DBRS Confirms the ratings of Merrill Lynch Financial Assets Inc., Series 2007-Canada 21

DBRS has today confirmed all classes of the Merrill Lynch Financial Assets Inc., Series 2007-Canada 21, all with a Stable trend. This action is reflective of the overall stable performance as exhibited by the portfolio, which had weighted-average DSCR (WADSCR) of 1.45x, as of the April 2011 remittance report, and a weighted-average loan-to-value (WALTV) of 63.9% for the same period, based on the original values as determined at issuance. There are 11 loans on the servicer’s watchlist, cumulatively representing 27.95% of the pool balance. The transaction has significant exposure to the Calgary office market, particularly in the top ten, which contains three loans collateralized by Class B office properties across three submarkets in the Calgary office market. Those three loans comprise 16.23% of the pool balance. There are no loans currently in special servicing in this transaction.

Geographically, the pool is diverse, with properties located across six provinces. Ontario represents the largest geographic concentration with 46.5% of the current pool balance. By property type, Office assets lead the transaction with 35.9% of the current pool balance. As of the April 2011 remittance report, the trust balance totals $353,415,639. One of the original 41 loans has been paid in full.

Four of the 11 loans on the servicer’s watchlist are in the top ten loans in the portfolio, representing a cumulative 17.99% of the pool balance. Two of the loans, Prospectus ID#5, 5055 Satellite Drive (4.35% of the current pool balance), and Prospectus ID#7, Hotel Gouverneur Dupuis (4.18% of the current pool balance), exhibited relatively healthy YE2009 debt service coverage ratios of 1.15x and 1.29x, respectively. 5055 Satellite Drive is on the watchlist for a decline in occupancy to 53%, as of January 2011, and Hotel Gouverneur Dupuis is on the watchlist for a decline in the DSCR of over 25%. DBRS will closely monitor the performance of these two assets.

The largest loan on the servicer’s watchlist is Prospectus ID#3, 550 11th Avenue Office Building (5.41% of the current pool balance), secured by a 97,000 sf, 11-storey Class B office property located in the Beltline district in central Calgary. The loan is on the servicer’s watchlist for the low YE2009 DSCR of 0.90x, which represented a significant decline from the YE 2008 DSCR of 1.45x. The decline can be attributed to increases in vacancy at the property throughout 2009. According to the servicer, the property’s occupancy ranged between 63% and 77% between YE2008 and YE2009. As of March 2011, the property was 61.5% physically occupied, with signed leases to bring the occupancy to 96.8% occupied by September 1, 2011, according to the servicer. The average rental rate for existing tenants, as of March 2011, is $18.87 psf and the range of rental rates for the newly-signed tenants was $12 to $14 psf, indicating that the submarket availability rate of 9.8%, as of Q1 2011, as reported by Altus InSite, is contributing to a decline in the rental rates the property is able to achieve. The sponsor provides partial recourse in the amount of $10 million for this loan.

The two other Calgary office assets in the portfolio’s top ten loan set are Prospectus ID#2 and ID#10, McFarlane Tower (6.95% of the current pool balance) and Franklin Tower (3.87% of the current pool balance), respectively. McFarlane Tower is an 18-storey Class B office property comprised of 240,000 sf located in the west core submarket in downtown Calgary. According to Altus InSite, the submarket availability rate for Q1 2011 was 8.9% for all building classes and 12.9% for Class B properties. The August 2010 rent roll showed the property was 91% occupied, with 22.5% of the NRA set for expiry by YE2011. The Q2 2010 DSCR was 1.61x, down from 1.72x at YE2009 due to a decline in occupancy from September 2009, when it was at 96.2%. The sponsor provides partial recourse on the loan, in the amount of 25% of the loan balance.

Franklin Atrium is comprised of two low-rise Class B office buildings with a total of 142,000 sf located in NE Calgary, approximately 5 km from downtown. According to Altus InSite, North Calgary had a Q1 2011 availability rate of 11.5%. The property’s largest tenant recently signed a five year renewal on their lease that expired in April 2011 at a rate of $15 psf for 15% of the property’s NRA, down from the rate of $16 psf they were paying at expiry. The August 2010 rent roll showed the property was 90.4% occupied, with no significant rollover scheduled until 2012, when 15.1% of the NRA is scheduled for expiry. The YE2009 DSCR of 2.23x is a significant increase from the YE2008 DSCR of 1.66x; according to the servicer, the increase is due to an increase in reimbursements at the property in 2009. The sponsor provides partial recourse on the loan, in the amount of 25% of the loan balance.

Because of the heavy reliance upon the energy industry for tenancy and the new supply being delivered, DBRS has been closely monitoring the Calgary office market. In 2009, RBC reported a decline in the real GDP of 4.5% for Alberta, as compared with an increase of 1.4% in 2008. However, 2010 has shown significant improvement, with RBC projecting real GDP growth of 3.4% for the year and forecasting an even bigger jump in 2011, when growth is predicted at 4.3% over 2010. These improvements are primarily due to a significant rebound in the overall stability of the energy sector in 2010, which is expected to continue into 2011.

The outlook for the Calgary office market has improved, with the least favourable expectations for Class B and C space. Previous forecasts had the overall vacancy rate hovering at 20% for Calgary upon completion of The Bow in the downtown core, which will add 1.8 million sf of fully-leased space to the market by YE2011 and open up 1.1 million sf in available sublease space by YE2012 as the property’s two tenants complete move-outs from their existing locations. However, with the improvements in the economy, overall vacancy rates have remained relatively stable (at YE2010, the overall vacancy rate was at 10.6%, down from 12.5% at YE2009, according to Avison Young), and most research firms are scaling back their previous vacancy rate predictions to more moderate levels. Even so, as Avison Young projects vacancy rates to be approximately 14% for the overall Calgary office market at spring 2012, this is still a significant increase over the Q1 2011 figure of 9.8% reported by the firm. The future vacancy is likely to be concentrated the heaviest in Class B properties, as tenants take advantage of Class A space that will be newly-available at attractive rental rates driven down by the increases in market vacancy over the next few years.

Although it is of significant concern that the portfolio’s Calgary office market exposure is completely comprised of Class B space, DBRS thoroughly analyzed the credit metrics of the three previously-discussed assets and determined that the loans were written to quite conservative levels that could withstand net cash flow declines at a weighted-average percentage of 39% (based on YE2009 figures for McFarlane Tower and Franklin Atrium and YE2008 for 11th Avenue, when the property was similarly occupied at the level to be achieved in September 2011) and retain a minimum DSCR of 1.00x. Furthermore, all three loans carry partial recourse provisions of at least 25% of the current loan balance and all mature in 2016, providing time for the market to stabilize before a replacement loan must be secured. DBRS will continue to monitor the performance of these loans and developments in the Calgary office market very closely.

For further detail and loan level analysis, please refer to the corresponding Surveillance report on www.dbrs.com

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodologies are CMBS Rating Methodology and CMBS Surveillance, which can be found on our website under Methodologies.