An increase in delinquencies on collateralized debt obligations backed by commercial real estate loans (CREL CDOs) is likely as asset managers cut down on repurchases of assets to better manage the pools, reports-based Fitch Ratings.
Most asset managers have been proactively managing their commercial real estate CDOs by drawing on their right to repurchase assets. However, liquidity pressures are likely to make the repurchasing option more difficult in future.
A CREL CDO delinquency index maintained by the ratings agency rose to 1.46% in July 2008, up from 0.36% last October, when Fitch first began tracking delinquencies with this index. After accounting for cumulative asset repurchases, the current delinquency rate would grow to 2.6%.
“Reduced CDO cushions are becoming more commonplace with the dual pressures of reduced liquidity and increased delinquencies,” notes Karen Trebach, a senior director with Fitch.
Nearly two-thirds of asset managers have repurchased nonperforming or underperforming assets from their CDOs. But that practice is unlikely to go on forever: Half of those asset managers face some degree of capital constraint that would limit their ability to continue to repurchase underperforming assets on an ongoing basis.
“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,” says Trebach.
The collateral that goes into commercial real estate CDOs is generally considered to be more transitional and uses more debt financing than traditional conduit loans.
Fitch has tracked a total of 24 loans that have been repurchased from 13 different CREL CDOs since October 2007. This makes up 1.31%, by dollar balance, of the pool of Fitch-rated collateral.
The majority of repurchased assets during this period have been commercial real estate loan interests. Whole loans and A-notes made up more than 43% of the repurchases by asset type. And B-notes accounted for about 24% of the repurchased assets.
Commercial mortgage-backed securities accounted for 2.5% of the repurchases, real estate bank loans more than 13%, and mezzanine loans about 17%.
Fitch expects that if delinquency rates on CREL CDOs continue to go up, more bonds from these pools could be downgraded or placed on watch for negative rating actions.