As rating agencies boost their CRE-surveillance criteria to defend against opacity, the Commercial Real Estate CDO market appears to be learning from transparency troubles in the ABS CDO space. Recently, Derivative Fitch released a report requesting CRE CDO managers to distribute enhanced and standardized loan-level information to investors in an effort to avoid downgrade shock, while increasing market liquidity.
"Our ratings are only as good as the information provided to us," said Jenny Story, managing director at Derivative Fitch. "We want to put this out and let investors know what kind of information they should be requesting within the indentures on deals, so they can make sure their deals are being properly monitored."
There really is no consistency in reporting loan information in CRE CDO deals, Story explained, noting that assets surveillance is done in-house, typically, where managers may not have systems in place to do sufficient reporting. "Not all asset managers are providing delinquency reports on a monthly basis," Story added. "For some asset managers, it is easy to get the information, for others, it is more difficult. The process is just not as efficient as it could be. It takes us longer to put out our reports because we are waiting on information, and we would like to be timelier [in our reporting]."
As part of its surveillance process, Fitch said it will request monthly loan-delinquency status reports, updated quarterly operating cash flows, the latest on debt stacks, quarterly reports on the current state of business plans for transitional loans, reserve status schedules and a schedule of watch-list loans.
More Data, More Money?
Investors welcome the additional reporting, noting that the extra data could increase liquidity in the market. For example, if CRE CDO managers underwrite their CDO's to safe standards, the added surveillance will show that the assets are actually stronger than the market's perception of them, which should prompt additional buying, a CRE CDO investor said. "Just because [some investors] are scared of the real estate market doesn't mean that [issuers] didn't underwrite [the loans] correctly," he said. However, it could also work in reverse, the investor added, explaining that the benefits of the additional reporting for the CDO manager will depend on the CDO and how loose the manager was in his or her underwriting. "[The enhanced surveillance reports] will basically double-check the underwriting standards behind these deals," he said.
Updated debt-stack reporting is particularly important, the investor said, noting that although a loan may be commercial does not mean it does not have residential risk in it, necessarily. "If I did a CDO and gave a bridge loan to a land developer to take down land-for instance 1,000 acres in California where the plan was to go in-and put up some infrastructure and sell it to a home buyer, now the developer might not have an exit strategy. [That's] because the homebuyers, based on the credit crunch and subprime troubles, are not going to be buying," he said.
When examining loans to office buildings, the investor noted, if the national economy suffers, that will affect the retail market, which could in turn impact employment and how much office space companies need. "Managers will need to make sure that their loan-to-value ratios [in the CDOs] are correct."
Indeed, understanding the amount of debt that has been repaid to each position in the capital stack and the performance of the remaining collateral will provide an accurate assessment of the last dollar of exposure to the trust position, Fitch said.
Future Still Bright
Delinquent loans within the CRE CDOs are still less than 1% for Fitch-rated transactions, the rating agency said. Of the defaulted loans, five were repurchased by the issuer from the pool within 90 days of the default at par-plus-accrued interest. Of the five remaining loans, two are 60 days delinquent and three are 30 days delinquent, as of Sept. 26, 2007.
Indeed, lack of transparency in portfolios is the biggest contributor to the pricing problems in the CMBS market-not the collateral, a CDO manager said. "There is no such thing as subprime CMBS. These are long-term leases to credit-worthy borrowers."
For now, the request for additional surveillance reports is in anticipation of a continued liquidity crisis as well as the fact that a lot of these loans are transitional, relying on liquidity for financing, Fitch's Story added. "We want to make sure we are on top of how they are progressing," she said. "This is the time when everyone is concerned; this is the time when issuers are making a lot more noise."
Fitch will begin publishing a monthly delinquency index at the start of each month. The reports will cover the average delinquency across all of the Fitch-rated CRE CDOs as well as pinpoint the drivers behind the delinquencies and what types of loans are being affected.
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