CDO Growth Creates New Servicing Opportunities

Rapid growth in the collateralized debt market also presents opportunities for commercial servicers. Commercial real estate-backed CDO issuance was at a record $20.53 billion in 2005, up 223.9% from 2004 levels, according to Wachovia Securities. And market participants expect CRE loan-backed CDO issuance to gather more steam, considering that this structure provides more flexibility for servicers to manage the loans on behalf of investors and avoid the rigidities of the REMIC format. The market trend right now, is for the transitional floating-rate loan-backed collateral that requires more servicer discretion to move to the CDO format, while the stabilized, fixed-rate-backed collateral sticks with the commercial mortgage-backed securities deals.

Rich Carlson, a director with Fitch Rating's structured finance group who is involved in CMBS servicer ratings, told Commercial Servicer that Fitch has received more inquiries in the last month from CMBS servicers regarding CDO servicing opportunities since they consider it as "additional product to supplement their servicing portfolios." He sees opportunities for servicers in this area, considering that not all issuers of CDO product have servicing capabilities in-house and often they have to hire someone to do the servicing. The opportunity he sees is for CMBS servicers to service whole loan CDOs.

Sometimes CDO issuers originate the loans and can service them for an interim period, and sometimes issuers purchase loans that already have servicers who are on a servicing contract that can be canceled if the loan is sold. Often, what happens is that after the loans are packaged, the issuer will hire a third-party servicer to do the servicing under the guidance of the issuer, according to Mr. Carlson. And if the loan is subordinate debt to a loan that has been contributed to a CMBS securitization and already has servicers attached to it, "in those cases, it is just another entity for the CMBS servicer to do additional reporting and keep in the loop."

While there is no requirement right now for the servicers of CRE loan CDOs to be rated and theoretically there are opportunities for all sorts of servicers, Mr. Carlson believes that CMBS servicers "have a leg-up on other servicers" considering that "if you already service in a securitized environment, you will be familiar already with the types of reporting that is associated with CDOs." The rating agency currently undertakes reviews of CDO servicers that are not already rated for their CMBS servicing capabilities to make sure that they have the required capabilities. Fitch often reviews servicers that are related to the CDO issuers (for instance the issuer's parent might have a group that services loans, but not for the CMBS market), Mr. Carlson said. There are also a few third-party servicers that have gone through the Fitch review process.

Mr. Carlson anticipates that CRE loan CDOs are going to expand, with a lot of transitional properties going into them, because the CDO format offers more flexibility than the REMIC format. "It gives capital markets opportunities to smaller players rather than just the big investment banks and so it allows them to compete for those types of assets and gives them a renewable funding source," he said.

Crown Northcorp, a small company whose U.S. servicing portfolio is currently under $100 million, is one servicer that is seeing opportunity in this niche. Roy Owen, Crown's managing director, U.S. operations, told Commercial Servicer, "We are just targeting the CDO servicing area. Crown is a small boutique, high-touch, low-volume servicer and has always dealt with unusual assets. And that's what CDO servicing is all about." According to him, CMBS servicing is "typically a matter of doing high volume servicing for homogenous assets" and CMBS servicers "are not in a position to provide the sort of differentiated high-touch, high customer attention servicing" that CDOs require.

Considering that CDOs are very flexible and allow loans to move in and out of the pool, the loan subset of the pool has loans that are very different from each other. For instance, mezzanine loans, construction loans and short-duration bridge loans, "all of which require a lot more attention than, say, if you have a pool of 500 CMBS loans which are all pretty much alike."

As for servicing-related fees in this niche, the margins are higher, but the volumes are lower and Crown intends to quote a fee each time based on the particular characteristics of the loans in a pool. And Mr. Owen also sees opportunities to do some co-investing with the other investors in a CDO, in addition to doing the servicing. Mr. Owen sees "a lot of the more sophisticated players looking to the CDO structure as a new and more attractive alternative for the kinds of investing they want to do than the CMBS structure" and therefore sees this as a "great growth opportunity." While he expects that a lot of servicers will be initially attracted to this niche, he believes that "the higher volume larger servicers are probably going to find that the economics are not as attractive as for other traditional servicing." (c) 2006 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com http://www.sourcemedia.com