DBRS Assigns Provisional Rating to S2 Hospitality, Series 2012-LV1

DBRS has today assigned a provisional rating of BBB (low) (sf) to the Class A notes to be issued by S2 Hospitality LLC, S2 Hospitality Participation LLC, S2 Hospitality REO Owner LLC and its subsidiaries (S2 Hospitality, Series 2012-LV1). The trend is Stable.

Although the indenture allows interest on the rated notes to be deferred for up to 12 months, the
DBRS ratings address the likelihood of timely receipt of interest without contemplation of deferral.

The transaction is a liquidating vehicle with the Class A rated notes secured by 23 performing loans (ten of which are participation loans that are subject to the interests of third-party participation holders), three non-performing loans and five REO properties. Collateral for the notes consists of all of the assets (including whole loans, participation interests and REO properties) and property owned by the issuers. The loans are all secured by hotel properties, and except for one partially-completed hotel, all REO properties are hotels that have been completed and are open for business. A joint venture formed by Square Mile Capital Management LLC (Square Mile) and real estate debt funds owned by an affiliate of The Blackstone Group L.P. (Blackstone) purchased the majority of the collateral from the Federal Deposit Insurance Corporation (FDIC) in April 2011. They subsequently purchased participations in seven of the loans from third parties in early 2012, bringing the total acquisition basis to $243.2 million.

With a total acquisition basis of $243.2 million financed by $159.5 million of the Class A rated notes, the sponsors retain a significant $83.7 million investment in the collateral. In addition, the sponsors’ and the asset manager’s combined experience make them ideally suited for their respective roles in the transaction. Blackstone, one of the two sponsors, is the world’s largest hotel investor with more than 810,000 rooms currently owned, managed, leased or franchised. Assets representing 48.5% of the pool are subject to a franchise agreement with one of the brands owned by Hilton Worldwide, Inc., which is owned by Blackstone. In 2010, Square Mile, which will operate the asset manager through a subsidiary, purchased a portfolio of hotel loans from the FDIC originated by the same lender that originated the subject portfolio. With the FDIC as a co-investor, Square Mile has had significant experience monitoring and working out loans that are very similar to the collateral for this transaction.

The pool is concentrated by property type, as all of the assets are loans secured by hotels or REO hotel properties. Hotels have the highest cash flow volatility of all traditional property types, due to the typically high expense ratios at which they operate in addition to the short-term (nightly, or at most weekly) rental streams they rely upon that can change swiftly with economic conditions. In step one of the NPL model, the DBRS base recoverable value, which DBRS considers to be a relatively conservative opinion of stabilized value given greater upside is expected to be achieved in many more instances than DBRS is recognizing, is stressed by approximately 11% at the BBB (low) rating category. In step two of the NPL model, in-place cash flow is stressed to different levels in each trial, with full cash flow decline realized between one and 24 months. The cash flow decline on a pool-wide basis can exceed 50%, stressing the pool’s ability to continue to generate enough cash to satisfy all obligations of the transaction parties and the rated notes per the priority of payments.

The pool is concentrated by loan/asset count/size, as there are only 31 assets with the top ten representing 53.1% of the pool. However, the relatively low asset count enabled DBRS to analyze each one in depth and perform site inspections on eight of the largest ten. Step two of the NPL model, the cash flow stress test, uses a Monte Carlo analysis that includes a 40% correlation factor at the BBB (low) rating category on the timing and loss severity inputs. DBRS believes that this part of the model adequately captures asset size concentration risk.

The rating assigned to the Class A notes by DBRS is based exclusively on the credit provided by the transaction structure and underlying trust assets. The notes will be subject to ongoing surveillance which could result in upgrades or downgrades by DBRS after the date of issuance.

Notes:
All figures are in U.S. dollars unless otherwise noted.

Class A is privately placed pursuant to Rule 144a.

The Rule 17g-7 Report of Representations and Warranties is hereby incorporated by reference and can be found by clicking on the link to the right under Related Research, or by contacting us at info@dbrs.com.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The applicable methodologies are CMBS Rating Methodology and Commercial Real Estate Non-Performing Loan Liquidating Trust Methodology, which can be found on our website under Methodologies.