Looking for Big Yields? Think Twice Before Investing in These Securities

The commercial debt business is currently experiencing somewhat of a revival, as some of the biggest banks scramble to write more business loans that can be packaged into products for sale to yield-hungry investors. Some types of commercial mortgage-backed securities offered by the likes of Wells Fargo (NYSE: WFC  ) , JPMorgan Chase (NYSE: JPM  ) , and Bank of America (NYSE: BAC  ) are riskier than others, giving them a fatter yield -- but, from what I can tell, the risks may not be worth it.

Single-loan securities are hitting the big time
This year has seen a real boost in CMBS activity, which could reach $85 billion by the end of 2013. Most CMBSes, much like those backed by home loans, include a large number of diverse loans packaged together, then sliced and sold in tranches that are rated according to risk.

But CMBSes based on a single loan have been gaining momentum since early last spring. Last March, JPMorgan offered a $125 million instrument based on a loan on the Seven World Trade Center in New York City, and Bank of America Merrill Lynch teamed up with Deutsche Bank (NYSE: DB  ) for a $324.8 million offering made up of a single loan on 261 restaurants. In April, a bigger deal, backed by a $412 million loan on the Fontainebleau Miami Beach Resort, hit the market -- and it's been uphill from there.

Part of the $12 billion in single-loan CMBSes sold this year occurred in March, when Wells Fargo originated a $310 million loan on the Equitable Building, owned by Silverstein Properties -- which essentially refinanced a CMBS mortgage originally taken out on the building in 2006. Bank of America put in a bid on this deal, too, showing that competition for these deals is heating up.

Less diversity, higher risk, dubious ratings
The Wall Street Journal notes that these type of investments have seen a lot less action since the financial crisis, since the reliance on only one loan is considered quite risky. But low interest rates have increased investor appetite for yield and, therefore, risk. Also a factor is that ratings agencies like (NYSE: MHFI  ) Standard & Poor's are often giving these products very high investment ratings, as well, fueling speculation that this entity in particular is easing standards in order to get a slice of the pie.

Recently, S&P has rejiggered its capitalization rate for single-loan rating parameters, muting the impact of economic conditions such as higher interest rates upon the expected income that the subject property could produce. A spike in interest rates, of course, could increase the risk of default -- and make refinancing problematic.

Fitch Ratings, on the other hand, has stated that many of the deals being highly rated by others would not have garnered such high marks from its own analysts. Similarly, Moody's has also warned that some recent deals are not deserving of the high-quality ratings other agencies have bestowed upon them.

Investor, beware
Still, there seems no shortage of investors for these products, despite the questions about risk. Even with yields so low, investors should consider the unusual debate on the subject of riskiness among the rating agencies -- as well as the fact that these loans seem to closely resemble something like a home equity loan on multimillion-dollar commercial properties -- as warning signals.

With CMBSes underpinned by pools of loans, at least, if one goes sour, the entire investment won't crumble -- not true of single-loan bonds. With odds like those, I think investors would be wise to sit out this particular venture.

With big finance firms still trading at deep discounts to their historic norms, investors everywhere are wondering if this is the new normal, or if finance stocks are a screaming buy today. The answer depends on the company, so to help figure out whether JPMorgan is a buy today, check out The Motley Fool's premium research report on the company. Click here now for instant access!


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