Demonstrating strength against both mother nature's wrath of hurricanes and father capitalism's M&A activity, CDOs backed by commercial real estate assets continue to show strong performance, according to Fitch Ratings. In fact, the number of upgrades in the sector has outpaced downgrades by a ratio of 13.8 to 1. In a review this month of all outstanding commercial real estate CDOs, the rating agency not only found a ubiquitous trend of strong performance, but a slow transition in underlying collateral and structure of the deals.
For example, transactions issued prior to 2002 had the following average collateral composition: 54.3% real estate investment trust debt; 42.6% CMBS and 2.8% "other" ABS. That mix is quite a variance from this year's average offering. Take NorthStar Realty Finance Corp.'s N-Star Real Estate CDO, brought to the market last month. The $500 million deal includes a 70.8% CMBS concentration, 19.8% allocation for REIT debt and 5% and 4.4% for CRE CDO notes and other commercial real estate interests, respectively. Additionally, it is "lightly managed," according to a presale report issued by Standard & Poor's.
Attendees at S&P's recent Global CDO Conference' held in New York named commercial real estate as one of the sectors to next be transformed by CDO technology. And as CMBS issuers have grown increasingly familiar with CDO technology and REIT spreads have tightened, commercial real estate CDO collateral compositions have generally shifted away from REIT debt in exchange for higher concentrations of CMBS. Within 2002 and 2003 vintages, the average deal had CMBS exposure north of 64%, while the exposure to REIT debt fell below 25%. Last year, commercial real estate loans crept into the sector, constituting a 12.6% average concentration. As of Sept. 30, less than 5% of commercial real estate CDO collateral is REIT debt, while roughly 38% is CMBS and more than 50% is, on
average, commercial real estate loans.
Fitch counted some 69 tranches in 17 CDOs that have received upgrades, and only five tranches within two of the deals had been downgraded. Because the majority of commercial real estate CDOs have traditionally been static transactions, performance has echoed that of the general commercial real estate market. Vintages from 2002 through 2004 are expected to continue that trend, while pre-2002 vintage CDOs are expected to have mixed performance going forward, due to RMBS exposure.
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