Cerberus buys $1bn of residential debt

The owner of struggling car giant Chrysler has plunged into another risky sector: US residential property.

In the alternatives space, there are those firms that like a challenge. And then there's Cerberus Capital Management.

The firm led by Steven Feinberg's most notable transaction of late was buying Chrysler for $7.4 billion last year in the mother of all turnaround deals. Not to pass up further opportunity in difficult industries, however, it recently made a $1 billion bet on the US residential sector. According to an announcement by Canadian bank (Canadian Imperial Bank of Commerce) CIBC, a fund controlled by the firm won a “competitive” auction to acquire $1 billion of CIBC's residential real estate portfolio via a sale of senior notes. The deal was announced on 3 October.

There was a pressing need for CIBC to reduce its exposure to the US residential sector. Canada's fifth-largest bank has been hit badly by exposure to subprime investments. In its last three financial quarters it has been forced to write down more than C$6.7 billion ($5.3 billion; €4.1 billion) on its assets. As a result of the deal, the bank is able to strengthen its financial position by improving its Tier 1 capital ratio.

Under the terms of the agreement, Cerberus is paying in cash for the debt. Once (or if) the debt is repaid, though, the Canadian bank will retain the whole ownership of the portfolio, allowing it to profit if the value of it should increase.

What's more, the bank has not agreed to provide any performance guarantee for the portfolio, adding more risk for Cerberus. CIBC will continue to collect the mortgage repayments from the US homeowners in order to pay the notes.

“This transaction sets a floor under CIBC's exposure to the US residential mortgage market,” said CIBC president and chief executive Gerry McCaughey. “At the same time, retaining ownership of these securities, combined with the option regarding the timing of any redemption of this note, provides us with important flexibility to benefit from a future recovery in the cash flows of these securities.”

The deal is being seen as unusual because, according to experts, similar sales have not allowed sellers to benefit from any upside and the sellers provided finance to the purchasers. Ron Lalonde, a senior vice president at CIBC told Reuters: “I don't think there have been any other deals done like this.”

In a way, Cerberus is doing what the US government has pledged to do with its $700 billion bailout plan. It is helping take assets off the balance sheet of a major bank. As with Chrysler, the success of Cerberus's transaction is not a given. However, you have to take your hat off to the firm for doing the due diligence in the first place and being able to put a value on the portfolio.

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