Fitch: U.S. CREL CDO Delinquencies Rise Due to One New Maturity Default

NEW YORK--(BUSINESS WIRE)--The maturity default of one participated loan secured by a hotel/condominium development was the primary contributor to a higher U.S. commercial real estate loan (CREL) CDO delinquency rate for June 2008, according to the latest CREL CDO Delinquency Index from Fitch Ratings. The index increased to 1.58% from last month's rate of 1.08%. The delinquency index includes loans that are 60 days or longer delinquent, matured balloon loans, and repurchased assets.

The CREL CDO Delinquency Index (CREL DI) of 1.58% is approximately four times the Fitch CMBS Delinquency Index (CMBS DI) of 0.39%. Although the CREL DI continues to be higher than the CMBS DI, it is not unexpected. Firstly, the assets securing the loans in a CREL CDO are either transitional in nature or highly leveraged. In addition, the CREL DI covers 35 transactions with 340 assets while the CMBS DI covers many more (500) transactions with significantly more (42,000) loans. As a result, because of the smaller number of loans in the index, one loan can have a big impact on the delinquency percentage. In fact, this month, one loan, contributed 38 basis points (bps) out of the 50 bps rise in the index. This newly matured loan is secured by a hotel/condominium development in South Florida. The whole loan was split into two pari-passu senior participations and two sequential junior participations. The two senior interests and one of the junior interests were contributed to three separate CREL CDOs.

The credit enhancement for CREL CDO bonds generally reflects the higher inherent risk compared to CMBS: the average credit enhancement for CREL CDO bonds rated 'BBB-' is approximately five times that of similarly rated CMBS bonds.

Of the 20 loans in the June 2008 CREL delinquency index, over one-third are land loans. It is generally acknowledged that land loans are expected to be more difficult to refinance in today's capital constrained market. Fitch-rated CREL CDOs are rated with the expectation of higher default probabilities for land loans. Similarly, hotel loans, which make up the next highest property type in the index at 26% are also, in general, modeled with higher default probabilities. Two loans secured by retail properties make up the third largest component by property type at 20%. Fitch anticipates delinquencies in this category to increase given the current stress on the U.S. economy. Retail property loans represent approximately 6% of the CREL CDO loan universe.

Fitch assumes 100% probability of default for loans which are 60+ days delinquent. As a result, continued increases in delinquencies will reduce the collateral managers' reinvestment cushions as the actual Fitch poolwide expected losses (PEL) approach the Fitch PEL covenant. While rising delinquencies will reduce managers' reinvestment flexibility for some CREL CDOs, the transactions were originally rated to withstand some negative migration. The reductions in cushions due to CREL delinquencies at this point have not warranted the placement of any transaction on Rating Watch Negative. Fitch will continue to monitor the reinvestment cushion for individual CREL CDOs as delinquencies increase.

While repurchases are a smaller percentage of the overall index compared to six months ago, asset managers continue to repurchase assets from their CDOs. For this reporting period, asset managers repurchased three assets (12 bps), including two from one CDO. The repurchased assets consist of a whole loan secured by a multifamily property and a mezzanine loan secured by an interest in an office property. Both of these loans were previously reported as 30 days or less delinquent in last month's CREL DI. In keeping with past trends, the third repurchased loan was a B-note secured by land intended for homesites. 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.

Although not included in the Index, 11 loans, representing 1.12% of the CREL CDO collateral were 30 days or less delinquent in June 2008. This statistic is up slightly from last month's total of 1.08%. Fitch views this delinquency bucket as a leading indicator for the delinquency index. The loans in the 30-day bucket have steadily increased since October 2007.

Five rated assets were considered credit impaired; these assets, however, were not delinquent and not included in the Index. The decrease from last month's total of 12 credit impaired assets results from the disposition of seven U.S. subprime RMBS bonds from one CDO. These securities were sold by the CDO at a steep discount resulting in realized losses for the CDO.

Fitch noted 20 reported loan extensions in June 2008, which is up from last month's total of 14. Approximately half of the extensions were a result of options contemplated at closing; while the other half were modifications from the original loan documents. These loan extensions continue to reflect the lower available liquidity for CRE loans, especially those typically found in CREL CDOs, which tend to be backed by transitional and/or highly leveraged CRE collateral.

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