Now that Credit Suisse First Boston has underwritten the second structured finance deal ever backed entirely by loans tied to the conversion of apartments into condominiums, other banks are looking to get into the game. Rating agencies say other dealers are likely to assemble transactions, and Dan Chambers, an analyst at Fitch Ratings, said he expects issuance in the incipient market will grow to $3 to $5 billion in 2006 from $2.7 billion this year, even as overall interest in condo conversions appears to be slowing.

The low interest-rate environment of recent years sparked a bit of a condo conversion craze, in which companies transformed rental apartments into condos that they could sell to buyers who were unable or unwilling to purchase single-family homes. This generated quick returns for the owners of apartment buildings, allowing them to cash out at what many perceived to be the top of the market. Some banks have loads of these loans on their balance sheets and are looking to move them off, so they've been included as part of the collateral packages backing a number of recent CMBS deals and some real estate CDOs.

CSFB has been the dealer pushing the envelope by structuring deals solely backed by condo conversion loans. Understandably, it has been careful in crafting the first couple of offerings in what is essentially a new asset class. "This is a very immature market, and what goes out initially to get investors comfortable will certainly be cherry-picked," Chambers said. "This is the best of the best, and as the market expands, it's safe to assume you will see more tolerance for risk."

New York properties make up more than 53% of the collateral in CSFB's latest deal, dubbed CND-2, which priced last month. Aaron Wessner, another Fitch analyst, has a favorable view of the New York assets involved in this deal, arguing they are generally well located and therefore more desirable than many other condominiums available in the city. The most valuable single property in the collateral consists of units in the Manhattan House, a monstrous 583-unit apartment building on 65th Street, an affluent neighborhood on the city's East Side.

The first few CMBS deals backed by condo conversion loans offer a sizable premium versus vanilla CMBS offerings. The latest offering, a $2 billion transaction, included a junior triple-A tranche with a 1.9-year average life that priced at 40 bps over Libor, 15 bps more than a like tranche in a typical CMBS deal.

There are some concerns about the potential for this market. One is that CMBS investors are typically insurance companies and pension funds with demand for 10-year fixed-rate debt, while these condo conversion deals tend to have shorter maturities. For instance, every tranche in the CND-2 transaction is shorter than 2.5 years. "These are short-term deals that in many cases begin paying off shortly after pricing, so my sense is a lot of banks believe that, given their short-term nature, they aren't worth the brain damage of structuring the deal and getting it reviewed by the lawyers and ratings agencies," said Chambers, who estimates this new route of financing condo conversions is likely to finance "well below 10%" of the total market.

Several market participants, including Fitch, have expressed concerns that the condominium conversion market is overheating. UBS recently said publicly that it is no longer lending to condo developers for projects in Miami or Las Vegas, while it is even a bit wary about the hot New York City market.

One analyst said traditional bank lenders almost always require borrowers to have commitments from buyers before they lend money for condo conversion projects. He worries that CMBS investors could be burned, because this is often not the case in these deals. At Manhattan House, which makes up 22.6% of CND-2, the developers have not sold any of the units to be converted, which is understandable because the New York Attorney General has yet to approve the project. Fitch's rating report on CND-2 notes that the project's developers, Jeremiah O'Connor and Richard Kalikow, have a great deal of experience successfully converting properties into condominiums.

(c) 2005 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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