbers in front of me. The top four underwriters were Morgan, Lehman, Goldman and DLJ represent 50% of the market. There are a total of 32 that are proported to underwrite CMBS transactions this year. (THIS IS ACCORDING TO JAN. 10 ISSUE OF COMMERCIAL MORTGAGE ALERT)

You mentioned league tables, how important are league tables to you?

MM: I think we want to be dominant in the market. In consolidation, if you are a mono-line shop, if you just have a conduit program, or if you just have a floating-rate program, you run the risk if that the market becomes very competitive that you can't make enough money to keep your franchise afloat. By running a very diverse book of business where we're doing single-borrower transactions, which typically pertain to one property, or conduit transactions, or you do transactions for clients where you're just an underwriter for a fee and you have great distributionto bring to the table. We think that's very important to have many aspects or diversified business. I think if you pursue a diversified business strategy, the ultimate outcome is going to be that you're probably going to rank higher in the League Tables. Are league tables important? I think it's a by-product of having a diversified business and trying to do as much business as possible. While it's not a driving force in our business, if we want to win market share and want to impress clients, staying pretty highly ranked in the league table shows a commitment to that diversification of business. In some ways, yes, as an outgrowth of our strategy it is an important thing because our strategy of being diversified is important.

SS: From our perspective, while league tables are an accurate reflection of who has the expertise, who has the track record and is involved in the flow of business - which are critical things when you're picking an investment bank or an underwriter of securities. In this market, in the commercial mortgage market, it's not as big as driving force as it is in other markets, and that's because this business is mainly a principal-driven business, meaning you're putting your money where your quotes are or where your advice is. If I want to do something and that is something that is off market but it's better for the borrower, my money is as green as anybody else's. Therefore, niche players or players who don't have the same very broad platform that we both do, can win transactions.

What property types did you like in 1999 and which ones will shine in 2000?

MM: I think that office properties are going to be the net beneficiaries of increased demand due to e-commerce and Internet companies growing everywhere. I think net/net, we like office products. Having said that, we could deal with almost any property in any location. I think that if the property is a very weak property, where we don't think it's securitizable, then we might not make the loan or we might express it where the loan proceeds would be so low per square foot - if the quality of the property were not good - that it would result in not having a transaction. Our ability to express things, because we're not a portfolio lender and we answer to the rating agencies , subordinate buyers, investors, our ability to take that information and distill it down and give the client a quote based on the merits of the property exist for almost any type of property. Again, we're not going to make bad loans, and we're not going to do very bad properties, but if the property is a poorer quality property - if we don't do the loan we may result in proceeds being quoted so low that it results in nothing. Having said that, there are some property types that you should be sensitive to - very niche property types like factory outlets, nursing homes and some limited service hotels where the property types are under pressure. It doesn't mean you won't make a factory outlet loan if you're a dominant property. Those are areas of concern in which you have to be very careful when you're quoting a deal.

SS: At Goldman Sachs, we are agnostic when it comes to property types. Subject to the caveats of appropriate sponsorship, we effectively think we can securitize anything and that it's really a question of the capital structures that would be getting imposed by the various rating agencies, the desire of the borrower for a certain amount of money and lastly, investor demand. It's just a question at that point of what is the actual component's price out and, subject to appropriate sponsorship and physical conditions, etc., almost anything can be sold in the markets. From our standpoint, it's not a question of what we like and don't like, it ends up being expressed in either very low dollars that we think is achievable, or very, very high pricing. That being said, the sectors where it seems to become tougher for the CMBS markets to compete vs. the portfolio lenders a couple of areas stand out: one, would be limited service hotels where right now the view from the rating agencies is fairly harsh and therefore, investors don't like them. That combination makes it very tough for us to come up with a optimal answer for a client who wants to borrow money. Retailing outlets that feel the potential impact for the Internet - those are also very tough to execute. The factory outlet center or the tertiary mall in a tertiary market - those get hit very hard by the rating agencies and also by investors. The combination of those two makes for something the borrower finds less than acceptable.

What will the CMBS volume be in 2000?

MM: I think the overall consensus in the market is somewhere between $50 billion and $60 billion. I think more important than the volume are a couple of points: One, the volume trends have been down, and while we did $65+ worth of CMBS in 1999, I'd say $5 billion to $7 billion of that was overhang from 1998 that did not get done. The volume for 1999 probably would have been high $50s showing a significant downtrend from 1998, more significant than the numbers might indicate. In 2000, I think that trend is going to continue, but more importantly, how that product breaks up is going to be very interesting to note. I think we started to see a lot of international this year. There were $9 billion in transactions that were done internationally. Goldman executed one or two of them. Lehman did not execute an international transaction, and I think both firms look to become more active in that arena. Of the $50 billion to $60 billion, we look to see about 20% of that in international, maybe more. We also think that unlike in 1998, where there was a deluge of fixed-rate conduit product, where there must have been something like $55 billion of fixed-rate conduit product - this year, we'll see a lot less of that. We'll see more floating-rate product partly because tertiary rates are very high, and partly because a lot of the REITs that are acquiring are going to be doing it on floating rate until they figure out where they're going to get their capital from. We think the configuration of the CMBS product is going to be very diversified this year which I think ultimately may lead to a very significant spread tightening of product because there will be no one source of product that will have too much supply.

SS: We've predicted a market size of somewhere in the neighborhood of $55 billion to $60 billion. Of that, somewhere between $10 billion to $12 billion will be international, and I think that's a big trend. We also feel that out of the $55 billion to $60 billion, you'll see a higher component this year of floating-rate, vis a vis, last year. I think that's, A, because there's a lot of floating rate loans that are on people's books right now that are going to come off in 2000 and be securitized, and I think, B, borrowers are thinking that rates are at abnormally high levels.

MM: I think one other area of the market to watch is the public REITs. There could be a number of things that go on there. There's a lot of talk about some of the REITs being very frustrated that they're trading at deep discounts. So you might find that some REITs are going to pursue a private strategy. The difficulty in that is just simply getting enough mezzanine debt to take out the equity in the public markets. That's a lot of equity to take out. It's not just done through straight mortgage debt. It's going to require mezzanine or preferred equity and that's very difficult. I think there's also going to be a number of REITs that have been rated