LAGUNA NIGUEL, CALIF. - As an increasing number of commercial real estate investors become first-time CDO issuers, investors are wondering: Are these deals much more than a form of secured financing? Commercial real estate CDO issuance this year is expected to triple to an estimated $14 billion to $15 billion, while upping its share of the CDO market to 10% from just 5% last year.

While investors favor the positive track record of commercial real estate CDOs, they concede that the deals behind the recent surge in issuance - in terms of collateral type, structure and issuer - are a different breed than their older counterparts. Issuers that are new to the sector, some say, are bringing deals to the market that allow for a mixed bag of collateral, including B-notes and mezzanine debt. With the new collateral types and issuers, participants at Opal Financial Group's CDO Summit held here last week said that they were looking twice at new issue deals in the sector.

Brian Koeller, a vice president at State Street Corp., said the firm is buying a lot of CRE CDOs in the secondary market, but that newer deals carry less credit enhancement and require more discretion. "We saw a number of transactions that were nothing more than secured financings," Koeller said, speaking during a panel discussion at the conference. The deals in question had up to eight-year revolving periods and weighted average rating factors in the 3,400 to 4,000 range.

"These are very, very deep credit profiles going into those deals, but they had eligibility criteria that allowed them to put about anything they wanted in there. They were consolidating the SPV on balance sheet and holding the equity ... that's what led us to back away," Koeller said, adding that if the corporation ran into trouble and other forms of liquidity dried up, financing through the CDO could "be the last resort."

Deals done prior to 2003, because the collateral type was relatively new, often had higher levels of credit enhancement. "We've enjoyed a great benign default environment over the last several years," said Ken Cheng, a director at Standard and Poor's. Cheng said among S&P's biggest concerns right now for the CRE CDO sector is ensuring that the deals have adequate subordination levels. "You really have to be careful," he said. Cheng said the fact that a majority of recent vintage CRE CDO deals are managed, albeit "lightly," is good news, but the bad news is the introduction of "reinvestment risk." "The manager has to know what they're doing," Cheng said.

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