Pressure on CDOs to Continue, Fitch Says

MBA (8/22/2008 ) Sorohan, Mike
Liquidity pressures will make repurchasing commercial real estate loan collateralized debt obligations an increasingly difficult option, according to a new report from Fitch Ratings, New York.
The report, CREL CDO Trends: Repurchases, suggests that even as asset mangers actively manage their CREL CDOs by exercising their rights to repurchase assets, such repurchases may become more difficult in the face of more loan delinquencies.

Karen Trebach, senior director at Fitch, noted that Fitch's CREL CDO Delinquency Index, while rising in recent months, has remained relatively low, which she said was attributable in part to asset managers removing underperforming loans. The Index rose to 1.46 percent in July from 0.36 percent in October 2007 when Fitch began tracking the index. The current delinquency rate, when accounting for cumulative repurchases, could grow to 2.6 percent, she said.

Nearly two-thirds of asset managers have repurchased nonperforming or subperforming assets from their CDOs to date, Trebach said; however, half of those asset managers face varying degrees of capital constraints that limit their ability to continue to repurchase underperforming assets on an ongoing basis.

“Reduced CDO cushions are becoming more commonplace with the dual pressures of reduced liquidity and increased delinquencies,” Trebach said. “Constrained liquidity may also lead to more managers modifying and extending loans rather than repurchasing them, which, if not merited, may only serve to delay the possible realization of losses on these loans.”

Trebach said Fitch views reduced repurchases as a factor that could contribute to increased delinquencies in CREL CDO pools.

“In periods of economic stress and constrained liquidity, Fitch anticipates increased delinquencies, especially for the type of loans found in CREL CDOs, which inherently require a sustained period of economic growth to achieve business plans necessary to achieve loan performance,” Trebach said. “While even this rate is considered low relative to the credit enhancement in these transactions, an accumulation of impaired assets much beyond this level, may result in more bonds from CREL CDOs being placed on Rating Watch Negative or downgraded.”