A lack of standard practices in the creation of commercial real estate collateralized debt obligations (CRE CDOs) poses unique challenges for those attempting to service the portfolios, according to a report by Derivative Fitch. The study, Commercial Real Estate CDO Servicing: A La Carte or Prix Fixe?, focused on CDOs composed of loans, or CREL CDOs.
“The high-touch nature of the loans and changing collateral composition of CREL CDOs make it that much more challenging to service the portfolios underlying these deals,” says Jenny Story, managing director and CRE CDO group head at Derivative Fitch, a subsidiary of Fitch Ratings.
A CRE CDO is a collection of commercial real estate debts that is pooled and resold as securities, similar to commercial mortgage-backed securities (CMBS). Key differences between the two involve management of the pool of assets, which is static in a CMBS transaction but can be revolving in a CDO. That means the manager of a CDO can include short-term debts, like construction loans, and replace those loans when they are paid off by substituting new debt in the pool.
CMBS has established standard roles for primary, master, and special servicers who see that borrowers meet loan conditions and make payments according to schedule. The role of the CDO servicer, however, is anything but standard, according to the Derivative Fitch report. Challenges to CDO servicers include more detailed investor reporting than in CMBS, dynamic pool management, special assets expertise, future funding administration, coordinating among multiple parties in the administration of the CDO.
“Servicers should be sure to determine their role up front when pursuing servicing assignments for CRE CDOs,” says Richard Carlson, a Fitch Ratings senior director who coauthored the report. “Servicers should look to their core competencies to determine which additional functions are most likely to add value to an asset manager’s platform.”
Copies of the report are available from Fitch Derivatives or Fitch Ratings.