DBRS Confirms Rating and Assigns Positive Trend to S2 Hospitality, Series 2012-LV1

DBRS has today confirmed its rating of BBB (low) (sf) of the Class A notes issued by S2 Hospitality LLC, S2 Hospitality Participation LLC, S2 Hospitality REO Owner LLC and its subsidiaries (S2 Hospitality, Series 2012-LV1). The trend has been changed to Positive.

The rating has been confirmed based on the performance of the transaction and, in aggregate, liquidation outcomes since issuance that compare favorably to the DBRS loan-level liquidation assumptions made at securitization. The Positive trend recognizes the significant paydown of the Class A notes, from $159.5 million at securitization to $60.6 million as of June 2013. When compared to the equity behind the Class A notes, this implies a substantial increase in credit enhancement to the Class A notes.

The transaction is a liquidating vehicle with the Class A rated notes that was originally secured by 23 performing loans (ten of which are participation loans 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. 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 a portion of the collateral from the Federal Deposit Insurance Corporation (FDIC) in April 2011 for a total price of $222.4 million. This venture subsequently purchased participations in seven of the loans from third parties in early 2012 at an additional price of $23.0 million, bringing the total acquisition basis to $243.2 million.

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.

Since securitization, nine loans have liquidated out of the trust. Six of those loans were disposed as par payoffs with no loss, while three were disposed as a discounted payoff. As a result of these liquidations, the Class A notes balance has been reduced to $60.6 million, from its original balance of $159.5 million.

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, which can change swiftly with economic conditions.

In step one of the NPL model, the DBRS base recoverable value (which DBRS considers 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 generating enough cash to satisfy all obligations of the transaction parties and the rated notes per the priority of payments.

The pool is also concentrated by loan/asset count/size. However, the relatively low asset count enabled DBRS to more thoroughly analyze the individual loans at securitization and as part of this surveillance review. 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.

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

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

Class A is privately placed pursuant to Rule 144a.

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