DBRS Updates its European CMBS Rating and Surveillance Methodology

DBRS Ratings Limited (DBRS) published its updated “European CMBS Rating and Surveillance Methodology” (the Methodology). The updated Methodology, effective today, replaces the prior version published on 10 January 2017. The publication follows the conclusion of the Request for Comment period, which began on 5 January 2018. No comments were received during the Request for Comment period.

The Methodology addresses the approach DBRS uses to rate European commercial mortgage-backed securities (CMBS), commercial real estate (CRE) loans and warehouse lines for CRE loans. European CMBS typically consists of one CRE loan backed by one or more real estate assets, or of a concentrated portfolio of CRE loans.

The material changes to the Methodology compared with the version published on 10 January 2017 involve the revision of the DBRS loan-to-value (LTV) sizing hurdles, namely, a reduction of the DBRS LTV sizing hurdles for ratings in the AA category and an increase of the DBRS LTV sizing hurdles for ratings in the BBB category and below. DBRS LTV sizing hurdles continue to be one of the substantial components of the Methodology.

The material changes and their rationale are as follows:

The DBRS LTV sizing hurdles are a function of a quantitative and qualitative analysis of European CMBS sector performance. DBRS constructed a proxy data set by observing the loan, property and rental income performance of approximately 800 European CRE loans with a total whole loan balance of approximately EUR 110 billion and that were securitised in the CMBS market between 2002 and 2016. A full data set including rental income was available for approximately 600 loans with a whole loan balance of approximately EUR 105 billion.

Based on the historical income and value performance of the properties securing these loans, DBRS determined the LTV levels commensurate with each rating level. DBRS considered that the DBRS LTV sizing hurdles are based on DBRS’s stabilised property value assumption whereas the historical data analysis was based on the appraised value or the purchase price at the time of loan origination and on periodic valuation updates or sales prices during the life of the respective loans. In comparison, DBRS’s stabilised property value is typically lower than the appraised value or purchase price at the time of loan origination.

As a result of the updated data analysis, DBRS found that in the previous version of the Methodology, the DBRS LTV sizing hurdles for ratings in the AA category were too high, but those for ratings in the BBB and below categories were too low. Hence, DBRS reduced the DBRS LTV sizing hurdles for the AA rating category by 2.5% and increased the DBRS LTV sizing hurdles for the BBB rating category by up to 10%. The Methodology also outlines the DBRS LTV sizing hurdles for the BB and B rating categories. DBRS kept its DBRS debt service coverage ratio sizing hurdles for European CMBS and CRE loans unchanged.

DBRS notes that there are certain limitations that make it difficult to derive the DBRS LTV sizing hurdles through data and statistical analysis alone, necessitating the consideration of qualitative factors. Such limitations include that the data analysis is based on the public European CMBS market, which is relatively small compared with the entire European CRE debt market. Considering the characteristics of past European CMBS issuance, U.K. and German loans and properties are over-represented in the analysed data. Likewise, the data is concentrated in the 2005 to 2007 origination vintages.

DBRS deems other changes in the updated Methodology as not material. Such changes include the following:

-- The consolidation of property types to better reflect European CRE market standards and naming conventions;
-- A summary of the DBRS underwriting approach for hotel properties;
-- Clarification on how DBRS analyses CMBS and CRE loans that do not benefit from third-party liquidity provisions;
-- Details about additional scenario analysis DBRS undertakes before upgrading bonds or loans; and
-- An explanation of the “first dollar loss” rating concept for CRE loans.

Other changes primarily consist of edits and additions to better reflect current practices in the European CRE and CMBS markets.

DBRS currently publicly rates 51 classes of 13 European CMBS true sale transactions. DBRS currently expects that up to 13 bonds in five of these transactions could be upgraded by up five notches, also considering recently announced loan prepayments. In addition to one bond that is already Under Review with Negative Implications, one European CMBS bond of one of these 13 transactions could be downgraded by up to two notches following the Methodology update. The provisional ratings currently assigned to Pietra Nera Uno S.R.L. are not expected to change following today’s publication of the updated Methodology, as outlined in the related press release that was published on 2 February 2018. DBRS publicly rates one interest rate swap related to one European CMBS transaction whose rating will not be affected by the updated Methodology.

In addition, DBRS maintains provisional ratings on 36 tranches of two transactions involving unexecuted, unfunded financial guarantees that reference two commercial real estate loan portfolios originated by two U.K. banks. For these two transactions, DBRS currently expects that the provisional rating of junior bonds currently rated BBB or lower could be upgraded by up to two notches.

DBRS expects to publish the relevant rating actions in the near term.

The Methodology providing additional analytical details is publicly available on www.dbrs.com under Methodologies or by contacting us at info@dbrs.com.

Notes:

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

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