UBS AG, which had more than $57 billion of losses and writedowns after the U.S. real-estate crash, is betting there’s enough demand for toxic commercial property assets to sell debt created at the height of the boom.
The bank is seeking buyers this week for collateralized debt obligations assembled in 2007 with a face value of $1.5 billion that contain securities tied to skyscrapers, malls and hotel loans. UBS is trying to follow the Federal Reserve Bank of New York’s record $7.5 billion sale of similar bonds last month acquired in the 2008 rescue of American International Group Inc.
The Fed unlocked a corner of the $600 billion commercial-mortgage backed securities market that’s been dormant for more than four years. Hedge funds, insurers and money managers bought the bonds to gain higher returns as the U.S. central bank pledges to hold interest rates near zero through at least 2014, with AIG buying $600 million of the debt, according to the New York-based insurer’s Chief Executive Officer Robert Benmosche.
“CMBS is very compelling in an environment where interest rates may remain low for some time,” said Richard Hill, an analyst at Royal Bank of Scotland Group Plc in Stamford, Connecticut. “There has been a lot of cash on the sidelines that is now being put to work as investors search for higher yielding assets.”
One benchmark gauge of commercial-mortgage debt has risen 2.4 cents to 59 cents on the dollar this year, up from 46.6 in October, according to Markit Group Ltd. data.
Bids for the securities are due May 9, Torie Von Alt, a spokeswoman for Zurich-based UBS said last week. She declined to comment further.
The CDOs, dubbed Wave when they were arranged by Wachovia Corp. in 2007, pull together 64 bonds from commercial-mortgage securities deals, according to RBS. Moody’s Investors Service and Standard & Poor’s gave pieces of the deals their top ratings.
These type of transactions helped inflate values by channeling cheap financing to landlords until sales dried up in 2007. Commercial property prices fell more than 38 percent from August 2007 and are still 7 percent below that level, according to a Green Street Advisors index.
About $107 billion of CDOs linked to commercial property loans are currently outstanding, according to RBS data. CDOs are pools of assets, such as securities or loans, sliced into new debt of varying risk and return.
Moody’s cut the ratings on one of the Wave deals in February to Caa1, the seventh-lowest level of junk, as property loans deteriorated.
Late payments on commercial mortgages packaged into bonds jumped 35 basis points in April, exceeding 10 percent for the first time, according to Credit Suisse Group AG. The recent rise was in part because of loans originated during the peak coming due, according to analysts led by Roger Lehman. The rate of increase had shown signs of slowing prior to that jump, he said.
“We are at or close to the bottom” in the commercial real estate market, said Nick Levidy, an analyst at Moody’s. That doesn’t mean the riskiest bonds are out of the woods.
Lower-rated bonds, which absorb losses first as defaults climb, can be damaged if a single building loses a tenant and can’t cover the rent, said Levidy.
“There is always a degree of idiosyncratic risk associated with commercial real estate,” he said.
Replicate Fed’s Success
UBS is attempting to replicate the Fed’s success, which held the bonds in its Maiden Lane III vehicle.
Barclays Plc and Deutsche Bank AG last month beat out two other teams of Wall Street banks to win the auction, paying an estimated price of about 67 cents on the dollar, JPMorgan Chase & Co. analysts said in an April 27 report. That translates into about $5 billion compared with the $4.2 billion valuation the Fed assigned to the portfolio in December, according to the district bank’s website.
The so-called Max CDOs, created by Deutsche Bank in 2007 and 2008, bundled securities from 103 commercial-mortgage bond deals. The banks broke apart the transactions and sold underlying bonds to investors.
The deals had a face value of about $7.5 billion, of which $3.4 billion have been cut to junk after being granted top grades at issuance, according to Citigroup Inc. data.
Dealers are looking to break apart the Wave deals, similar to the strategy used by Barclays and Deutsche Bank, and have been taking bids on securities held within the CDOs, JPMorgan analysts led by Edward Reardon wrote in a May 4 report. The bonds are “generally weaker credits,” with more than two thirds of the debt ranked below investment-grade, the analysts said.
Commercial-mortgage debt values initially slid when the Fed said April 4 that it was considering selling the assets, on concern there wouldn’t be enough buyers. Demand proved to be “robust”, Citigroup analysts led by Jeffrey Berenbaum said in an April 27 report.
AIG bought $600 million of the debt as part of its investment portfolio, Benmosche said on a May 4 conference call discussing first quarter results.
“AIG’s appetite for this risk should mean that the asset sales will continue,” Sanford C. Bernstein & Co. analysts led by Josh Stirling said in a May 4 note to clients.
The New York Fed said last week it’s also seeking bids for parts of two CDOs tied to home-loan debt, also acquired from the AIG rescue, after receiving “several strong” unsolicited bids. In January and February, the bank sold $19.2 billion of home-loan bonds that helped to unwind its separate Maiden Lane II vehicle at a profit of $2.8 billion for taxpayers.
“Low interest rates create certain incentives by design,” said Bill Stasiulatis, a managing director at Torchlight Investors, a New York-based commercial real-estate investment firm. “People need to take on risk. These are opportunities for them to put large amounts of capital to work.”
While the Fed’s MAX trade shows demand for CMBS has improved considerably since a sell-off last fall, the level of potential supply creates challenges, the JPMorgan analysts wrote.
“A great deal of ‘dry powder’ that was allocated to the sector has now been deployed in these trades,” the analysts wrote. With many investors already overweight the debt, or holding more than in benchmark indexes, CMBS spreads have limited potential to narrow in the near-term, they said.
The extra yield investors demand to hold top-ranked commercial-mortgage bonds rather than Treasuries has dropped 20 basis points to 184 basis points since April 11 and is down from 261 basis points in December. A basis point is 0.01 percentage point.
Reservoir of Demand
“There appears to a sizeable reservoir of pent-up demand awaiting such opportunities as there are relatively few comparable alternatives in credit currently,” said Chris Sullivan, who oversees $1.9 billion as chief investment officer at United Nations Federal Credit Union in New York.
Still, with Europe’s debt crisis unresolved, and U.S. employers adding fewer workers than forecast in April, prices may be unlikely to rise in the near term, he said.
“There are sufficient macro risks on the horizon that also argue for further concession in the prices of these assets to make them a compelling trade from here,” he said.