American International Group Inc. (AIG:US) is increasing direct investment in real estate to reduce its reliance on Wall Street as record-low interest rates pressure investment income.
“It’s making sure that we are taking control of the risks we’re going to put on our books, and we can’t rely on the public markets,” including commercial mortgage-backed securities, Chief Executive Officer Robert Benmosche said at a conference this week in Chicago. “We have to do direct investment.”
The insurer boosted real estate bets this year by buying back mortgage bonds assumed by the Federal Reserve Bank of New York in the insurer’s 2008 bailout. Benmosche, the CEO since 2009, is increasing direct lending, investments in rental properties and home loans, he said Oct. 29 at trade group Limra’s annual conference. New York-based AIG was rescued after mortgage-related losses and is working to attract private capital to replace the government’s remaining 16 percent stake.
AIG needs to deploy about $50 billion into assets such as real estate that can generate more “alpha,” an above-market return earned by the skill of its money managers, said Benmosche.
The insurer, scheduled to report third-quarter results today, is seeking ways to generate yield as the Federal Reserve keeps interest rates near record lows to stoke growth in the world’s largest economy. That’s driven down rates on debt from Treasuries to high-yield corporate bonds and raised investor concern that underwriting standards in some markets including CMBS are slipping.
The extra yield investors demand to own top-ranked CMBS rather than Treasuries fell to 1.01 percentage points last week, the lowest in at least four years, and down from 2.47 percentage points on Jan. 3. Holders get paid about 2.6 percentage points to buy newly issued commercial mortgage bonds maturing in 10 years, compared with as much as 4 percent to make the loans themselves, according to Deutsche Bank AG data.
Skilled investors can boost returns on real estate investments by betting on individual properties they think will excel, rather than paying a fee for a bundle of loans of varying quality, said Jim Leonard, an analyst at Morningstar Inc. (MORN:US)
Investors are trying “to pick off single properties,” which also allows them to understand the risk they’re taking, Leonard said.
Underwriting standards are deteriorating as lenders compete for new loans amid a surge in sales, increasing the risk within higher-yielding portions of new commercial-mortgage bond sales, Bank of America Merrill Lynch analysts said in a report last month. Banks have arranged $29.4 billion in bond offerings linked to skyscrapers, shopping malls and hotels this year, up from $28 billion in 2011, according to data compiled by Bloomberg. Sales peaked at $232 billion in 2007.
The insurer may be trading the liquidity of mortgage-backed bonds for the higher yield available from direct investing, said Paul Newsome, an analyst at Sandler O’Neill & Partners LP. The strategy may also help diversify the insurer’s investment and guard it against a downturn in the market for mortgage-backed securities.
“You can’t sell the building as easily as you can sell a mortgage-backed security,” he said by phone. “But your ability to hold it on your books and hold on through a crisis may actually be better.”
Warren Buffett has said liquidity shouldn’t be sacrificed to offset low bond yields at his Berkshire Hathaway Inc. (A:US)
“The need for ample liquidity occupies center stage and will never be slighted, however inadequate rates may be,” Buffett wrote in his annual letter to shareholders.
In the current interest-rate environment, there aren’t many good ways of boosting investment returns once risk is taken into account, Jay Fishman, CEO of Travelers Cos. (TRV:US) said in September.
“People say, ‘Where are you going for yield?’ and the answer is ‘Nowhere,’” Fishman said at a conference. “If we thought that there was a place where, on a risk-adjusted basis, yield was better than where we are today, we would move in that direction. But we don’t see it, we don’t perceive that there is such a place.”
AIG has gained 51 percent this year, the best return among the 22 companies on the Standard & Poor’s 500 Insurance Index. (S5INSU) Travelers, based in New York, has advanced 20 percent and Berkshire is up 13 percent. Still, AIG has lost about 96 percent since the end of 2007.
Beyond its bond holdings and mortgages, AIG’s real estate investments were $2.92 billion as of June 30, a 5.1 percent increase from six months earlier, according to a filing.
Investments include providing equity to a 510-unit rental project in Williamsburg, Brooklyn, on the waterfront overlooking the East River across from Manhattan, where developers broke ground in August.
The insurer’s portfolio stood at $413 billion, with about 71 percent invested in bonds. AIG also held $13.7 billion of commercial mortgages on June 30, up from $13.3 billion a year earlier.
MetLife Inc. (MET:US), the largest U.S. life insurer, originated more than $11 billion in commercial mortgages last year, up from more than $8 billion in 2010. The New York-based company had $8.5 billion of real estate and real estate joint ventures and $55.8 billion of mortgage loans, mostly on commercial property, in its investment portfolio of more than $500 billion as of June 30.
AIG bought $7.1 billion of mortgage bonds from the Maiden Lane III vehicle created by the New York Fed to aid in its rescue, the insurer said in August. The Fed wound down the vehicle, its last piece of AIG’s $182.3 billion bailout, later that month.
The U.S. Treasury Department still owns (AIG:US) 16 percent of the insurer, down from as much as 92 percent acquired in the rescue. It sold $20.7 billion of shares in September, recouping the taxpayers’ bailout cost and cutting its stake from 53 percent.
AIG can draw on its experience backing home loans as it evaluates which ones to buy, Benmosche said. Mortgage insurer United Guaranty, acquired by AIG in 1981, has information that can help the company predict which borrowers are most reliable.
“The policies of the Fed are telling us that we’re going to see low interest rates for a long period of time, and we’re going to have to figure out how to manufacture our own yields,” Benmosche said. “We have to accept long-term investing, like we did in the good old days. That means real estate.”
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