Goldman CMBS Loan Signals Investors’ Growing Risk Appetite

Commercial-Mortgage Bond Sales Signal Growing Risk
A trader works at the Goldman Sachs Group Inc. booth on the floor of the New York Stock Exchange (NYSE) in New York on Aug. 13, 2012. Photographer: Scott Eells/Bloomberg

Investors are devouring commercial-mortgage bonds at the fastest pace since 2007, with a deal that incorporates an underwriting practice that helped fuel the bubble sold at the tightest relative yields in 18 months.

Wall Street banks including Citigroup Inc., Goldman Sachs Group Inc. and Bank of America Corp. have sold $1.25 billion of the securities this week, according to people familiar with the transactions who asked not to be identified because terms aren’t public. Wells Fargo & Co., Royal Bank of Scotland Group Plc, UBS AG, Barclays Plc and Deutsche Bank AG are marketing an additional $2.34 billion in bonds, the people said.

Buyers are gravitating toward the debt even as lenders include risker loans in new offerings. Citigroup and Goldman Sachs sold about $1 billion of securities that include a $100 million mortgage for a tower in lower Manhattan that uses projected rents for vacant space to calculate the building’s income. The practice was common during the boom years leading up to the property market crash in 2007.

“It’s not a trend we want to see,” said Lea Overby, a debt strategist at Nomura Holdings Inc. in New York. Lenders “are starting to push the envelope,” she said. “Underwriters will push the market as much as buyers will let them.”

Scott Helfman, a spokesman for Citigroup, and Michael DuVally of Goldman Sachs, declined to comment.

222 Broadway

Citigroup and Goldman Sachs this week sold top-ranked bonds maturing in 10 years yielding 100 basis points more than the benchmark swap rate, the tightest spread on such debt since Wells Fargo and Royal Bank of Scotland sold similar securities in February 2011, Nomura data show. The banks initially marketed the bonds to pay as much as 115 basis points over the benchmark, a person familiar with sale said.

The deal includes Goldman Sachs’s loan on 222 Broadway. Bank of America, which takes up 75.8 percent of the building, agreed to sell it to Beacon Capital Partners LLC and L&L Holdings Co. in April. The property was 79.1 percent occupied as of May 29, leaving 164,442 square-feet of empty space, according to deal documents.

“We cannot assure you that the vacant space will be leased up at the presumed market rates or at all,” Goldman Sachs and Citigroup advised potential investors in a footnote in the offering’s term sheet.

Pro Forma

So-called pro forma loans issued during the market’s peak allowed borrowers to take on more debt on the assumption that higher income in the future would be able to cover principal and interest payments. Rents plummeted and vacancies climbed as the recession crimped business and consumer spending, leading to a surge in defaults.

Late payments on commercial mortgages packaged into bonds soared past 10 percent this year, according to Wells Fargo analysts. Loans written in 2007 are the worst performers, with 14.16 percent behind on payments, the analysts, led by Marielle Jan de Beur, said in an Aug. 28 report. A record $232 billion of the securities were sold that year, according to data compiled by Bloomberg.

The 222 Broadway loan is not as risky as the deals done in 2006 and 2007, as the building is mostly occupied and current income covers debt payments, Nomura’s Overby said.

Not 2007

“It should perform for the next couple of years,” she said. “What you are riding on is whether or not Bank of America contracts and if they can lease it back up. It’s not the type of thing we would like to see in a CMBS deal, but it’s not 2007 all over again.”

Lower Manhattan’s class A office vacancy is climbing, and may reach 17.4 percent by the end of next year from 8.8 percent at the end of June, according to data from Cassidy Turley, a commercial property brokerage with offices in New York. The Port Authority of New York and New Jersey has about 45 percent of 3 million square feet at One World Trade Center still empty.

The 222 Broadway loan was a “moderately bold inclusion,” said Christopher Sullivan, who oversees $2 billion as chief investment officer at United Nations Federal Credit Union in New York. The underwriters “understand that what matters mainly today is spread and to what extent it will be scrutinized by investors.”

Sales of commercial-mortgage bonds are rising as investors chase riskier assets with the Federal Reserve saying today that it likely will hold its benchmark lending rate near zero at least through mid-2015. September is forecast to be the busiest month since issuance revived after coming to a halt amid the 2008 credit-market seizure, Deutsche Bank analysts led by Harris Trifon said in a Sept. 5 report.

Underwriting Standards

Wall Street has arranged $22 billion of the debt this year, compared with $28 billion in all of 2011, Bloomberg data show. At least $40 billion will likely be issued in 2012, Jefferies Group Inc. analysts led by Lisa Pendergast said in a Sept. 11 report.

Underwriting standards have slipped “modestly” on loans contained in the rush of deals, though bonds with investment-grade ratings are “still well-insulated,” the Jefferies analysts said. The most senior bonds on newly issued commercial-mortgage bonds are built to withstand the first 30 percent of losses before incurring principal losses.

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