Repurchases Drive CDOs’ Mounting Troubles

NEW YORK CITY-Having yo-yoed up and down over the past several months, delinquency rates for commercial real estate CDOs went back up over 12% for June, Fitch Ratings reported Friday. The ratings agency pinned the increase on $136.9 million in asset manager repurchases of troubled assets.

Nine months ago, Fitch’s CREL CDO delinquency index stood at 8.7%. “CREL CDO delinquencies have more than tripled since September of last year,” senior director Karen Trebach said at the time. While the increases since September 2009 have been far more gradual, and have just as frequently been offset by factors that lowered the delinquency rate for a given month, the rate has exceeded 10% each month since October, peaking at 13% this past December.

June’s increase to 12.2% follows a decline to 11.6% in May, a monthly drop that Fiotch attributed to asset managers continuing to extend loans and trade out credit risk assets, and slightly exceeds the 12.1% delinquency rate recorded in April. In reporting the June index, Fitch notes that asset managers are continuing to actively repurchase defaulted and credit-impaired assets from CDOs.

“Resolving credit-impaired assets at a loss to the CDO has become a consistent trend among asset managers,” director Stacey McGovern commented in April. “Further, not all of the credit-impaired assets are delinquent at the time of the resolution.”

In June, seven whole loans totaling 58 basis points were repurchased from three different CDOs, compared to seven bps for May and 25 bps for April, Fitch says. Aside from these repurchases, new delinquent assets include four term defaults, six matured balloons and 11 credit-impaired rated securities. There were 35 loan extensions reported in June, including two former matured balloon loans.

Fitch says realized losses of about $39.4 million were reported in June from the disposal or resolution of other troubled assets, down from $50 million in May. The highest asset loss to a CDO was $15 million, which reflected the impact on a real estate bank loan of a bankruptcy reorganization plan. Another high realized loss was related to the discounted payoff at approximately 50% of par of a mezzanine loan interest on a mall in Hawaii.

Losses were also incurred on the sale of junior mezzanine and B-notes. Anecdotally, the agency says, managers have noted greater interest from prospective loan purchasers with loan-to-own strategies. The reasoning, Fitch says, is that acquiring junior portions of the capital stack of a loan can provide an opportunity to gain control over a collateral asset.

Of the 35 CREL CDOs rated by Fitch Ratings, 34 reported delinquencies in June that ranged from 1.2% to 39.8%. Additionally, 15 Fitch-rated CREL CDOs in June were failing at least one overcollateralization test, one less than the total for May. Failing OC tests generally leads to the cutoff of interest payments to subordinate classes, including preferred shares, which are typically held by the CDO asset managers.

Twenty-four percent of the delinquent loans in the June index were backed by multifamily properties, which comprise 17% of the loans in the Fitch-rated CDO universe. The second largest pool of delinquent loans occurred in the office sector at 13%, although office represents 24% of the CDO universe as rated by Fitch. Whole loans and A-notes comprise 51% of the Fitch-rated CDO universe and 61% of the collateral in the June delinquency index.

The Fitch universe of 35 rated CREL CDOs currently encompasses approximately 1,100 loans and 350 rated securities/assets with a total balance of $23.8 billion. The CREL delinquency index includes loans and assets that are delinquent for 60 days or more, as well as matured balloon loans and the current month’s repurchased assets.