DBRS Confirms Six Classes, Maintains Two Classes and Places One Class of Institutional Mortgage Securities Canada Inc., Series 2013-4 Under Review with Negative Implications

DBRS Limited (DBRS) has today confirmed the ratings on the following classes of Commercial Mortgage Pass-Through Certificates issued by Institutional Mortgage Securities Canada Inc., Series 2013-4:

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

The trends on Classes C and D have been changed to Negative from Stable. Trends on Classes A-1, A-2, X and B remain Stable.

Additionally, DBRS maintains the Under Review with Negative Implications status first assigned in March 2016 for the following two classes:

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

Finally, DBRS has also placed the following class Under Review with Negative Implications:

-- Class E at BBB (low) (sf), Under Review with Negative Implications

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

These actions reflect the increased risks for the pool in the sharp performance decline for the Franklin Suites loan (Prospectus ID #12, 3.1% of the pool balance) and continued concerns surrounding the fourth-largest loan, Nelson Ridge (Prospectus ID#4, 7.0% of the pool balance), which was transferred to the special servicer in February 2016 because of imminent default. The concern and uncertainty surrounding these loans has increased in recent months in light of wildfire activity in Fort McMurray, Alberta, where both properties are located. The Nelson Ridge loan represents the A-1 portion of a pari passu loan, which had an original aggregate balance of $31.0 million. The A-2 piece, which had an original balance of $8.0 million, was included in the IMSCI 2014-5 transaction. The whole loan also includes subordinate debt of $4.5 million. Both the Nelson Ridge and Franklin Suites loans are discussed further below.

The transaction closed in December 2013 with 33 fixed-rate loans secured by 37 commercial properties. Since issuance, the transaction has experienced a collateral reduction of 5.6% as a result of scheduled amortization with all of the original 33 loans remaining in the pool. Approximately 27.1% of the pool is reporting YE2015 financials and the weighted-average (WA) debt service coverage ratio (DSCR) and WA debt yield for these loans is 1.36 times (x) and 9.2%, respectively. Based on 97.1% of the pool that reported YE2014 financials, the WA DSCR and WA debt yield were 1.90x and 13.6%, respectively. These performance metrics for the pool compare with the DBRS underwritten (UW) Term DSCR and Term Debt Yield at issuance of 1.39x and 9.3%, respectively.

At the June 2016 remittance, there was one loan in special servicing, representing 7.0% of the current pool balance, and four loans on the servicer’s watchlist, representing 10.8% of the current pool balance.

The Nelson Ridge loan is secured by three four-storey apartment buildings consisting of 225 two-bedroom units located in Fort McMurray. The area is heavily reliant on the oil industry, and the weakened market has affected the performance of the property, leading to decreased cash flows. Furthermore, the property is located in the area where a widespread wildfire broke out in early May 2016, which led to an evacuation of the region through the first week of June 2016. According to the most recent update from the servicer, as of late June 2016, the property has experienced smoke damage and remains vacant. The servicer estimated that repairs to the property could be completed by the beginning of July but advised that a full damage estimate had not been completed to date. According to the servicer, total initial cost estimates range from $15.0 million to $18.0 million for all affected properties (including the subject) in Fort McMurray and owned by Lanesborough Real Estate Investment Trust (LREIT). It has also been noted that an insurance claim can be filed that 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 occupancy prior to the wildfires was reported at 48.0% as of YE2015, which represents a significant decline from the prior year when occupancy was 88.0%, lost revenue supplements received as part of any insurance claim are likely to represent a fraction of the revenues in place at issuance. This decrease in occupancy has led to a YE2015 DSCR of 1.10x, down from the YE2014 of 1.63x and the DBRS UW DSCR of 1.81x.

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 $68.8 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 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 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 to reflect the increased risk to the trust.

The Franklin Suites loan (Prospectus ID#12, 3.1% of the pool balance) is secured by a 75-room, extended-stay, limited-service hotel located in Fort McMurray. This loan was added to the watchlist in June 2016 as performance was negatively affected by the economic decline in the area related to the oil sector. According to YE2015 financials, the DSCR decreased to 0.96x from the prior-year DSCR of 1.79x, with cash flow declines largely attributable to a decrease in effective gross income by approximately 30.0% year over year. At YE2015, the property reported a year-to-date occupancy of 51.0%, an average daily rate (ADR) of $165.00 and a revenue per available room (RevPAR) of $83.67. Performance decreased across all metrics when compared with the YE2014 figures for occupancy, ADR and RevPAR of 65.0%, $185.00 and $120.35, respectively. This property is also located in the affected area of the Fort McMurray wildfire as previously mentioned; however, according to a property update dated June 2, 2016, posted on the sponsor’s website, the subject property is open and fully occupied. Given the need for accommodations for workers and residents displaced by the wildfire, it is expected that hotel properties within the area will be experiencing increased occupancy as the region recovers from the impact of the wildfire. However, similar to the outlook for the Nelson Ridge loan, DBRS anticipates that performance improvements would be temporary until the energy markets experience sustained improvement. This loan benefits from full recourse to Temple Hotels Inc. (Temple), which was taken over by Morguard Corporation effective April 2016 and holds a 39.0% stake and control of all 29 hotels within the Temple portfolio.

Similar to the approach for the Nelson Ridge loan, the Franklin Suites loan was modelled with a stressed cash flow scenario that results in a significantly increased probability of default and loss severity. The resulting enhancement levels for both loans directly influence the maintenance of the Under Review with Negative Implications status for Classes F and G, the placement of Class E Under Review with Negative Implications and the Negative trends assigned to Classes C and D. DBRS anticipates that, given the uncertainty regarding the workout for the Nelson Ridge loan and the continued decline in performance for the energy sector that contributed to performance declines in 2015 for both the Nelson Ridge and Franklin Suites 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.

At issuance, DBRS shadow-rated one loan investment grade: Calloway Courtenay (Prospectus ID#1, 8.9% of the current pool). DBRS confirms with this review that the performance of this loan remains consistent with investment-grade loan characteristics.
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.

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.

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