Fitch Downgrades Resource Real Estate Funding CDO 2007-1; Assigns Outlooks, LS & RR Ratings

NEW YORK--(BUSINESS WIRE)--

Fitch Ratings has downgraded all classes of Resource Real Estate Funding CDO 2007-1 Ltd./LLC (RRE 2007-1) reflecting Fitch's base case loss expectation of 35.9%. Fitch's performance expectation incorporates prospective views regarding commercial real estate market value and cash flow declines. A detailed list of rating actions follows at the end of this release.

RRE 2007-1 is collateralized by both senior and subordinate commercial real estate (CRE) debt: 59.6% are either whole loans or A-notes and 23.0% are either B-notes or mezzanine loans. Fitch expects significant losses upon default for the subordinate positions, since they are generally highly leveraged debt classes. Further, one loan (1.5%) is currently defaulted while six loans (21.4%) are considered Fitch Loans of Concern. Fitch expects partial losses on the defaulted asset and Loans of Concern.

RRE 2007-1 is a $500 million CRE collateralized debt obligation (CDO) managed by Resource Real Estate, Inc. The transaction has a five-year reinvestment period during which principal proceeds may be used to invest in substitute collateral. The reinvestment period ends in June 2012.

As of the March 2010 trustee report and per Fitch categorizations, the CDO was substantially invested as follows: CRE whole loans/A-notes (59.6%), commercial mortgage-backed securities (CMBS: 15.9%), B-notes (12.5%), mezzanine loans (10.5%), and cash (1.5%). All overcollateralization and interest coverage (IC) ratios remained above their covenants as of the March 2010 trustee report.

Under Fitch's updated methodology, approximately 70.2% of the portfolio is modeled to default in the base case stress scenario, defined as the 'B' stress. In this scenario, the modeled average cash flow decline is 10.9% from the most recent available cash flows (generally third or fourth quarter 2009). Fitch estimates that recoveries will average 48.8%.

The largest component of Fitch's base case loss expectation is a mezzanine loan (4.0%) secured by interests in a Midtown Manhattan office complex totaling 1.2 million square feet. Cash flow from the property is not sufficient to support debt service. Fitch modeled a term default with a full loss in its base case scenario on this highly leveraged mezzanine position.

The next largest component of Fitch's base case loss expectation is a whole loan (6.1%) secured by a 244-key hotel property located in Tucson, Arizona. Despite a recent loan modification to remove the interest rate floor, the current property cash flow is insufficient to cover debt service and the borrower is covering the debt service shortfall out of pocket. Fitch modeled a term default with a partial loss in its base case scenario.

The third largest component of Fitch's base case loss expectation is a whole loan (6.2%) secured by a 260-unit multifamily property located in Renton, Washington. While the borrower renovated many of the units at the property, rents have remained significantly below market. The loan was recently modified to reduce the interest rate floor. Nevertheless, current cash flow from the property is still insufficient to support debt service. Further, Fitch is concerned that the interest reserve will become depleted prior to loan maturity. Fitch modeled a term default with a partial loss in its base case scenario.

This transaction was analyzed according to the 'Surveillance Criteria for Commercial Real Estate Loan CDOs,' which applies stresses to property cash flows and uses debt service coverage ratio (DSCR) tests to project future default levels for the underlying portfolio. Recoveries are based on stressed cash flows and Fitch's long-term capitalization rates. The default levels were then compared to the breakeven levels generated by Fitch's cash flow model of the CDO under the various default timing and interest rate stress scenarios, as described in the report 'Global Criteria for Cash Flow Analysis in CDOs.' Based on this analysis, the credit characteristics for classes A-1 and A-R are generally consistent with the 'BBB' rating category. The credit characteristics for class A-2 are generally consistent with the 'BB' rating category. The credit characteristics for class B and C are generally consistent with the 'B' rating category.

The ratings for classes D through M are based on a deterministic analysis, which considers Fitch's base case loss expectation for the pool, and the current percentage of defaulted and delinquent assets and Fitch Loans of Concern factoring in anticipated recoveries relative to each class' credit enhancement.

Based on this analysis, classes D through L are consistent with the 'CCC' rating category, meaning default is a real possibility. Fitch's base case loss expectation of 35.9% exceeds these classes' respective current credit enhancement levels. The rating for class M is deemed to be consistent with the 'CC' rating category, meaning default appears probable given the lack of cushion between the class's credit enhancement and the losses expected on the currently defaulted asset and Loans of Concern in the pool.

