New York - As the number of commercial real estate CDO transactions increases, analysts and investors are calling for improved surveillance in a market that still lacks transparency, according to speakers at the Information Management Network's Second Annual Real Estate CDO Symposium held here last week. To that end, ratings agencies are attempting to provide at least some information on this somewhat opaque market, beginning with the managers themselves.
Standard & Poor's has a collateral manager focus group that publishes background information about the collateral managers, including their deal history and investment philosophy, said panelist James Palmisano, managing director at S&P.
The asset manager review is also a big component of Fitch Ratings' analysis. Managers must have the ability to oversee performing assets, and if not they must have a rated servicer in place. The rating agency also examines the managers' ability to monitor covenants and keep its funds invested, said panelist Jenny Story, managing director at Derivative Fitch Structured Credit. The rating agency publishes CDO asset manager profiles and currently rates 44 asset managers, according to its website.
New managers may have a problem getting a rating in the space, as ratings agencies like to see at least one transaction under a company's belt, Story said. "If the manager does not have much experience then we might not even rate the deal."
Ratings agencies also take into account regulations on trading. S&P calls for a manager to maintain par, meaning that if the securities or assets are sold in a portfolio, for example if they are downgraded and are sold in order to liquidate and limit losses, the manager must reinvest the funds. Right now, the majority of CRE CDO vehicles are made up of loans on transitional properties like office buildings and hotels, S&P's Palmisano said.
And transaction analysis is expected to continue and expand, Story said. "Everybody has a different level or reporting. We need more consistent and available information," she said. And firms like accounting agencies may step in to assist managers in processing more surveillance information, she added.
All eyes on CRE
Surveillance once the fund is invested is also a critical focus for the ratings agencies. Fitch has a group that is solely focused on CRE CDO surveillance, producing monthly reports on issues such as whether covenants are being upheld. "The loans are changing all the time so you need a team to be focused deal by deal," Story said.
With CRE CDOs still relatively young, it is hard to gage just how the debt will play out in the event of a downturn or even market slowdown. "CRE CDOs were really born in 2004 and have grown up in an extraordinary period for commercial real estate," said panelist Nicholas Levidy, managing director at Moody's Investors Service.
And whole-loan CDOs are also in their early stages, providing the rating agencies with very little information to monitor performance. Most of these CDOs are still in their reinvestment period, said Palmisano. "What drives an upgrade is improved collateral and debt pay down and until we really get to the end of the reinvestment period we will not see rating actions in either direction," he said.
Going forward, trends to look for in the CRE CDO market will mimic those of 2006, said the panelists. We will continue to see an import of securities from other markets like asset-backed securities and residential mortgage-backed securities, said Moody's Levidy.
Loan deals have not gone beyond the scope of their business plans, said Fitch's Story, who suggested that managers may look for "funkier assets" to get wider spreads.
In an earlier panel Jignesh Patel, managing director at Bear Stearns, also noted the introduction of new securities and was confident about their place within the CDO structure. "We will get creative and try to accommodate new assets. We will be able to come up with something that will work," he said.
Spread compression will also lead to many CRE CDOs being called in the near future, said panelist Richard Hill, vice president at Banc of America Securities. But this is not a complete negative, "the good news about having deals called is that issuers will have more experience despite the higher leverage on the deal," said panelist Glen Roder, director at MBIA Insurance Corp.
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