DBRS Assigns Provisional Ratings to Sutherland Commercial Mortgage Trust 2019-SBC8

DBRS, Inc. (DBRS) assigned provisional ratings to the following classes of Commercial Mortgage Pass-Through Certificates, Series 2019-SBC8 to be issued by Sutherland Commercial Mortgage Trust 2019-SBC8:

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

All trends are Stable.

The collateral consists of 1,227 individual loans secured by 1,227 commercial and multifamily properties with an average loan balance of $248,456. The transaction is configured with a modified pro-rata pay pass-through structure. Given the complexity of the structure and granularity of the pool, DBRS applied its “North American CMBS Multi-borrower Rating Methodology” (CMBS Methodology) and the “RMBS Insight 1.3: U.S. Residential Mortgage-Backed Securities Model and Rating Methodology” (RMBS Methodology).

CMBS Methodology
Of the 1,227 individual loans, 276 loans, representing 20.2% of the pool, have a fixed interest rate with a straight average of 7.9%. The floating-rate loans are structured with interest-rate floors ranging from 0.0% to 1.125% with a straight average of 0.08% and interest-rate margin ranging from 1.25% to 5.875% with a straight average of 3.24%. To determine the probability of default (POD) and loss given default inputs in the CMBS Insight Model, DBRS applied a stress to the various indexes that corresponded with the remaining fully extended term of the loans and added the respective contractual loan spread to determine a stressed interest rate over the loan term. DBRS looked to the greater of the interest-rate floor or the DBRS stressed index rate when calculating stressed debt service. The DBRS weighted-average (WA) modeled coupon rate was 6.331%. The loans have original term lengths of ten- to 30-year basis and amortize over periods of 15 to 40 years. When the cut-off loan balances were measured against the DBRS Net Cash Flow and their respective actual constants or stressed interest rates, there were 112 loans, representing 10.4% 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.

The pool has an average original term length of 319 months or 26.6 years with an average remaining term of 156 months or 13 years. Based on the original loan balance and the appraisal at origination, the pool had an average loan-to-value (LTV) ratio of 63.8%. Based on the current loan amount, which reflects 37.2% amortization, and the appraisal at origination, the pool has an average LTV of 39.2%. DBRS applied a pool average LTV of 56.1%, which reflects a more recently obtained broker’s opinion of value (BOV) for loans located in more urban markets and the lesser of the updated BOV or the original appraised value for loans located in all other markets. Furthermore, all but 38 of 1,227 loans fully amortize over their respective remaining loan terms, resulting in 96.4% expected amortization; this amount of amortization is not represented in typical commercial mortgage-backed security (CMBS) conduit pools. DBRS research indicates that, for CMBS conduit transactions securitized between 2000 and 2018, average amortization by year has ranged between 7.5% to 22.0% with an overall median of 12.5%.

As contemplated and explained in DBRS’s “Rating North American CMBS Interest-Only Certificates” methodology, the most significant risk to an interest-only (IO) cash flow stream is term default risk. As noted in that methodology, for a pool of approximately 63,000 CMBS loans that fully cycled through to their maturity dates, DBRS noted that the average total default rate across all property types was approximately 17%; the refinance default rate was 6% (approximately one-third of the total rate); and the term default rate was approximately 11%. DBRS recognizes the muted impact of refinance risk on IOs by notching the IO rating up by one notch from the Reference Obligation rating. When using the ten-year Idealized Default Table default probability to derive a POD for a CMBS bond from its rating, DBRS estimates that, in general, a one-third reduction in the CMBS Reference Obligation POD maps to a tranche rating that is approximately one notch higher than the Reference Obligation or the Applicable Reference Obligation, whichever is appropriate. Therefore, following similar logic regarding term default risk supported the rationale for DBRS to reduce the POD in the CMBS Insight Model by one notch because refinance risk is largely absent for this pool of loans.

RMBS Methodology
The DBRS CMBS Insight Model does not contemplate the ability to prepay loans, which is generally seen as credit positive since a prepaid loan cannot default.

The CMBS predictive model was calibrated using loans which have prepayment lockout features. Those loans’ historical prepayment performance is close to 0 conditional prepayment rate (CPR). If the CMBS predictive model had an expectation of prepayments, DBRS would expect the default levels to be reduced. Any loan that prepays is removed from the pool and can no longer default. This collateral pool does not have any prepayment lockout features. The historical prepayments have averaged around 12.5% and have been in a range from 4.5% to 26.0%. DBRS expects that this pool will continue to have some prepayments over the remainder of the transaction. DBRS applied the following to calculate a default rate prepayment haircut: using Intex Dealmaker, DBRS calculated a lifetime constant default rate (CDR) rate that approximated the default rate for each rating category. While applying the same lifetime CDR, DBRS applied a 2.0% CPR. When holding the CDR constant and applying 2.0% CPR, the cumulative default amount declined. The percentage change in the cumulative default prior to and after applying the prepayments was then applied to the cumulative default assumption to calculate a fully adjusted cumulative default assumption.

The fully adjusted default assumption and model generated severity figures from the DBRS CMBS Insight Model were then applied to the RMBS Cash Flow Model, which is adept at modeling pro-rata structures on loan pools in excess of 1,000 loans.

