Fitch: U.S. CREL CDO Delinquencies Fall Slightly on Forbearance

2008-08-11 20:27:03 -

- Delinquencies within U.S. commercial real estate loan (CREL) CDOs remain relatively low and declined from June levels due to forbearance and extensions, as well as asset managers' continued repurchasing of troubled assets out of the pools, according to the July 2008 CREL CDO delinquency index from Fitch Ratings.

This month, the reported forbearance of a maturity defaulted loan led to a slight decrease in the CREL CDO delinquency rate, to 1.46% from last month's rate of 1.58%. If this loan were added back in to the Index, the rate would increase to 1.80% due to the inclusion of three smaller, newly delinquent loans. The Index includes loans that are 60 days or longer delinquent, matured balloon loans, and the current period's repurchased assets.

The reduction in the Index is primarily attributed to a former matured balloon loan that accounted for 34 basis points (bps) that is currently operating under a forbearance agreement pursuant to which interest is paid currently. The two senior participation interests and one junior participation interest in this loan, which were contributed to three separate CREL CDOs, are likely to be extended under a short-term extension agreement to allow the sponsor to negotiate a potential sale or refinance of the property. Partially offsetting this decrease in the Index was the addition of three new loans (24 bps); all of which were multifamily or condo conversion loans.

In addition to the participated matured balloon described above, another whole loan (four bps) dropped from this month's Index as the asset manager granted it a nine month extension. This month, Fitch noted 25 reported loan extensions in July 2008, which is up from last month's total of 20. This statistic continues to trend upwards reflecting the lower available liquidity for CRE loans. Over half of these extensions were not contemplated in the original loan documents, and many are short term extensions of one to three months. By their actions, managers are indicating that extending the loan to allow time to ride out the market is the prudent course of action at this time. Fitch is concerned that this trend serves only to delay the possible realization of losses on these loans.

Of the 19 loans in the July 2008 CREL Delinquency Index, nearly one-third by balance are related to multifamily, condo conversion, or residential land properties, including the three new delinquencies this month. Further, over 80% of the loans in the 30 day bucket are secured by multifamily properties. Typically, the multifamily loans are secured by assets in a state of transition. Generally the borrowers' business plan was to make capital improvements to the property to improve the property quality to the next category and thus increase rents. But often the capital dollars infused per unit were used more to cure deferred maintenance or dated amenities as opposed to materially improving the quality of the asset vis a vis the market. As such, projected rents have not been obtainable.

Increased delinquencies means riskier collateral pools. Fitch assumes a 100% probability of default in its modeling for loans which are 60+ days delinquent. Increases in delinquencies, therefore, lead to increased Fitch poolwide expected losses (PEL), and decreases in the Fitch PEL cushion as the PEL approaches the Fitch PEL covenant. Fitch recently placed the first CREL CDO on Rating Watch Negative due to insufficient PEL cushion arising from delinquencies. One class of Gramercy RE CDO 2007-1 was placed on Rating Watch Negative due to the delinquency and corresponding default of two hotel loans. Further, over one-third of all Fitch rated CREL CDOs now have below-average PEL cushions as of the last Fitch review. The decline in cushion is due to one or more of the following: increased delinquencies, properties falling behind on their business plans, reduced property net cash flows, and the application of Fitch's corporate Portfolio Credit Model (PCM) on the corporate debt and REBL assets, if any, and the interim surveillance stacking model methodology on the CMBS and CRE CDO assets, if any. While rising delinquencies will reduce managers' reinvestment flexibility, the transactions were originally rated to withstand some negative migration. Significant decreases in cushions, however, could lead to more transactions placed on RWN or downgrades.

Asset managers continue to repurchase assets from their CDOs. For this reporting period, asset managers repurchased three assets (15 bps). The repurchased assets consist of a mezzanine loan secured by an interest in a New York City office portfolio and a mezzanine loan secured by an interest in a portfolio of multifamily properties located throughout the Unites States. The first mortgage of this multifamily portfolio remains in the CDO. The third repurchased asset consists of the first loss piece of a commercial mortgage backed security. Repurchases of troubled loans are expected to be limited to the few issuers with liquidity remaining within their balance sheets. Repurchases of credit impaired assets are an important component of the Index as their exclusion would overstate the performance of the CDOs.

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