Fitch Downgrades Seven Classes of Morgan Stanley 2007-XLC1

NEW YORK--(BUSINESS WIRE)--Fitch Ratings downgrades and places on Rating Watch Negative seven classes of Morgan Stanley 2007-XLC1, Ltd. and Morgan Stanley 2007-XLC1, LLC, (Morgan Stanley 2007-XLC1) as follows:

--$91,677,034 class A-2 notes to 'AA' from 'AAA' and placed on Rating Watch Negative;

--$58,613,508 class B notes to 'A' from 'AA' and placed on Rating Watch Negative;

--$25,549,254 class C notes to 'A-' from 'A+' and placed on Rating Watch Negative;

--$12,022,836 class D notes to 'BBB+' from 'A' and placed on Rating Watch Negative;

--$9,768,918 class E notes to 'BBB+' from 'A-' and placed on Rating Watch Negative;

--$20,288,900 class F notes to 'BBB' from 'BBB+' and placed on Rating Watch Negative;

--$14,277,482 class G notes to 'BBB-' from 'BBB' and placed on Rating Watch Negative.

The following class is affirmed:

--$274,278,585 class A-1 notes at 'AAA' and assigned a Stable Outlook.

Fitch does not rate the class H, J, and K notes.

Fitch's downgrades of classes A-2 through G are based on the transaction breaching its poolwide expected loss (PEL) covenant and failing cash flow modeling stresses. Fitch conducts cash flow modeling to test the transaction's structure under various default and interest rate stress scenarios.

The placement of class A-2 through G on Rating Watch Negative is due to the HRO Hotel Portfolio (12.1% of the portfolio), which is a mezzanine loan that matured on Oct. 8, 2008 and has not yet been extended. A one-year extension is currently under negotiation. However, if the loan is not extended, classes A-2 through G could be further downgraded. The extent of the downgrades will be dependent upon Fitch's estimate of net recovery on this loan.

The HRO Hotel Portfolio loan is secured by interests in six full service hotels (2,201 rooms) located in five states. The borrower intends to invest over $40,000/key into the properties to increase the portfolio's performance.

Fitch conducted this review as approximately $70.6 million of the portfolio has paid down since last review and the PEL covenant was breached as of the October determination date. A breach of the Fitch PEL covenant for two consecutive determination dates triggers a switch to sequential pay of the notes from pro-rata pay.

Transaction Summary:

Morgan Stanley 2007-XLC1 is a commercial real estate (CRE) cash flow collateralized debt obligation (CDO) that closed May 8, 2007. The transaction is static and fully ramped.

The CDO has been subject to a modified pro-rata paydown feature, which allowed principal proceeds to be applied pro-rata to pay down the class A-1 through class J notes under certain conditions. To date, the CDO has received pro-rata paydowns totaling $200,599,584. Should a breach of the Fitch PEL sequential trigger occur for two consecutive determination dates, sequential paydown of the notes will be triggered. As of the October determination date, the trustee reported a failure of the PEL covenant. Based on Fitch's review, the PEL covenant is expected to be breached on Nov. 9, 2008, the next determination date, resulting in sequential payment being triggered. Paydowns are expected from four amortizing loans and sales of units from a residential condominium project in Manhattan.

Since last review, the Fitch PEL has increased to 42.500%. The increase is primarily due to several assets in the portfolio that are underperforming their business plans, as well as, two matured balloons, one of which is not performing. The CDO has negative reinvestment cushion of 5.500% based on the current PEL covenant of 37.000%.

Repayments to date (24%) are the result of the full payoffs of eight separate loans, and partial payoff or amortization of four other loans. As a result of these loan payoffs, the pool is more concentrated. The Fitch Loan Diversity Index (LDI) has increased to 1,027 from 861 at last review and 728 at close, which continues to represent below average diversity as compared to other CRE CDOs. The higher LDI is an additional reason for the increased as-is Fitch PEL.

The overcollateralization and interest coverage ratios of all classes have remained above their covenants, as of the Oct. 9, 2008 trustee report.

Collateral Analysis:

As of the Oct. 9, 2008 trustee report and based on Fitch categorizations, the majority of the collateral is comprised of B-notes (37.4%) and mezzanine debt (36.2%). The remainder of the collateral is commercial mortgage whole loans/A-notes (16.7%) and a CMBS rake bond (9.6%). Subordinate debt generally carries higher expected losses than whole loans/A-notes. Most of the subordinate loans are secured by interests in institutional quality assets with experienced sponsors.

Based on Fitch categorizations, office properties comprise the largest percentage of assets in the pool at 34.9%. Hotel loans are the second largest percentage at 32.5%. The hotel loans are secured by interests in the luxury, full-service, and limited-service segments of the industry, which provides some diversity by hospitality type. The highest percentage of assets is located in New York at 19.5%.

For a summary of the Fitch Loans of Concern and the 10 largest loans, please refer to the Morgan Stanley 2007-XLC1 CREL Surveyor Snapshot, which will be available beginning Nov. 12, 2008 on the Fitch web site www.fitchratings.com.

Asset Manager:

The portfolio is monitored by CT Investment Management Co., LLC (CTIMCO). CTIMCO, the collateral manager for the transaction, is a wholly owned subsidiary of Capital Trust Inc. (CT). CT, a specialty finance and investment management company founded in 1997 by Sam Zell and John Klopp, is a balance sheet investor and investment manager focused on structured finance products. The company is one of the leading real estate mezzanine investors in the U.S. and has originated over $10.0 billion of mezzanine and other high-yield investments.

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, and G notes address the likelihood that investors will receive ultimate interest and deferred interest payments, as 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.