DBRS Finalizes Provisional Ratings on RAIT 2017-FL8 Trust

DBRS, Inc. (DBRS) finalized its provisional ratings on the following classes of secured Floating Rate Notes issued by RAIT 2017-FL8 Trust (the Issuer):

-- Class A at AAA (sf)
-- Class A-S at AAA (sf)
-- Class B at AA (low) (sf)
-- Class C at A (low) (sf)
-- Class D at BBB (low) (sf)
-- Class E at BB (sf)
-- Class F at B (sf)

All trends are Stable.

The collateral for the transaction consists of 23 recently originated floating-rate mortgages secured by 26 transitional commercial real estate properties totaling $259.8 million based on current cut-off balances and $262.8 million based on the fully funded loan amount. The loans are secured by currently cash flowing assets, some of which are in a period of transition, with plans to stabilize and improve the asset value. The floating-rate mortgages were analyzed to determine the probability of loan default over the term of the loan and its refinance risk at maturity based on a fully extended loan term. Because of the floating-rate nature of the loans, the index (one-month LIBOR) was applied at the lower of a DBRS stressed rate that corresponded to the remaining fully extended term of the loans and the strike price of the interest rate cap, with the respective contractual loan spread added to determine a stressed interest rate over the loan term. When the cut-off balances were measured against the DBRS In-Place net cash flow (NCF) and their respective stressed constants, there were 13 loans, representing 39.2% of the pool, with term debt service coverage ratios (DSCRs) below 1.15 times (x), a threshold indicative of a higher likelihood of term default. Additionally, to assess refinance risk, DBRS applied its refinance constants to the balloon amounts, resulting in 18 loans, or 74.0% of the pool, having refinance DSCRs below 1.00x relative to the DBRS Stabilized NCF. The properties are frequently transitioning, with potential upside in the cash flow; however, DBRS does not give full credit to the stabilization if there are no holdbacks or if other loan structural features in place are insufficient to support such treatment. Furthermore, even with structural features provided, DBRS generally does not assume the assets will stabilize above market levels.

The loans were all sourced by a commercial mortgage originator with strong origination practices. Classes E, F, G and H will be retained by the Issuer and represent 17.0% of the transaction balance. The loans are secured by traditional property types (i.e., multifamily, retail and office), with no exposure to higher-volatility property types or those with short-term leases such as hotels or self-storage. The properties are located in primarily core (urban and suburban) markets that benefit from greater liquidity. Only four loans, representing 8.9% of the pool, are located in tertiary markets. Twenty-two loans totaling 93.1% of the deal balance represent acquisition financing, with borrowers contributing equity to the transaction. All loans are structured with cash management in place from origination. Twenty-two loans, representing 93.4% of the pool, are structured with springing cash management in the form of soft lockboxes for all tenants at the property. One additional loan, representing 6.6% of the pool, is entirely structured with springing cash management in the form of a hard lockbox. Additionally, all loans are structured with reserves for future capital improvements or leasing costs. The borrowers of each loan have purchased LIBOR rate caps with a range of 1.10% to 4.75% to protect against a rise in interest rates over the term of the loan.

The pool is relatively concentrated based on loan size, as there are only 23 loans in the pool and it has a concentration profile similar to a pool of 18 equally sized loans. The ten largest loans represent 66.0% of the pool and the largest three loans represent 24.7% of the pool. Furthermore, the pool is relatively geographically non-diverse. The top five states (Texas, Georgia, California, Florida and Minnesota) account for 15 loans and 18 properties, representing 72.2% of the pool. Although the concentration profile is similar to a pool of 18 equally sized loans, which is typically worse than most fixed-rate conduit transactions, the concentration profile is superior compared with many floating-rate transactions that generally have fewer than 20 loans and a concentration profile more similar to a pool of ten to 15 loans.

The loans have been analyzed by DBRS to a stabilized cash flow that is, in some instances, above the current in-place cash flow. There is a possibility that the sponsors will not execute their business plans as expected and that the higher stabilized cash flow will not materialize during the loan term. Failure to execute the business plan could result in a term default or the inability to refinance the fully funded loan balance. DBRS made relatively conservative stabilization assumptions and in each instance considered the business plan to be rational and the future funding amounts to be sufficient to execute such plans. In addition, the weighted-average (WA) DBRS Debt Yield is based on the DBRS In-Place NCF and the fully funded loan amount (including the junior participation structures) is 7.2%, which is significantly lower than the WA DBRS Exit Debt Yield, based on the DBRS Stabilized NCF of 8.2%. This indicates that a fair amount of upside is being considered.

