Fitch Downgrades 8 Classes of Petra CRE CDO 2007-1; Assigns Outlooks

NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded and assigned Rating Outlooks to the following eight classes of notes for Petra CRE CDO 2007-1, Ltd./Corp. (Petra 2007-1):

--$57.50 million class C to 'A' from 'A+'; Outlook Negative;

--$25.50 million class D to 'A-' from 'A'; Outlook Negative;

--$22 million class E to 'BBB+' from 'A-'; Outlook Negative;

--$33 million class F to 'BBB' from 'BBB+'; Outlook Negative;

--$20 million class G to 'BBB-' from 'BBB'; Outlook Negative;

--$26.50 million class H to 'BB' from 'BBB-'; Outlook Negative;

--$42.50 million class J to 'B' from 'BB'; Outlook Negative;

--$32.50 million class K to 'CCC' from 'B'.

Fitch has also affirmed the following classes and assigned Rating Outlooks:

--$400 million class A-1 notes at 'AAA'; Outlook Stable;

--$133.75 million class A-2 notes at 'AAA'; Outlook Negative;

--$76.75 million class B notes at 'AA'; Outlook Negative.

Fitch has also removed classes D through K from Rating Watch Negative, where they were originally placed on July 10, 2008, as the 90-day period stated at last review has passed without the asset manager making any material changes to the composition of the collateral pool. Additionally, the percentage of assets of concern has increased to 24% from 16.1% at last review.

Fitch's downgrades of classes C through K are due to the transaction breaching its poolwide expected loss (PEL) covenant and failing cash flow modeling stresses. Fitch assigned Negative Outlooks to those classes failing the property value decline stress testing at their respective rating stresses. Despite the pool's credit deterioration, credit enhancement to the class A-1, A-2, and B notes remains adequate under cash flow modeling stresses to support the current ratings. Fitch conducts cash flow modeling to test the transaction's structure under various default and interest rate stress scenarios.

Transaction Summary:

Petra 2007-1 is a revolving commercial real estate (CRE) cash flow collateralized debt obligation (CDO) that closed on June 27, 2007. The portfolio is selected and monitored by Petra Capital Management LLC (Petra). Petra 2007-1 has a six-year reinvestment period during which, if all reinvestment criteria are satisfied, principal proceeds may be used to invest in substitute collateral. The reinvestment period ends June 2013. Petra 2007-1 became effective on March 23, 2008.

Performance Summary:

Since last review, the as-is PEL has increased to 45.125% from 39.875%. Based on the current PEL covenant of 44.125%, the CDO has negative reinvestment cushion of 1%. The higher as-is PEL is attributed to the continued presence of Petra REIT debt in the portfolio as well as a decline in the credit quality of assets remaining in the portfolio. Several properties are underperforming their business plans and/or have depleted their interest reserves. Fitch is also concerned with the pool's exposure to hotel and retail loans, which are expected to face economic stress in the near term.

A principle concern at the time of Fitch's last review was the collateral manager's contribution of $50 million of debt (5%) from its subsidiary, Petra Fund REIT Corp. (Petra REIT), to the CDO portfolio in May 2008. The Petra REIT debt is still the only asset added to the CDO since the effective date. Fitch is concerned with the limited number of unencumbered assets held by Petra REIT, four of which are deemed assets of concern by Fitch: two B-notes backed by the former site of the Drake Hotel and two positions backed by Westin Aruba. In addition, a significant portion of Petra REIT's cash and cash equivalents are committed to future funding obligations for assets in the CDO. Petra REIT and its affiliates also own the below investment grade notes and preferred shares of this CDO, which presents concentration risk to the pool. Fitch is further concerned with the potential conflicts of interest arising from manager-affiliated debt being contributed to the CDO. As such, Fitch assumed a 100% expected loss in its CREL Surveyor model and 0% recovery in its corresponding stress test analysis for the Petra REIT debt.

Since last review, three additional CRE whole loans have become assets of concern, increasing the total number of such assets to nine (24% of the pool). The first new asset of concern is a whole loan (2.4%) for a ground-up condominium development located on the Upper West Side of Manhattan. The loan is secured by three contiguous properties, each currently improved as multifamily developments which would be razed as part of the borrower's business plan. Fitch's concern centers on the interest reserve being depleted, and the asset manager's anticipation that the sponsors will be unable to continue paying debt service out-of-pocket. Fitch assumed a 100% probability of default for this asset for modeling purposes.

The next asset of concern (2.2%) is a whole loan secured by a condominium conversion located on the Upper East Side of Manhattan. While all of the renovations at this Park Avenue property are complete, there have been no signed sales contracts on any of the three four-story luxury units. The loan matures in December 2008, and Fitch is concerned with the borrower's ability to repay the outstanding balance. Fitch assumed a 100% probability of default on this asset and also decreased its estimated stressed property value for modeling purposes.

