DBRS Confirms Ratings on Seven Classes of Institutional Mortgage Securities Canada Inc., 2012-2 and Maintains Three Classes Under Review with Negative Implications

DBRS Limited (DBRS) has today confirmed the following classes of Commercial Mortgage Pass-Through Certificates issued by Institutional Mortgage Securities Canada Inc., 2012-2:

-- Class A-1 at AAA (sf)
-- Class A-2 at AAA (sf)
-- Class B at AA (sf)
-- Class C at A (sf)
-- Class D at BBB (sf)
-- Class XC at AAA (sf)
-- Class XP at AAA (sf)

DBRS has changed the trends on Classes C and D to Negative from Stable. Trends on Classes A-1, A-2, B, XC and XP remain Stable.

In addition, DBRS has maintained the remaining classes in the transaction Under Review with Negative Implications, as listed below.

-- Class E at BBB (low) (sf), Under Review with Negative Implications
-- Class F at BB (sf), Under Review with Negative Implications
-- Class G at B (sf), Under Review with Negative Implications

The ratings for Classes E, F and G do not carry trends.

DBRS has maintained Class E through Class G Under Review with Negative Implications and assigned Negative trends to Class C and Class D because of concerns surrounding the third-largest loan, Lakewood Apartments (Prospectus ID#3, 8.3% of the pool), which transferred to special servicing in February 2016 for imminent default. The uncertainty with regard to the loan’s resolution has increased in recent months because of wildfire activity in Fort McMurray, Alberta, where the property is located. This loan will be discussed further below.

The transaction collateral consists of 31 fixed-rate loans secured by 33 commercial and multifamily properties. As of the June 2016 remittance, the pool had an outstanding principal balance of approximately $208.0 million, representing a collateral reduction of 13.4% since issuance because of scheduled amortization and two loan repayments. The transaction also benefits from defeasance as four loans, representing 5.5% of the pool, have fully defeased. As of the June 2016 remittance, 25 non-defeased loans, representing 96.9% of the pool, reported YE2015 net cash flow (NCF) figures. The pool is highly concentrated by loan size as the Top 10 and Top 15 loans represent 68.8% and 83.4% of the pool, respectively. Based on the most recent year-end cash flows for the Top 15 loans, the weighted-average (WA) amortizing debt service coverage ratio (DSCR) was 1.29 times (x) compared with the DBRS underwritten (UW) figure of 1.36x, reflective of a WA -4.1% NCF decline from the DBRS UW figures. Excluding the Lakewood Apartments loan, the Top 15 loans had a WA DSCR of 1.38x, reflective of +2.9% NCF growth over the DBRS UW figures.

There are eight loans in the Top 15, representing 45.1% of the pool, exhibiting NCF declines compared with the DBRS UW figures with declines ranging from -0.7% to -67.6%. Based on the YE2015 cash flows for these eight loans, the WA amortizing DSCR was 1.14x compared with the WA DBRS UW figure of 1.43x, reflective of a WA NCF decline of -19.8% from the DBRS UW figures. Excluding the Lakewood Apartments loan, these seven loans had a WA DSCR of 1.30x compared with the WA DBRS UW figure of 1.44x, reflective of a WA -9.1% NCF decline from the DBRS UW figure. DBRS analyzed these loans and determined that, for most, cash flow declines are likely temporary because of short-term occupancy declines and/or increases in operating expenses that will likely normalize over the near term. For the loans showing cash flow declines that are likely to continue through the near to medium term, stressed cash flow figures were modelled to capture the increased credit risk to the trust.

There are nine loans with maturities scheduled through the end of 2017, representing 31.7% of the pool. The DBRS WA Refinance DSCR and WA Exit Debt Yield for these loans is 1.28x and 11.0%, respectively. As of the June 2016 remittance, there is one loan in special servicing and two loans on the servicer’s watchlist, representing 8.3% and 3.3% of the pool, respectively. These loans will be discussed in detail below.

The Lakewood Apartments loan is secured by a four-storey apartment building comprising 111 units located in the Timberlea area of Fort McMurray. Prior to the loan’s transfer to special servicing in February 2016 for imminent default, the loan was being monitored for property performance declines related to the downturn in the oil industry over the past few years. The area has recently sustained widespread damage as a result of a wildfire that broke out in early May 2016. All residents of Fort McMurray, including those at the subject property, were evacuated and allowed to return to the area in the first week of June. The special servicer has advised that the property remains vacant as of July 2016, noting that there has been no official property evaluation performed to date outside of an initial assessment that indicated possible smoke, water and incidental property damage. According to the servicer, initial estimates range from $15.0 million to $18.0 million for all properties owned by Lanesborough Real Estate Investment Trust (LREIT), which includes the subject property.

An insurance claim will be filed once a complete damage assessment has been completed; the servicer has indicated that a time frame for the complete assessment is not available at this time as insurance adjusters and property owners must navigate time and resource limitations for this hard-hit, relatively remote region of Alberta. The servicer has advised that, once a claim is filed, insurance will cover lost revenue from June 2016 up to the date that tenants are able to move back into their units for a maximum of 24 months. However, as the property’s pre-wildfire occupancy rate (as of the February 2016 rent roll) was already depressed at 32.0% with average rental rates down by approximately $900 per unit from the prior year as well as YE2014 and YE2015 DSCRs of 1.04x and 0.45x, respectively, it is unlikely that lost rent payments would provide enough cash flow to cover operating expenses and fund debt service obligations for the loan as it is currently structured. Additionally, although the property could experience a short-term improvement in occupancy rates as displaced residents need housing during reconstruction, DBRS believes that those improvements would likely be temporary in nature as long-term performance improvements are dependent on the oil industry’s ability to rebound. The special servicer has not ordered an updated appraisal and reports that one will be ordered pursuant to the guidelines prescribed in the pooling and servicing agreement, which call for an appraisal to be ordered once the loan reaches 90 days delinquent. As of the June 2016 remittance, the servicer lists the loan as 60 days to 89 days delinquent. The appraised value at issuance was $34.8 million; however, DBRS expects the value to have declined significantly since that time, given the property’s performance declines in recent years and the general economic difficulty in the area.

