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Exponential growth

Over the past two years, issuance of CDOs backed by CRE loans has grown exponentially. The growth of CREL CDOs can be attributed to two primary reasons: the ability to have a revolving structure and to be able to manage more high touch loans.

CMBS transactions are generally issued as real estate mortgage investment conduit (Remic) transactions. As such, the issuer enjoys certain tax benefits. However, with the benefits come certain restrictions imposed by Remic tax laws. CDOs, on the other hand, are not subject to Remic regulations. As such, CDO issuers have more flexibility.

Firstly, one of the advantages of working outside of the Remic environment is that the collateral pool does not have to be fully identified at closing. Rather, a CDO allows the issuer to contribute additional loans to a transaction during a ramp up period and recycle principal proceeds received from loan payoffs into new loans. This allows the CDO asset manager to establish a more predictable life for the deal, creating a better vehicle through which to monetize costs. As a result, CDOs have become a vehicle of choice for short-term floating rate loans.

Another advantage of a CDO is that it allows the asset manager to remove credit-impaired or credit-defaulted assets.

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