The Issuer, Servicer, Special Servicer, Mortgage Loan Seller, Advancing Agent and Trust Administrator are the same party, a non-rated entity. RAIT Financial Trust was established in 1998 and has a proven track record of originating and servicing commercial mortgage loans. Within the servicing agreement, the Indenture Trustee has been enlisted as backup Servicer and Advancing Agent to step in should there be an un-remedied Servicer event of default. Wells Fargo Bank National Association, as Indenture Trustee, is considered a large, highly experienced commercial mortgage servicer. Wells Fargo Bank, N.A. is currently rated AA with a Stable trend by DBRS, which meets the Advancing Requirement.

The loans have future funding commitments residing outside the trust with the junior participations. The failure of the holder of the junior participations (an affiliate of the trust asset seller and sponsor) to make future advances as required by the loan documents could result in liability to the trust. The future funding commitments will be first and foremost funded by a committed warehouse line. RAIT 2017-FL8 A-2 Holdings, LLC and RAIT Partnership LP have indemnified the trust against any liability relating to funding the future commitments. Additionally, the parent of the obligor, RAIT Financial Trust, owns and currently manages a portfolio of commercial real estate assets totaling approximately $1.8 billion, comprising over 220 multifamily units and 4.3 million square feet of office and retail space as of September 30, 2017. As of the same period, RAIT Financial Trust had $2.9 billion of assets under management across both equity and debt platforms, which is considered sufficient to advance the future funds.

The overall WA DBRS Term and Refi DSCRs of 1.12x and 0.93x, respectively, and corresponding DBRS Debt and Exit Debt Yields of 7.2% and 8.2%, respectively, are considered high-leverage financing. The DBRS Term and Refi DSCRs are based on the DBRS In-Place NCF and debt service calculated using a stressed interest rate. The WA DBRS stressed rate used is 6.3%, which is greater than the current WA LIBOR floor and WA loan gross margin combined rate of 5.3%. Regarding the significant refinance risk indicated by the DBRS Refi DSCR of 0.93x, credit enhancement levels are reflective of the increased leverage and substantially higher than recent fixed-rate transactions. The DBRS Refi DSCR of 0.93x is calculated using a WA risk-free interest rate of 6.3%, which is conservative relative to the current U.S. ten-year treasury rate of approximately 2.4%. The assets are generally well positioned to stabilize and any realized cash flow growth would help to offset a rise in interest rates and improve the overall debt yield of the loans. DBRS associates its probability of default (POD) based on the assets’ in-place cash flow, which does not assume that the stabilization plan and cash flow growth will ever materialize.

All loans in the pool are two- to three-year floating-rate loans with 24- to 36-month extension options out to a fully extended term of five years, which creates interest rate risk. The borrowers of all loans have purchased interest rate caps to protect against a rise in interest rates over the term of the loan. Given that the interest rate caps had relatively low LIBOR strike rates ranging from 1.1% to 4.75%, the WA DBRS stressed interest rate for the pool is only 1.0% higher than the pool’s WA interest rate. DBRS considered five loans, representing 31.8% of the pool, to have Weak sponsorship quality resulting from limited net worth and liquidity or past credit issues. Loans with Weak sponsors were assigned increased POD levels to mitigate increased risk.

The DBRS sample included 16 of the 23 loans in the pool. Site inspections were performed on 17 of the 26 properties in the portfolio (83.5% of the pool by allocated loan balance). DBRS conducted meetings with the on-site property managers, leasing agents or representatives of the borrowing entities for 83.5% of the pool. A cash flow review as well as a cash flow stability and structural review was completed on 16 of the 23 loans, representing 83.5% of the pool by loan balance. The DBRS sample had an average In-Place NCF variance of -8.2% from the Issuer NCF and ranged from -56.0% to +42.6%. DBRS excluded two loans that had unique situations where haircuts were excluded, as their NCFs were not indicative of averages. Furthermore, the DBRS sample had an average DBRS Stabilized NCF variance of -16.2% and ranged from -35.3% to +7.3%.
All ratings will be subject to ongoing surveillance that could result in ratings being upgraded, downgraded, placed under review, confirmed or discontinued by DBRS.

For more information on this transaction and supporting data, please log into viewpoint.dbrs.com. DBRS will continue to monitor this transaction with periodic updates provided in the DBRS Viewpoint platform.

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

With regard to due diligence services, DBRS was provided with the Form ABS Due Diligence-15E (Form-15E), which contains the description of the information that the third party reviewed in conducting the due diligence services and a summary of the findings and conclusions. While DBRS did not require due diligence services outlined in Form-15E, DBRS did use the Data File outlined in the Independent Accountant’s Report in its analysis to determine the ratings.

The principal methodology is North American Multi-borrower CMBS Methodology which can be found on dbrs.com under Methodologies. For a list of the Structured Finance related methodologies that may be used during the rating process, please see the DBRS Global Structured Finance Related Methodologies document on www.dbrs.com. Please note that not every related methodology listed under a principal Structured Finance asset class methodology may be used to rate or monitor an individual structured finance or debt obligation.

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

The rated entity or its related entities did participate initially in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.