DBRS Confirms Ratings on Seven Classes of Institutional Mortgage Securities Canada Inc., Series 2013-3 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., Series 2013-3:

-- Class A-1 at AAA (sf)
-- Class A-2 at AAA (sf)
-- Class A-3 at AAA (sf)
-- Class B at AA (sf)
-- Class C at A (sf)
-- Class D at BBB (sf)
-- Class X at AAA (sf)

DBRS has assigned a Negative Trend to Classes C and D. The trends on Classes A-1, A-2, A-3, B and X remain Stable.

In addition, DBRS has maintained the Under Review with Negative Implications status on the remaining classes in the transaction 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 Classes C and D because of the concerns surrounding three loans that were transferred to special servicing in February 2016 because of imminent default. The loans are secured by multifamily properties located in Fort McMurray, Alberta, and collectively represent 8.8% of the current pool balance. The uncertainty with regard to the loans’ resolution has increased in recent months because of the wildfire activity in Fort McMurray. The details of the loans are discussed below.

At issuance, the transaction consisted of 38 loans secured by 43 properties. As of the June 2016 remittance report, 35 loans remain in the pool, as three loans prepaid in January 2016 ahead of their respective loan maturities in 2019. The aggregate outstanding principal balance of the trust is $221.7 million, which represents a collateral reduction of 11.5%. Loans representing 50.6% of the pool are reporting YE2015 financials. Ten loans in the Top 15, representing 45.3% of the current pool balance, have YE2015 financials and reported a weighted-average (WA) amortizing debt service coverage ratio (DSCR) of 1.34 times (x) with a WA debt yield of 9.8%. As of the June 2016 remittance, there are three loans in special servicing and two loans on the servicer’s watchlist, representing 8.8% and 5.1% of the current pool balance, respectively. The specially serviced loans and watchlisted loans are highlighted below.

The Lunar and Whimbrel Apartments (Prospectus ID#10), Snowbird and Skyview Apartments (Prospectus ID#11) and Parkland and Gannet Apartments (Prospectus ID#17) loans are secured by multifamily properties located in Fort McMurray, Alberta. Prior to the loans’ transfer to special servicing in February 2016 for imminent default, the loans were 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 properties, were evacuated and allowed to return to the area the first week of June. The special servicer has advised that the properties remain vacant as of July 2016 and noted that there have been no official property evaluations performed to date outside of an initial assessment that indicated possible smoke, water and incidental property damage at all six locations. 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 properties.

An insurance claim will be filed once a damage assessment has been completed; the servicer has indicated that a timeframe 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 tenants are able to move back into their units, for a maximum of 24 months. However, since the properties’ pre-wildfire occupancy rates (as of the February 2016 rent rolls) were already depressed, ranging from 51.5% to 63.5%, with average rental rates down by approximately $500 per unit from the prior year and WA YE2014 and YE2015 DSCRs of 0.87x and 0.45x, respectively, it is unlikely that lost rent payments will provide enough cash flow to cover operating expenses and fund debt service obligations for the loans as currently structured. Additionally, although the properties could experience a short-term improvement in occupancy rates, as displaced residents will need housing through reconstruction, DBRS believes those improvements would likely be temporary in nature, with long-term performance improvements being dependent on the ability of the oil industry to rebound. The special servicer has not ordered updated appraisals and reports those will be ordered pursuant to the guidelines prescribed in the pooling and servicing agreement, which call for an appraisal to be ordered once the loans reach 90 days delinquent. As of the June 2016 remittance, the servicer lists the loans as 60 to 89 days delinquent. The appraised value at issuance was $14.8 million for the Lunar and Whimbrel properties, $13.7 million for the Snowbird and Skyview properties and $11.2 million for the Parkland and Gannet properties. DBRS expects the values to have declined significantly since that time, given the properties’ performance decline in recent years and the general economic difficulty in the area.

The loans have full recourse to LREIT and a partial guarantee from of 25.0% of the loan balance by 2668921 Manitoba Ltd. 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 loans’ transfer to special servicing, two other assets located in Fort McMurray and 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 2016 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 anticipated value decline as well as unknowns surrounding the properties’ operating status and ability to rebound to historical performance levels, the loans were modelled with significantly increased probabilities of default and loss severities, which directly influences the Under Review with Negative Implications status for Classes E, F and G and the Negative trends assigned to Classes C and D. DBRS anticipates that, given the uncertainty regarding the workout for the subject loans, the Under Review status will remain in place for those Classes for an extended period of time. DBRS will monitor the loans closely for developments and will take rating action as necessary.

The largest loan on the servicer’s watchlist, Sherbrooke Street Office (Prospectus ID#6, 4.2% of the current pool balance), is secured by a Class B office building in the Le Plateau – Mont Royal borough of Montréal, Québec. This loan was originally placed on the watchlist in September 2014 because the former largest tenant, Aro Inc., previously occupying 32.8% of the net rentable area (NRA), exercised its early termination option and vacated the property in May 2015. According to the January 2016 rent roll, the property was 35.2% occupied following the departure of another tenant, Conservatoire Lasalle (14.5% of NRA), which vacated the property at its lease expiration in May 2015. Occupancy may have fallen even further since, however, as the second- and third-largest tenants, which collectively represented 9.7% of NRA, had leases that expired in April and May 2016, and both units were listed for lease on Altus InSite as of June 2016. In total, Altus InSite lists 78,581 square feet (sf) of space, or 61.9% of NRA, as available. DBRS has requested leasing updates from the servicer for the listed spaces as well as for the property’s largest tenant, Collège April-Fortier Inc., which occupies 7.9% of the NRA on a lease that expires in December 2016.

According to the CBRE Montreal office Marketview Report, the Q1 2016 average vacancy rate and average rental rate for the Montréal central business district was reported at 10.8% and $19 per square foot (psf) compared with the subject’s January 2016 vacancy rate of 64.8% and average rental rate of $17 psf. The YE2014 OSAR reported an amortizing DSCR of 1.77x, which is an increase from the YE2013 DSCR of 1.76x and the DBRS underwritten DSCR of 1.16x; however, cash flows are expected to decline significantly given the sharp occupancy decline at the property over the past year. As such, this loan was modelled with a stressed cash flow to reflect the increased risk to the trust. The loan benefits from full recourse to an experienced sponsor with a large portfolio of commercial real estate, specializing in Québec markets. Additionally, this loan is cross-collateralized and cross-defaulted with two other loans in the pool that are also secured by properties in Québec, and those two loans reported a WA DSCR of 1.78x.

The other loan on the watchlist, Rene Patenaude Industrial (Prospectus ID#33, 0.8% of the current pool balance), is secured by a 30,000 sf industrial property most recently used as a produce distribution centre. The property is located in the industrial sector of Magog, Québec, which is approximately 37 kilometres south-east of Sherbrooke and benefits from easy access to major highways. This loan was placed on the servicer’s watchlist in June 2016 when the single tenant, Anniefruit Inc., vacated in January 2016, ahead of its scheduled lease expiration in October 2020. The property is currently vacant, and the entire building is listed as available on CBRE. According to the YE2015 financials, the DSCR was reported at 0.98x, a decrease from the YE2014 DSCR of 1.64x and the DBRS underwritten DSCR of 1.29x. The borrower has kept the loan current despite the lack of cash flow. This loan has full recourse to an experienced sponsor with a large portfolio of commercial real estate, specializing in Québec markets. This loan is also cross-collateralized and cross-defaulted with one other property in Québec, which reported a YE2015 DSCR of 1.64x. Given the vacant status of the collateral property, the loan was modelled with a stressed cash flow figure to reflect the increased risk to the trust.

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.

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.