It is not just corporate America that is benefiting from investors’ hunt for yield. The Federal Reserve Bank of New York has been another beneficiary. Last week it successfully sold two large bundles of commercial real estate securities with a combined original face value of $7.5bn.
These collateralised debt obligations, known as the “Max” deals, are securities that were at the heart of the financial crisis and the bail-out of AIG, the insurer. In November 2008, with a loan from the New York Fed and equity from AIG, a special vehicle called Maiden Lane III bought them and other mortgage debt as part of AIG’s rescue.
The latest auction of some of these assets held the attention of traders and investors that specialise in buying and selling complex packages of loans. But it has broader implications. Its success relied on investors’ appetite for risk, which has been stimulated by central banks’ monetary easing policies.
From the outset, the assets in Maiden Lane III were seen as a tough sell because they were illiquid securities of CDOs rather than the underlying mortgage securities that had already rallied this year.
Yet cheap loans from the European Central Bank to the region’s banks and a pledge by the Federal Reserve to keep US rates near zero have sent investors flocking to the highest yielding securities, including the “toxic” packaged mortgage debt that triggered the financial crisis.
“There is a large incentive to reach for yield, and anything that has a spread on it has a strong bid despite the risks,” says Bill Stasiulatis, a director at Torchlight Investors.
This year, the New York Fed had seized on demand for high-yielding, risky assets to sell the remaining securities from Maiden Lane II, a portfolio of subprime residential bonds also acquired as part of AIG’s bail-out, earning a $2.8bn profit.
Maiden Lane III’s Max CDOs were sold last week to a consortium of Barclays and Deutsche Bank after several Wall Street banks teamed up to make bids. The two banks found strong demand with a plan to collapse the CDOs, disgorging the underlying commercial real estate bonds and selling them to clients, hopefully for a profit.
“Most of the investors that would buy this sort of product will be the traditional real money investors,” says Darrell Wheeler, a commercial mortgage-backed securities strategist at Amherst Securities.
That includes insurance companies, money managers, mutual and pension funds. However, some hedge funds may have been interested in bonds from 2007 with the hope of selling them back into the marketplace, he says.
Though the price was not disclosed, analysts from JPMorgan estimate that the winning bid from Deutsche Bank and Barclays was 67 cents on the dollar. That would mean the underlying bonds generated enough demand for the price of the CDOs to surpass the $4.2bn the New York Fed reckoned was fair market value at the end of 2011.
“A good portion of this was highly valuable to people who just wanted to buy yield in a market where Treasury yields are 2 per cent,” Mr Wheeler says.
He estimates that the underlying bonds, which date from 2005 to 2007, carry adjusted default yields of between 5 and 12 per cent depending on vintage.
Ahead of the sale, prices for commercial real estate bonds fell on fears that unwinding such a large deal would overwhelm the market. But prices have since stabilised.
Indeed, in the few days since the New York Fed auctioned the Max CDO s, UBS is already planning to take bids on $1.5bn of similar securities, while speculation has emerged about additional sales from Maiden Lane III. The New York Fed declined to comment.
By most accounts, the Max sales are being declared a success. The proceeds of the sales first go to repay the New York Fed, which is still owed about $8.7bn on Maiden Lane III. AIG is entitled to the next $5.5bn and the remaining proceeds will be split, with a third going to AIG and two-thirds to the New York Fed. The New York Fed will remit any gains to the US Treasury.
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