Wall Street Securitization Machine Back Into Gear?
A crucial part of the securitization market — the Wall Street credit machine that helped set off the financial crisis — is kicking back into gear.
In the last few weeks, a number of big banks have successfully bundled and sold new securities backed by commercial real estate loans. Morgan Stanley and Bank of America completed a $1.55 billion deal last month that included office and retail properties. So far this year, financial firms have sold about $5 billion of commercial mortgage-backed securities, almost as much as was done in all of 2010.
More deals are in the works. JPMorgan Chase , for example is in the process of selling a $1.5 billion commercial mortgage-backed security. If the pace continues, the volume of these sales could hit $45 billion this year, according to JPMorgan.
Bankers even have a nickname for the postcredit crisis crop of commercial mortgage-backed securities: C.M.B.S. 2.0, referring to new versions of old products.
“Things have gone vicious to virtuous,” said Brian Lancaster, a securitization specialist at the Royal Bank of Scotland , which in conjunction with Wells Fargo & Company recently sold a $1.3 billion commercial mortgage-backed security.
Other sectors of this market, including car loans and collateralized loan obligations, are also showing signs of life. But the recovery is being led by commercial real estate, which did not reach the lows that experts expected.
Commercial real estate was supposed to be the next shoe to drop, sending the economy into a tailspin like the housing market did. But while residential prices continue to sputter, the values of office, retail and other commercial properties are stabilizing. As of December 2010, the Moody’s/Real Commercial Property Index, which tracks prices on such buildings, was up modestly from its August lows.
Such stability has helped bond investors set prices on the related securities, even in some of the areas most devastated by the crisis. In a recent $2.2 billion commercial deal by Deutsche Bank and UBS, roughly 15 percent of the underlying assets were in Arizona, a state hit hard by the broad real estate problems.
Some on Wall Street, however, are raising warning flags about the new crop of C.M.B.S. deals. The rating agency Standard & Poor’s says that some of the new deals are becoming increasingly complex and underwriting standard have loosened.
“We have seen some examples where appraisals/valuations look quite aggressive to us, especially given the downward property price movements over the past few years,” the agency said in a recent report titled “15 months Later… The Caution Flag is Out for C.M.B.S. 2.0.”
As part of the securitization process, commercial real estate loans, credit card balances and other types of debt are bundled into bonds, pieces of which are then sold to investors. The yield on a commercial mortgage security is based on the rent or revenue collected on the underlying properties.
With Wall Street firms aggressively packaging loans at inflated values at the peak of the boom, the total volume of securitization reached $2.5 trillion in 2007, according to JPMorgan. Banks issued a record $230 billion of commercial mortgage bonds that year.
Then the market collapsed in 2008 as the underlying loans soured, helping to incite the worst economic rout since the Great Depression. Some pundits predicted the end of securitization.
But with investors nervously on the sidelines, the government started a series of initiatives to help kick-start lending, including the Term Asset-Backed Securities Loan Facility. Under the program, which was expanded to include commercial mortgage-backed securities, the Federal Reserve lent money to big investors willing to buy such securities.
The shopping center owner hired Goldman Sachs to prepare one loan backed by 28 properties — worth about $400 million — through the Fed’s program.
“TALF really helped the markets to recover,” said Mike Millette, who is responsible for the structured finance group at Goldman Sachs. “It did what it needed to do and then disappeared.”
As the government steps back, Wall Street continues to chug along on its own. Although the securitization market could always become overheated again, banks seem to be taking a more cautious approach — a discipline in part enforced by the government.
Under the Dodd-Frank regulatory reform, banks are required to hold 5 percent of any securities they sell to investors. The move is intended to reduce risk by forcing banks to eat their own cooking.
Another rule, which will most likely take effect early next year, requires banks and other financial firms that issue asset-backed securities to review the quality of the underlying assets, including commercial real estate. The banks must then disclose their findings to investors. If the assessment shows that the assets did not meet the underwriting standards promised to investors, financial firms must explain the discrepancy in a filing.
Banks are also improving their lending standards on their own. The securities today are more diverse, including multiple loans from a number of developers across the country. The recent deals, for instance, includes a broad set of properties like the Christiana Mall in Newark, Del., the Kenwood Towne Centre in Cincinnati, the Pearlridge Center near Honolulu and 7 Hanover Square in New York.
“The banks can cherry-pick the loans they are making and typically only top-quality prime borrowers are getting financed,” said Tony Plath, a finance professor at the University of North Carolina at Charlotte.