Classes A through C were assigned a Negative Outlook reflecting Fitch's expectation of further negative credit migration of the underlying collateral. These classes were also assigned Loss Severity (LS) ratings ranging from 'LS3' to 'LS5' indicating each tranche's potential loss severity given default, as evidenced by the ratio of tranche size to the expected loss for the collateral under the 'B' stress. LS ratings should always be considered in conjunction with probability of default indicated by a class's long-term credit rating. Fitch does not assign Outlooks or LS ratings to classes rated 'CCC' or lower.

Classes D through M were assigned Recovery Ratings (RR) to provide a forward-looking estimate of recoveries on currently distressed or defaulted structured finance securities. Recovery Ratings are calculated using Fitch's cash flow model and incorporate Fitch's current 'B' stress expectation for default and recovery rates (70.2% and 48.8%, respectively), the 'B' stress USD LIBOR up-stress, and a 24-month recovery lag. All modeled distributions are discounted at 10% to arrive at a present value and compared to the class's tranche size to determine a Recovery Rating. The assumptions for the 'B' stress USD LIBOR up-stress scenario are found in Fitch's report, 'Criteria for Interest Rate Stresses in Structured Finance Transactions' (Feb. 17, 2010), available on Fitch's web site at 'www.fitchratings.com'.

The assignment of 'RR2' to class D reflects modeled recoveries of 79% of its outstanding balance. The expected recovery proceeds are broken down as follows:

--Present value of expected principal recoveries ($12.3 million);

--Present value of expected interest payments ($9 million);

--Total present value of recoveries ($21.3 million);

--Sum of undiscounted recoveries ($40.3 million).

The assignment of 'RR3' to class E reflects modeled recoveries of 62% of its outstanding balance. The expected recovery proceeds are broken down as follows:

--Present value of expected principal recoveries ($4.5 million);

--Present value of expected interest payments ($2.8 million);

--Total present value of recoveries ($7.3 million);

--Sum of undiscounted recoveries ($17.2 million).

The assignment of 'RR5' to class F reflects modeled recoveries of 12% of its outstanding balance. The expected recovery proceeds are broken down as follows:

--Present value of expected principal recoveries ($0.3 million);

--Present value of expected interest payments ($1.1 million);

--Total present value of recoveries ($1.4 million);

--Sum of undiscounted recoveries ($2.9 million).

Classes G through M are assigned a Recovery Rating of 'RR6' as the present value of the recoveries in each case is less than 10% of each class's principal balance.

Fitch has downgraded, assigned LS and RR ratings and Outlooks to the following classes as indicated:

--$180,000,000 class A-1 to 'BBB/LS3' from 'AAA'; Outlook Negative;

--$50,000,000 class A-R to 'BBB/LS3' from 'AAA'; Outlook Negative;

--$57,500,000 class A-2 to 'BB/LS5' from 'AAA'; Outlook Negative;

--$22,500,000 class B to 'B/LS5' from 'AA+'; Outlook Negative;

--$7,000,000 class C to 'B/LS5' from 'AA'; Outlook Negative;

--$26,750,000 class D to 'CCC/RR2' from 'AA-'

--$11,875,000 class E to 'CCC/RR3' from 'A+';

--$11,875,000 class F to 'CCC/RR5' from 'A';

--$11,250,000 class G to 'CCC/RR6' from 'A-';

--$11,250,000 class H to 'CCC/RR6' from 'BBB+';

--$11,250,000 class J to 'CCC/RR6' from 'BBB';

--$10,000,000 class K to 'CCC/RR6' from 'BBB-';

--$18,750,000 class L to 'CCC/RR6' from 'BB';

--$28,750,000 class M to 'CC/RR6' from 'B.

Additionally, all classes are removed from Rating Watch Negative.

These rating actions reflect the application of Fitch's current criteria which are available at 'www.fitchratings.com' and specifically include the following reports:

--'Global Structured Finance Rating Criteria' (Sept. 30, 2009);

--'Surveillance Criteria for U.S. Commercial Real Estate Loan CDOs' (Nov. 9, 2009);

--'Criteria for Structured Finance Loss Severity Ratings' (Feb. 17, 2009);

--'Criteria for Structure Finance Recovery Ratings' (Aug. 17, 2009);

--'Global Criteria for Cash Flow Analysis in CDOs' (Nov. 9, 2009).

Additional information is available at 'www.fitchratings.com'.

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