Credit metrics should remain stable for U.S. commercial real estate collateralized debt obligations (CRE CDOs) well into next year despite fewer upgrades, reports Fitch Ratings. A potential for higher loan losses in the event of a prolonged liquidity crisis and sustained value declines could also result in downgrades to investment-grade classes of CRE CDOs backed by subordinate
“The slower rate of CRE CDO upgrades, particularly from newer vintages, will partially arise from higher interest-only (IO) concentrations among recent vintage CMBS that will slow the amortization of the most senior classes,” says Fitch Senior Director Karen Trebach.
Fitch predicts that substantially all managed CRE CDOs composed primarily of loans (CREL CDOs) will continue to be affirmed in 2008. But reinvestment cushions should tighten in CREL CDOs with exposure to condominium conversions, home sites, construction loans, and other transitional assets that could fall behind plan with little to no reserves to cover debt service and capital improvements.
A total of 33 transactions were upgraded and only three were downgraded. Less than 9% of the CRE CDO universe has significant exposure to subprime RMBS.
Even so, new CRE CDO issuance has stalled in recent weeks due to liquidity issues in the broader capital markets. While 2007 year-to-date issuance remains on par with last year (26 transactions and $19 billion of collateral through September 2007), managing director and CRE CDO group head Jenny Story says that “issuance is likely to be lower this year compared to last [year] primarily because of a capital-constrained and distracted investor base as opposed to poor performance on the underlying collateral. Performance to date is strong.”