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Cerberus shelves commercial mortgage bond that mimics CDO: sources

[NEW YORK] Cerberus Capital Management has shelved the sale of a US$390 million commercial mortgage bond that packaged nearly junk-rated securities into new debt with top AAA grades, according to people with knowledge of the matter.

Investors were demanding higher yields for the debt offering, said the people, who asked not to be identified because the information is private. The bond sale also struggled because of weak liquidity, and changing terms in the so-called repo market, they added.

The deal, which began marketing in late September, grabbed attention because the structure was reminiscent of collateralised debt obligations (CDO). Those bonds, made up of complex home mortgage investments, were created in the 2000s and helped nearly bring down the financial system in 2008 when they soured.

Cerberus was also selling it at a time when the market for commercial real estate was being clobbered by the pandemic. Around 9 per cent of commercial mortgages bundled into bonds were delinquent in August, according to data from research firm Trepp, as Covid-19 keeps shoppers out of malls, travellers away from hotels and workers home from offices.

Representatives for Cerberus, as well as for bookrunners Deutsche Bank, JPMorgan Chase & Co and Wells Fargo & Co declined to comment.

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The transaction took derivatives of CMBS (commercial mortgage-backed securities), known as interest-only strips, and packaged them into around US$390 million of notes, about US$300 million of which were expected to get top ratings from DBRS Morningstar, according to pre-marketing messages seen by Bloomberg.

A representative for DBRS said that the bond grader never issued any kind of rating for the transaction.

Some investors considered the deal's structure to be a CDO.

"Interest-only cash flows and returns are much more difficult to forecast now, given the elevated delinquency rate on CMBS loans and the growing number of loans that are on rating agency watch lists for downgrade," said Jen Ripper, a CMBS investment specialist at Penn Mutual Asset Management.

The number of distressed CMBS loans with loan-workout specialists known as special servicers hit an all-time peak of 10.48 per cent in September, according to Trepp. That eased to 10.28 per cent in October because so many of the loans have been granted forbearance.

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