The loan has full recourse to the sponsors: LREIT, 2668921 Manitoba Ltd. and Shelter Canadian Properties Limited. LREIT’s assets are heavily concentrated in Alberta, and the portfolio has been significantly affected by the downturn in the oil industry. In its Q1 2016 financial statements, LREIT reports total assets of $275.9 million and total liabilities of $286.4 million, resulting in a deficit of $10.5 million. In addition, LREIT reported a loss before discontinued operations of $5.8 million and a cash deficiency from operating activities of $1.5 million for the Fort McMurray properties for the three months ending March 31, 2016. In conjunction with the subject loan’s transfer to special servicing, seven other assets secured by DBRS-rated commercial mortgage-backed security loans in LREIT’s portfolio were also transferred to special servicing for similar issues leading to imminent default. According to LREIT’s Q1 financial statements, all 12 mortgages with an aggregate balance of approximately $194.0 million and secured by 13 LREIT-owned properties in Fort McMurray are in default. LREIT notes that there are plans to negotiate with the respective lenders to restructure the terms. Given the financial difficulty for the sponsor and the anticipated value decline as well as unknowns surrounding the subject property’s operating status and ability to rebound to historical performance levels, the loan was modelled with a significantly increased probability of default and loss severity, which directly influence the Under Review with Negative Implications status for Classes E and G and the Negative trends assigned to Classes C and D. DBRS anticipates that, given the uncertainty regarding the workout for the subject loan, the Under Review status will remain in place for those classes for an extended period of time. DBRS will monitor the loan closely for developments and will take rating action as necessary.

The largest loan on the servicer’s watchlist is the Pacific Building (Prospectus ID#21, 1.8% of the pool), which is secured by a six-storey multifamily and retail property located in Halifax, Nova Scotia. The building was originally constructed in 1911 and consists of 28-apartment units and 11,363 square feet (sf) of retail space. The loan was added to the watchlist in October 2015 because of a low DSCR caused by increased operating expenses. Cash flow declines continued into 2015 and, as of the YE2015 financials, the loan had a DSCR of 0.62x, down from the DBRS UW figure of 1.18x. Since issuance, operating expenses have increased by 33.0%, primarily as a result increased general and administrative, repairs and maintenance as well as utility costs. Although operating expenses have increased substantially, income has remained in line with or above issuance levels. According to the June 2016 rent roll, the property was 95.0% occupied (multifamily occupancy rate of 92.8%, retail occupancy rate of 100.0%), up from 89.0% at issuance. According to Canada Mortgage and Housing Corporation and Cushman & Wakefield, multifamily and retail properties in Halifax reported vacancy rates and rental rates of 3.4% and $974.00 per unit as of October 2015 and 9.8% and $15.08 per square foot (psf) as of March 2016. The subject’s occupancy rates and rental rates compare favourably with the submarket averages, mitigating concerns surrounding the rising expenses at the property.

The other loan on the servicer’s watchlist, Clyde Avenue Industrial (Prospectus ID#23, 1.5% of the pool), is secured by a 60,000 sf industrial property located in Mount Pearl, Newfoundland and Labrador, approximately 12 kilometres northeast of St. John’s. The loan was placed on the watchlist in October 2015 because of a low DSCR caused by a substantial decline in occupancy and rental concessions. As of April 2014 and May 2014, former tenants, Domtar Corporation (Domtar; 16.0% of the net rentable area (NRA)) and Bird Design (40.0% of the NRA) vacated upon their respective lease expirations. According to the December 2014 rent roll, the property was 44.0% occupied by two tenants, RGR Enterprises Ltd. (24.1% of the NRA) and TFI Transport 2 L.P. (29.2% of the NRA), which have both recently expanded by signing lease extensions at increased rents through April 2021 and March 2020, respectively. Two tenants also signed new leases in early 2015 and, according to the December 2015 rent roll, the property was 100.0% occupied with an average rental rate of $10.50 psf, up from an average of $8.08 psf in 2013; however, one of the two new tenants, Iron Mountain Canada (31.6% of the NRA) was on a short-term lease and appears to have vacated at lease expiry in May 2016. The servicer noted that a leasing reserve in the amount of $230,000 was collected prior to loan closing with ongoing monthly collections of $2,200 bringing the leasing reserve balances to $300,000 ($5.00 psf) prior to the expiration of Domtar and Bird Design. DBRS has requested a leasing update and confirmation of the current reserve amounts from the servicer. The loan benefits from partial recourse to Cluny Group Ltd., limited to $1.85 million. Given the occupancy fluctuations, however, the loan was modelled with a stressed cash flow to reflect the increased risk to the trust with this asset.

DBRS continues to monitor this transaction in its Monthly CMBS Surveillance Report with additional information on the DBRS viewpoint for this transaction, including details on the largest loans in the pool. The June 2016 monthly surveillance report for this transaction will be published shortly. If you are interested in receiving this report, contact DBRS at info@dbrs.com.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are 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 North American CMBS Rating Methodology (March 2016) and CMBS North American Surveillance (December 2015), which can be found on our website under Methodologies.