The last new loan of concern is a whole loan (3.3%) which did not repay at its November 2008 maturity. The loan, which is secured by undeveloped land located in Las Vegas, Nevada, and two manufactured housing sites in Florida, has been extended and restructured in a forbearance agreement with the borrower. According to the asset manager, the borrower is marketing the sites for sale. Fitch is concerned that the properties' poor quality, in combination with current market stresses, will lead to low recovery prospects. Fitch assumed a 100% probability of default in the modeling for this asset.

Collateral Analysis:

As of the Oct. 27, 2008 trustee report and based on Fitch categorizations, the CDO was substantially invested in commercial mortgage whole loans/A-notes (70%). Additionally, it is invested in commercial real estate mezzanine loans (21.7%), B-notes (2.5%), real estate investment trust (REIT) debt (5%), and cash (0.8%). The CDO is also permitted to invest in CRE CDOs, commercial mortgage-backed securities (CMBS), credit tenant lease (CTL) loans, and real estate bank loans (REBLs).

The CDO is within all its property type covenants per the October 2008 trustee report. According to Fitch categorizations, office and multifamily properties represent the largest concentrations of traditional property types at 18.5% and 13.1%, respectively. The portfolio also contains an above average concentration of non-traditional property types per Fitch categorizations, including loans on land (20.7%), condominium conversions (8.7%), and construction projects (4%).

Additionally, the transaction remains within all of its geographic location covenants with the highest concentration of properties in New York (38.6%), most of which are located in Manhattan. The next highest concentration is California (10.6%).

The October 2008 trustee reported weighted average spread (WAS) of 5.51% and weighted average coupon (WAC) of 10% exceed the covenanted minimums of 2.40% and 5%, respectively. The CDO's PEL covenant varies depending on the in-place weighted average spread (WAS/PEL Matrix).

The Fitch Loan Diversity Index (LDI) is 349 compared to the covenant of 500. The current LDI represents average diversity as compared to other CRE CDOs.

The overcollateralization (OC) and interest coverage (IC) ratios of all classes have remained above their covenants as of the October 2008 trustee report. The OC tests have improved since last review; however, the F/G/H OC test result (124.8%) is tight compared to its covenant (120%) considering 24% of the portfolio consists of Fitch assets of concern. Should the OC ratio decline below 120%, interest will be diverted from the below investment grade notes and preferred shares in order to redeem the Class A-1 notes and subordinate classes sequentially until the OC test is satisfied. Any diversion in cash flow from the subordinate notes and preference shares will result in stress to the Petra REIT debt asset. Further, Fitch is concerned that the use of forbearance agreements may present additional risks to the transaction. The effect of some forbearance agreements may be to only delay an inevitable default, thereby challenging the effectiveness of OC triggers.

For a summary of the Fitch Loans of Concern and the 10 largest loans, please refer to the Petra CRE CDO 2007-1 CREL Surveyor Snapshot, which will be available beginning Dec. 3, 2008 on the Fitch web site www.fitchratings.com.

Rating Definitions:

The ratings of the class A-1, A-2, and B notes address the likelihood that investors will receive full and timely payments of interest, as per the governing documents, as well as the aggregate outstanding amount of principal by the stated maturity date. The ratings of the class C, D, E, F, G, H, J, and K notes address the likelihood that investors will receive ultimate interest payments, as well as the stated balance of principal, by the legal final maturity date, per the governing documents, as well as the aggregate outstanding amount of principal by the stated maturity date.

Ongoing Surveillance:

Upgrades during the reinvestment period are unlikely given the pool could still migrate to the PEL covenant. Fitch will consider assigning Negative Outlooks or placing classes on Rating Watch Negative should the reinvestment cushion fall to 2% or below. Additionally, Fitch performs underlying property value decline stress testing on the CDO's liabilities. To the extent investment grade rated bonds could be impaired by a 25% property value decline, classes could also be assigned Negative Outlooks, placed on Rating Watch Negative or downgraded. The Fitch PEL is a measure of the hypothetical loss inherent in the pool at the 'AA' stress environment before taking into account the structural features of the CDO liabilities. Fitch PEL encompasses all loan, property, and poolwide characteristics modeled by Fitch.

Fitch will continue to monitor and review this transaction and will issue an updated Snapshot report after each committeed review. The surveillance team will conduct a review whenever there is approximately 15% change in the collateral composition, quarterly, or semi-annually.

For more information on the Fitch Rating Methodology for CRE loan CDOs, see 'Rating Methodology for U.S. Commercial Real Estate Loan CDOs' dated Dec. 20, 2007, which is also available at www.fitchratings.com.

Fitch introduced Rating Outlooks for U.S. structured finance in September 2008 to provide investors with forward-looking analysis for a structured finance tranche's credit performance. Fitch's Rating Outlook indicates the likely direction of any rating change over a one- to two-year period and may be Positive, Negative, Stable or, occasionally, Evolving. More information is available in Fitch's Sept. 11, 2008 report 'Introducing Rating Outlooks for U.S. Structured Finance Bonds'.

For CREL CDOs, a Negative Outlook may be assigned to any class that fails Fitch's stress testing. Fitch's stress testing assumes various property value declines for each rating stress. Based on these results, any loan whose loan-to-value ratio is greater than 100% is assumed to default with the recovery calculated based on the property value in that rating stress.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.