Another first-time commercial real estate CDO issuer has come to the market, with a $416 million deal expected to close Nov. 10. JER Investors Trust Inc., a publicly traded REIT, primarily buys and originates commercial mortgage-backed securities and loans, mezzanine loans, mortgage loan B-notes and net leased real estate investments.
The company Chairman and CEO Joseph Robert said the company will use the CDO to provide match-fund assets and liabilities. The company will retain a portion of the triple-B minus rated notes, the non-investment grade notes and all of the preferred shares. The JRE CRE CDO 2005-1 will issue $276 million worth of triple-A through triple-B minus notes. The deal includes a $46 million ramp facility.
Commercial real estate CDO issuance continues to boom as more and more first-time issuers become involved in the market. Through the third quarter, 71 commercial real estate CDOs totaling $36 billion have come to the market, according to a report issued by Citigroup Global Markets last week. Commercial real estate CDO issuance is on track for a 130% increase over 2004, and 96% over its previous high reached in 2002, Citigroup researchers estimate.
While asset managers have found arbitrage difficult to achieve with the currently tight spread CMBS market, real estate loan investors and mortgage real estate investment trusts - such as JER Investors Trust, Antracite Capital Inc. and Newcastle Investment Corp. - are enjoying the match term financing without mark-to-market risk that CDO issuance can entail. Recent transactions have been issued primarily as a source of financing, which generally means that the manager retains the most subordinated tranche. Nearly 30 separate managers or sponsors have issued commercial real estate CDOs through Sept. 30, according to Citigroup.
And, a relatively wide investment base looking to diversify out of the residential sector is also helping to fuel the fire. The majority, 62%, of commercial real estate CDO investors are within the U.S., while 22% lie in Asia and Australia. Asset managers constitute 34% of buyers, while financial institutions, insurance companies and hedge funds are 32%, 18% and 16% of the base, respectively.
So far, deal performance has been strong. Of 68 deals issued between May 1999 and September, the upgrade to downgrade ratio has been 14 to four, according to Citigroup, and according to Fitch Ratings, three of those downgrades were the result of manufactured housing exposure within 2000 and 2001 vintages. But as the new issuers come to the market and both the structure and content of the commercial real estate CDOs changes (see ASR 10/17/05) to more innovative, managed deals, what can be expected of performance?
Historically, new-issue spreads are wider than CMBS, among other securities, including even at times home-equity ABS, Citigroup researchers found. As of the third quarter, new issue triple-A commercial real estate CDO spreads were wider than triple-A CBOs and five-year triple-A CMBS paper, and only slightly tighter than five-year triple-A home equity paper.
While positive CMBS performance has driven upgrades, new issue CMBS is significantly less cushioned with overcollateralization than later vintages, Citigroup analysts noted. The average commercial real estate CDO issued this year is either fully or lightly managed with a five-year reinvestment period and a three-to-five year no call period - and, because it is a tool used for financing purposes, the collateral can vary. Certain collateral types found within these CDOs, such as rake bonds, could be unfamiliar territory for a traditional ABS or CDO investor.
As of Sept. 30, CMBS constituted about 38% of commercial CDO collateral, according to Fitch, while more than 50% of collateral is commercial real estate loans. The rating agency is expecting performance to echo that of the commercial real estate loan market.
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