More commercial real estate (CRE) CDOs look set to take the stage despite the lack of available collateral needed to fuel market growth. The expansion of European CRE CDOs still heavily depends upon the ability of the commercial loan and CMBS markets to source assets.
In Europe, CRE CDO issuance has been much more muted when compared to U.S activity, with only two deals pricing over 2006 totaling 935 million ($1.217 billion). "Given the recent performance of the EMEA CMBS market, we expect to see a number of CRE CDO transaction in 2007," said Christian Aufsatz, a vice president at Moody's Investors Service, during the rating agency's EMEA gathering held in London last week. Some market estimates place the combined growth of European and U.S. CMBS at a volume of $350 billion to $370 billion, which is equivalent to a growth of 25% to 30% over 2006 volumes. However, European collateral is lumpy when compared to U.S. collateral. Deals are originated and structured in different European legislations, thus rarely are these transactions similar. The lack of prepayment deterrents for European commercial property loans also allow borrowers to prepay at no additional cost, leaving the CDO manager with principal proceeds invested in cash accounts. Both of these factors have so far prevented CRE CDOs from taking off with greater momentum.
According to Moody's, performance of CRE CDOs has historically been similar to that of commercial mortgage-backed transactions, which means that CRE CDOs should benefit from strong CMBS performance. Analysts said that CMBS transactions are likely to continue gaining from amortization and price appreciation with upgrades outpacing downgrades, particularly within the earlier vintages. "CRE CDOs however exhibit both a high degree of overlap and a low asset credit quality," Aufsatz said. "Risks need to be understood and modeled correctly."
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