DBRS Requests Comments on North American CMBS/Real Estate Methodologies

DBRS has today requested comments on its proposed “North American Single-Asset/Single-Borrower Methodology” (the SASB Methodology). The SASB Methodology is a new methodology that is intended to replace certain appendices of the “North American CMBS Rating Methodology.” The methodology “Rating Corporate Real Estate Entities” is also being published today on a request-for-comment basis, as its appendix (which covers Canadian first mortgage bonds) will now also reference the SASB Methodology.

In addition, DBRS has also today published (but not on a request for comment basis) its “DBRS Commercial Real Estate Property Analysis Criteria,” which, as a separate document, merely replicates the same discussion of property analysis as is currently set out in the “North American CMBS Rating Methodology” without any material changes. DBRS will update the “North American CMBS Rating Methodology” in due course to reflect the publication of the property analysis discussion in a separate document.

Comments should be received on or before March 8, 2017. Please submit comments to the following email address: Structured.Finance.Comments@dbrs.com. DBRS publishes all comments received on its website, except in cases where confidentiality is requested by the respondent.

The SASB Methodology addresses the approach DBRS uses to rate (1) one or more real estate assets with a single borrower and (2) highly concentrated pools of commercial real estate (CRE) where there may be more than one borrower and more than one CRE asset. The SASB Methodology is intended to supersede certain appendices in the “North American CMBS Rating Methodology.” Material changes in this methodology include an update to the DBRS Capitalization Rate (Cap Rate) ranges, updates to the DBRS Loan-to-Value (LTV) Sizing Hurdles and the use of DBRS LTV Sizing Hurdles as the primary sizing hurdle.

DBRS is also discontinuing the use of the DBRS Debt Service Coverage Ratio (DSCR) Sizing Hurdles. DBRS has found the DSCR hurdles to be less relevant and typically not a constraining factor in the majority of its ratings, given that the mortgage loans in the single-asset/single-borrower (SASB) sector typically have an interest-only period combined with very low interest rates or very limited amortization. Therefore, in lieu of the DBRS DSCR Sizing Hurdles, DBRS will maintain a minimum DSCR threshold for investment-grade-rated tranches, and absent such a minimum, DBRS may adjust the DBRS Direct Sizing Hurdles to be more conservative.

The updated DBRS Cap Rate ranges are, on average, 200 basis points (bps) to 400 bps above current prevailing market cap rates and thus allow for some level of future stress should current cap rates increase. DBRS Cap Rates are applied to the DBRS Stabilized Net Cash Flow (NCF) to determine the DBRS Value for CRE asset(s). For the DBRS approach to estimating the DBRS Stabilized NCF for a commercial property, see the “DBRS Commercial Real Estate Property Analysis Criteria.”

As part of this update, DBRS has expanded its DBRS Direct Sizing Hurdles to include levels for non-investment-grade ratings down to the B rating category and has updated the values for the DBRS LTV Sizing Hurdles. The updated DBRS LTV Sizing Hurdles are a function of a quantitative and qualitative analysis of SASB sector performance. DBRS notes that defaults and losses in the SASB sector have been very limited, and thus the DBRS LTV Sizing Hurdles could not be directly derived through statistical analysis of the performance of the SASB sector, given the limited data points for defaults and losses. DBRS did, however, construct a proxy data set by observing the conduit loan-level data and property performance of DBRS-rated conduit loans over $50 million from 1998 to 2015.

Using statistical techniques, DBRS extrapolated the results of this analysis to larger loans and incorporated the results of the analysis into the final determination of the updated DBRS LTV Sizing Hurdle ranges.

As noted above, the changes in the SASB Methodology are material, as they include updated DBRS Sizing Hurdles and an expanded DBRS Cap Rate range for various CRE property types. All U.S. and Canadian SASB commercial mortgage-backed securities will be affected by the application of this methodology. An impact analysis that considers this change in approach on the applicable certificates rated by DBRS, in combination with various changes in assumptions that DBRS may make, including those made to better align these assumptions with recent market experience, indicates that potential rating actions could be either confirmations or upgrades.

Also as noted above, the methodology “Rating Entities in the Real Estate Industry” will now reference the SASB Methodology in its first mortgage bond appendix, which previously referred to certain portions of the “North American CMBS Rating Methodology.” DBRS expects that adoption of the SASB Methodology into the context of the Canadian first mortgage bonds rated using the appendix to the “Rating Entities in the Real Estate Industry,” in combination with various changes in assumptions that DBRS is making, including those made to better align these assumptions with recent market experience, are not expected to result in any rating changes.

In conjunction with the finalization of the methodology, DBRS will review all affected securities and take timely and appropriate rating actions under the new methodology, as warranted.

Notes:
DBRS criteria and methodologies are publicly available on its website www.dbrs.com under Methodologies.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.