B-Piece CRE CDO Strategies In The New Market

by Jessica Lillian
on November 03, 2007 No Comments
Categories : E-Features

While economic conditions have demanded revised strategies for the most effective presentation and use, B-piece commercial real estate collateralized debt obligations (CRE CDOs) can still generate healthy returns for investors, according to panelists at the recent Commercial Mortgage Securities Association (CMSA) CRE CDO Conference in New York.
A CRE CDO is often not viewed as an investment or asset class in itself, said Chris Milner, managing director at BlackRock. "It's a tool that we utilize to re-package – or package in the first place – cashflows from a broad range of asset classes," he explained.
When discussing the vehicle with investors, CWCapital Investments and Asset Management LLC focuses on cashflow and fundamentals, according to Craig Lieberman, managing director at the firm. He also recommended underwriting to cashflows rather than devoting excessive attention to portfolio factors such as correlation and credit ratings.
Those two hot issues, along with CDR breaks, nevertheless weigh heavily on many current and potential investors' minds.
In particular, the evolution of the ratings model and investors' growing skepticism of the analysis in the volatile space of commercial real estate may rank as greater concerns than the asset content associated with the CRE CDO itself.
"The risk we see right now is that there is a great deal of uncertainty about how these analytical approaches are going to change," Milner said.
Uncertainty abounds elsewhere in the capital markets as well, and B-piece CRE CDOs have not been immune to the lower availability of capital, drops in loan origination volume and large-scale macroeconomic events that have rattled other investment structures. According to Milner, many originators have faced recent volume drops of approximately 50% to 75%.
Yet some resulting trends have been welcome, remarked Paul Smyth, senior managing director and co-group manager of the commercial real estate group at Centerline Capital Group.
Lower percentages of interest-only (IO) loans in pools – and the elimination of IO deals completely from certain funds – create stronger investment performance through greater amortization, for example. A moderate amount of inflation can raise values and help remaining IO loans repay upon maturity, Lieberman added.
In addition, many investors now request less complexity in the CRE CDO pool than might have been acceptable in earlier eras, and demand for static pool structures has risen, reported Lieberman. Lenders must also consider the changing demands of balance sheet management, which has become a particular challenge for smaller firms in the new climate.
"You have to look at the world differently this week than you did six weeks ago," said Milner. With the potential for disastrous defaults now on the rise, he recommended applying a "modestly higher loss expectation" and assuming cashout refinances to occur only rarely.
Loss assumptions under a variety of possible outcomes should be factored into analysis of leverage, Milner added. While B-piece CDOs are used as a leverage tool, the vehicle often features relatively low leverage percentages.
That trend may be shifting, according to Smyth. "As we go into a CDO, we're moving that 45 to a 70," he said.
To further encourage pool performance and attract investors, CWCapital emphasizes large loans with locked low rates, said Lieberman.
"When we underwrite a B-piece portfolio, we look at the top 15, top 20 loans as bulletproof," he explained. Despite the significant exposure that accompanies a pool of large loans, investors must feel confident that such exposures will pay off.
Smyth pointed out that his firm has experienced very few defaults in its recent series – a likely result of programmatic buying and Centerline Capital Group's policy of underwriting every loan in even in the largest CRE CDO pools.
Another possible key to success is increasing diversity, said Lieberman, adding that his firm has done straight re-packs but also frequently mixes subordinates with other assets such as b-notes and mezzanine pieces "to make a full complement."
More aggressive efforts toward achieving pool diversity, however, must be undertaken with caution – particularly if reducing correlation is the only motivating factor.
Although a portfolio consisting of unusual property assets is all but guaranteed to behave in a satisfactorily uncorrelated fashion, said Milner, the approach may introduce more risk than it eliminates.
A lender's team assigned to "very intensively analyze and put together that portfolio and then administer it, oversee it, surveil it" would be unlikely to carry enough experience in such unusual assets to prevent the operation from causing practical risk greater than the investment risk it reduces, he explained.
Instead, he suggested that investment managers inform investors where the risk is being provided in the CRE CDO and then leave the portfolio instructor the responsibility of more granular diversification within the larger asset classes.

E-FYI

NeighborWorks Establishes Financing Arm

NeighborWorks America has named James Ferris executive director of NeighborWorks Capital, the newly formed real estate development financing arm of the corporation. The new entity is the result of the recent merger Neighborhood Capital Corp. and RNA Community Builders.
NeighborWorks Capital will provide loans to enable NeighborWorks organizations to carry out real estate development projects beneficial to their communities, including affordable rental housing, affordable homeownership housing and commercial projects.
Similar to its predecessors, NeighborWorks Capital's lending will consist primarily of short-term loans for pre-development costs, acquisition of sites and properties, construction or rehabilitation, and interim financing during operations. The company also will offer new products to serve its expanded market and provide development services to assist clients in structuring viable loan applications and projects.
Previously, Ferris was executive director of Codman Square Neighborhood Development Corp, Boston – a NeighborWorks network affiliate.

KeyBank Adds To KCMD Platform

KeyBank Real Estate Capital, a Cleveland-based commercial real estate capital provider, has appointed four senior commercial mortgage professionals to the bank's Key Commercial Mortgage Direct (KCMD) small-loan origination and securitization platform.
Managing director Charles Krawitz will head KCMD with the support of 12 originators, including three professionals joining the bank with Krawitz: directors Ryan Welsh, Jonathan Willems and Chad Eisenberg. The new hires will be based in Chicago.
"Charles is a leader in the small loan securitization business, and Ryan, Jonathan and Chad are all exceptional professionals with proven track records," says Norman V. Nichols, executive vice president and head of KeyBank Real Estate Capital. "This expansion is a reflection of the momentum Key has created in the commercial mortgage arena."

E-Dealmakers

IL: BUTTERFIELD EXCHANGE II, ELMHURST

WHAT: The property, located at 360 West Butterfield Road, is occupied by about a dozen medical and professional tenants. The bottom three floors of the commercial building total approximately 70,000 square feet.
WHO: NorthPoint Capital, Chicago, arranged the loan for the buyer, who purchased only the bottom three floors of the building.
$$$: $7,625,000.
TERMS: The loan includes a fixed interest rate of 5.67% for a term of 10 years, a three-year interest-only term and a 30-year amortization.
NorthPoint Capital: (312) 669-9300.

FL: GLEN OAKS, NORTH TAMPA

WHAT: Glen Oaks Apartments is a 64-unit garden-style apartment complex housed in four two-story buildings. The property was constructed in 1989.
WHO: Spring Hill, Fla.-based AIB Capital Management LLC secured financing through
Nomura Credit & Capital on behalf of the Glen Oaks Land Trust.
$$$: $2.7 million.
TERMS: The 10-year nonrecourse loan carries a fixed rate of 6.28% and is based on a 25-year amortization schedule.
AIB Capital Management: (352) 797-4850.

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