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Commercial-Mortgage Market Slows Ahead Of Maiden Lane Sale

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04/25/2012 | 01:50pm CET

(This article was originally published Tuesday.)

 
 
   By Al Yoon 
   Of  
 

Trading in riskier commercial mortgage-backed securities has slowed to a trickle in the past week as the Federal Reserve Bank of New York prepares a potentially market-churning sale of $7.5 billion of similar securities the bank acquired while bailing out the American International Group (AIG) in 2008.

Investors are watching as eight banks form a pair of ad hoc Wall Street alliances to bid on the collateralized debt obligations, which are backed by traditional commercial mortgage bonds packaged at the height of the real estate boom. The New York Fed last week said it was initiating a process that could result in the sale of the CDOs as early as Thursday.

At stake for investors are prices on junior bonds that make up about 45% of the total of the commercial real estate CDOs held in the portfolio, known as Maiden Lane III. The so-called "AJ" bonds are more exposed to losses as borrowers default, leading to reduced demand and an expanding risk premiums relative to the most-senior debt.

"You can't really trade while this is going on," said Darrell Wheeler, head of CMBS strategy at Amherst Securities Group. "There's no credit trading taking place in the CMBS market while we all watch this."

Bid lists for "AJ" and slightly safer "AM" CMBS since April 16 has dropped to as little as $12 million in a day in the past week, compared with $100 million to $300 million per day earlier this month, according to Adam Murphy, president of Empirasign Strategies, which tracks trading in CMBS.

Investors have pulled back on expectations that the dealer, or dealers, that win the bidding will unwind the CDO, whose CMBS parts are seen worth more than the whole.

On Monday, Citigroup (>> Citigroup Inc.), Credit Suisse (CS, CSGN.VX) and Goldman Sachs Group (>> Goldman Sachs Group, Inc.) banded together for a more competitive bid, investors said. Drama intensified on Tuesday as Morgan Stanley (MS) and Bank of America Merrill Lynch (>> Bank of America Corp) told investors they would forge a second alliance.

Analysts said alliances may be necessary to reach investors and produce a strong enough offer to ensure a profit to the New York Fed, and to counter the embedded advantages of a third alliance comprising Deutsche Bank (DB, DBK.XE) and Barclays PLC (BCS, BARC.LN).

Barclays, which controls an interest-rate swap on the CDO, and Deutsche Bank, which likely owns subordinate debt of the CDO, are in discussions to partner up and leverage those advantages, said investors close to those firms. Barclays and Deutsche Bank spokesmen declined to comment.

What isn't clear is if any of the dealers will prevail in their bidding for the assets that are valued above 80 cents on the dollar, well above the 55 cent value implied by the New York Fed's disclosures for year end 2011. Morgan Stanley and Bank of America had indicated a possible bid in the low 60-cents area, showing the discount that they will ask for to account for costs in breaking up the CDO, said two investors in touch with the dealers.

Deutsche Bank would have to be paid to release its subordinate interests, according to investors familiar with the structure.

Barclays would have to be paid more than $1 billion to unwind the interest-rate swap, also eroding the profit for a buyer. Wheeler estimated the swap could cost $1.3 billion to unwind, and added that Barclays could charge any other winner far more.

What's more, the dealers with an eye to dismantling the CDO into its parts are likely pricing in a drop in AJ bonds that would probably follow as the debt is resold, he said.

"The Fed may realize that they might achieve higher sales proceeds by having the Maiden Lane manager negotiate directly with the swap provider and subordinate CDO holders," Wheeler said in a recent research note. "And then sell the underlying (CMBS) over time, ensuring an orderly disposition."

The New York Fed last week said any sale would have to represent good value for the public while taking care to avoid a market disruption. That may be hard to avoid as the $3.6 billion of AJ bonds in the CDOs represent 19% of all such debt issued in 2007, according to Wheeler.

"Its really a race to see if the dealer groups can find sufficient interest in buying the floating-rate CDO bonds," he said.

-By Al Yoon, Dow Jones Newswires; 212-416-3216; albert.yoon@dowjones.com

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