Does this sound familiar? (The Big Short)
(Bloomberg) — Cerberus Capital Management is selling debt that packages commercial mortgage-backed securities rated at the cusp of speculative-grade into top-rated securities, a practice employed by collateralized debt obligations (CDOs) that contributed to the global financial crisis.
The offering bundles so-called interest-only slices of CMBS rated the lowest tier of investment grade into $300 million of bonds with preliminary ratings of AAA by DBRS Morningstar, the senior portion of a $390 million transaction. Some market observers are concerned that these strips might eventually be subject to losses.
“This is a CDO,” said Jen Ripper, an investment specialist at Penn Mutual Asset Management in Horsham, Pennsylvania. “There could be a real risk of some principal loss at the BBB- level, which most of these interest-only tranches are ‘stripped’ off of.”
The deal comes at a time when the CMBS market is in crisis, a victim of shutdowns stemming from the coronavirus pandemic that have battered revenues for malls, hotels and other commercial properties that back the debt. But the challenges also mean that hedge funds are looking for opportunities to profit amid the fallout.
The transaction is being referred to as a “resecuritization” in deal documents seen by Bloomberg. Those marketing materials say it is structured so that cash flows are “protected from both prepayments and losses.”
The deal is backed by about 9,300 mortgages, 27.6% of which are office, 25% retail and 15.5% hotel, while the rest is a mix of other commercial real estate sectors, initial marketing materials show. The short duration of the product — the AAA slice matures in just 2.2 years — and the top shelf rating could attract yield-hungry investors.
“I’m sure the ratings are what’s driving the demand,” said Jason Callan, head of structured assets at Columbia Threadneedle Investments.
CMBS interest-only strips are linked to the performance of corresponding bonds with the same ratings that pay both principal and interest. They represent securities backed by the excess interest generated from a pool of commercial mortgages.
A representative from DBRS Morningstar said that the ratings are still pending and that no presale report was available yet. A representative for Cerberus didn’t immediately provide a comment.
The deal is being arranged by Deutsche Bank AG, JPMorgan Chase & Co., and Wells Fargo & Co. Representatives for JPMorgan and Deutsche Bank declined to comment while a press officer for Wells Fargo didn’t immediately provide a comment.
Here is an example of Goldman Sach’s ABACUS CDO to refresh your memory. And read the following instead of listening to Selena Gomez and Richard Thaler explain synthetic CDOs.
Abacus 2007-AC1 is paid off. Here is the A1 tranche.
Of course, office space is the worst performing property type in the mid-Atlantic region.
The CMBX 12 synthetic price fell to 58 in late March, but since rebounded to 79.86.
You can see the impact of Covid on CMBX prices in the following chart.
Here we are again, back in the CDO-era of the 2000s.