Fitch: CRE CDOs Report More Loan Extensions

MBA (5/8/2008 ) Murray, Michael
Fitch Ratings, New York, reported 25 April loan extensions for commercial real estate loan collateralized debt obligation (CRE CDOs) in the United States, keeping CRE CDO delinquencies lower than in March.

The majority of extensions were based on options contemplated at closing, and nearly 40 percent of the extensions were modifications from the original loan documents, the ratings agency said.

In March, Fitch reported 32 loan extensions, but fewer loans were repurchased in April, contributing to a slightly lower CRE CDO delinquency rate for the month—0.69 percent—down from March’s 0.74 percent delinquency rate, Fitch’s CRE CDO Delinquency Index reported.

The loan extensions, typically between one to six months, reflect the lower available liquidity for commercial real estate loans, particularly for ones found in CRE CDOs, which tend to be backed by transitional and/or highly leveraged CRE collateral, Fitch noted.

In a Standard & Poor's CMBS Quarterly Insights report, S&P said 47 of 50 commercial mortgage-backed securities (CMBS) loans with extension options did extend while three were paid off.

S&P said the ratio of extended loans to paid-off loans jumped to 15.67:1 in the first quarter, up from 1.92:1 for all of 2007 and 1.03:1 in 2006. Four of six property categories had no loan payoffs during the recent quarter, and retail properties had the most loan extensions with 16, the report noted.
"Borrowers that extend their floating-rate loans may just be delaying the day of reckoning, especially if the related properties are significantly behind in their operating projections," S&P said. "An extension essentially gives a borrower additional time to realize its projections. A floating-rate loan can be viewed as a form of bridge loan, in which a borrower tries to improve a property's cash flow before locking in fixed-rate financing. Historically, loans in their extension periods were often assumed to be troubled; in the current environment, however, an extension could simply reflect the tighter lending market. In most cases, we would prefer to see the borrower pay off a loan rather than extend it, but in the current environment, an extension could provide an ounce of prevention against a potential default."

Fitch rates 35 CRE CDOs of nearly 1,100 loans and 330 rated assets with a $23.8 billion balance. The delinquency index includes delinquent loans for 60 days or longer, matured balloon loans and repurchased assets. Despite the low overall rate, the CRE CDO delinquency rate reported in April is still more than two times the U.S. CMBS loan delinquency rate of 0.33 percent from March, the ratings agency said.

"We think that CRE CDO issuance lags behind CMBS," said Karen Trebach, senior director at Fitch. "We don't expect issuance to return until CMBS investors return to the CMBS markets."

Fitch anticipates the CRE CDO Delinquency Index could be more volatile than the CMBS delinquency index because of a smaller loan universe and more transitional nature of collateral. The Fitch CMBS delinquency index covers nearly 42,000 loans and $562 billion in nearly 500 CMBS transactions.

S&P also recorded delinquency increases in CMBS during first quarter, rising nearly 20 percent to $2.73 billion from $2.28 billion at the end of 2007. The rise marked the fourth consecutive quarter of increasing delinquencies since they bottomed out in the first-quarter last year.

"If the favorable outcomes for maturing loans continue, we believe growth in delinquencies could remain near the levels we've seen recently given current economic conditions," S&P said.

CMBS delinquencies for total 2005-2007 vintages increased nearly 39 percent between the fourth quarter 2007 and the first quarter this year, S&P noted.In the first quarter, 2005-2007 vintages accounted for 52 percent, or $1.41 billion of the period's total delinquencies, up from 45 percent, or $1.02 billion in the fourth-quarter 2007.

"We expect growth in the delinquency rate to continue to exceed growth in the delinquent principal balance based on the limited amount of CMBS issuance thus far in 2008," the S&P report said. "We expect 2008 will bring further challenges for CMBS performance. Besides anemic economic growth and higher levels of balloon maturities, the aggressively underwritten loans of the 2005-2007 CMBS vintages are either entering or are already in their 13th to 18th months of seasoning, which is typically a period of increased default risk."

In CRE CDOs, collateral transitions with other assets, including subprime loans. While rated collateral was not reported delinquent this month, 12 rated assets were considered “credit impaired” by Fitch—mostly subprime residential mortgage-backed securities (RMBS) assets that serve as collateral for two CRE CDOs.

The impaired assets represent 0.38 percent of all CRE CDO assets, but 7.2 percent and 2.8 percent of their respective CRE CDOs. The two most junior-rated tranches from one of these CRE CDOs are on Rating Watch Negative because of subprime exposure.

Two loans 60 days or more delinquent are in foreclosure—0.08 percent of the pool. One new matured balloon appeared in February’s index prior to a two-month extension. Two matured balloon mezzanine loans—0.21 percent of the pool—were included in the index this month, restructured and extended during the month. The now-current loans have interests in the same New York City office portfolio.

The April delinquency index consists of 11 loans. It includes six loans that are 60 days or more delinquent and five matured balloons. No rated assets were delinquent this month. Although not included in the delinquency index, 11 loans—0.36 percent of the CRE CDO collateral—were 30 days or less delinquent in April, lower than last month’s total of 0.47 percent. Three of the loans were brought current after the cutoff date for this Fitch report, and the other loans suggest that overall delinquencies could increase next month, the ratings agency said.

Fitch said it would increase the probability of default to 100 percent for delinquent loans that are unlikely to return to current as part of its ongoing surveillance process. The adjustment could increase the loan's expected loss in the cases where the probability of default was not already 100 percent.

The weighted average expected loss on all loans, or Poolwide Expected Loss (PEL), is the credit metric Fitch uses to monitor the performance of a CRE CDO. Fitch analysts monitor the as-is PEL over the life of the CDO. The difference between the PEL covenant and the as-is PEL represents the transaction's cushion for reinvestment and negative credit migration, the ratings agency said.