Historically, this pool has had a CPR ranging from just above 25.0% in 2009 to a low of approximately 5.0% in 2018. The initial CPR in 2008 was about 15.0%, but the linear trend has reduced to just above 10.0% as of the end of 2018. As part of the RMBS Cash Flow Model, DBRS incorporated three CPR stresses – 5.0%, 10.0% and 15.%.

Additional assumptions in the RMBS Cash Flow Model include a 22-month recovery lag period, 100% servicer advancing and three default curves (uniform, front and back). The shape and duration of the default curves were based on the RMBS seasoned loss curves; however, the timing was adjusted to consider the 22-month recovery lag period. Lastly, rates were stressed, both upward and downward, based on their respective loan indices, including the one-year, three-year, five-year Constant Maturity Treasury and six-month LIBOR.

The pool is relatively diverse based on loan size with an average balance of $248,456, a concentration profile equivalent to that of a pool with 710 equal-sized loans and a top-ten loan concentration of only 5.0%. Increased pool diversity helps to insulate the higher-rated classes from event risk. The loans are mostly secured by traditional property types (i.e., retail, multifamily, office and industrial) with no exposure to higher-volatility property types, such as hotels, self-storage or manufactured housing community. Furthermore, the loans have a DBRS average market rank of 4.9 with 1.6% in a market ranked 8 and 33.6% in a market ranked 6 or 7, indicative of more urban markets with more liquidity. Furthermore, only 4.7% of the pool is located in markets with a DBRS rank of either a 1 or 2, indicative of traditional tertiary or rural markets. Moreover, the pool has reduced term risk as supported by the strong WA DBRS DSCR of 2.58x, including the DBRS stressed interest rates. Furthermore, the pool has a cut-off LTV of 29.9% based on the BOVs dated between October 2018 and June 2019. Based on the origination appraised value and the cut-off balance, the pool still has a relatively low WA LTV of 39.2%. All but 38 loans in the pool fully amortize over their respective loan terms between 180 and 360 months, thus virtually eliminating refinance risk. Lastly, on average, the loans have a loan term of 26.6 years with 13.6 years of seasoning. Seasoned loans typically have a lower default rate because of market value appreciation.

The pool is heavily concentrated with mixed-use (40.9% of the pool) and multifamily (27.8% of the pool) properties. Based on the DBRS inspections, the loans classified as mixed-use represented buildings with street-level commercial space and several floors of multifamily units above. Based on DBRS research, multifamily properties securitized in conduit transactions have had lower default rates than most other property types. Just over three-quarters of the loans by pool balance are located in strong suburban or urban markets, which typically have a stronger tenant demand for multifamily properties.

Of the 50 loans on which DBRS performed exterior inspections, 22 loans, representing 3.8% of the pool (35.3% of the DBRS sample), were modeled with Average (-) to Below Average property quality and, on an overall basis, the mean DBRS property quality was between Average and Average (-). Lower-quality properties are less likely to retain existing tenants, resulting in less stable performance. DBRS increased the POD for these loans to account for the elevated risk. Furthermore, DBRS modeled any uninspected loans as Average (-), which has a slightly increased POD level.

Limited property-level information was available for DBRS to review. Asset Summary Reports, Property Condition Reports (PCR), Phase I/II Environmental reports, appraisals and historical financial cash flows were not provided in conjunction with this securitization. DBRS received a BOV, but not the actual report, for all loans and the appraised value from origination. To calculate the LTV for the DBRS model, DBRS relied on the BOV figure for assets located in urban markets identified with a DBRS Market Rank of 6, 7, or 8 as more likely to experience value appreciation since loan origination. For all other loans, DBRS assumed a value based on the lower of the appraisal or BOV. This hybrid assumption produced an averaged modeled LTV of 56.1% versus an LTV of 46.5% based solely on the BOV and the original loan amount. The DBRS LTV of 56.1% is also significantly greater than the LTV of 29.9% based on the cut-off loan amount and the BOV figure. While 63.3% of the loans DBRS inspected were of Average property quality, DBRS applied an Average - property quality to all non-sampled loans, given the lack of PCRs, which increases the default stress. No environmental reports were provided; however, only 6.7% of the pool consists of secured industrial properties, which would typically have an increased risk of environmental concerns originating at the property. DBRS was unable to perform a loan-level cash flow analysis on loans in the DBRS sample. Based on cash flow analysis from another small balance commercial loan pool, DBRS applied a -15.5% reduction to the BOV-estimated NOI for this transaction. This cash flow reduction is well above the median historical reduction of -8.0% and provides meaningful stress to the default levels.

DBRS was provided no borrower information, net worth or liquidity information and very limited credit history. DBRS modeled loans with Weak borrower strength, which increases the stress on the default rate. Furthermore, DBRS was provided a 24-month pay history on each loan. Any loan with more than two late pays within this period or two consecutive late pays was modeled with additional stress to the default rate. This assumption was applied to 92 loans, representing 7.4% of the pool balance. Finally, a borrower FICO score as of May 1, 2019, was provided on 852 of the 1,227 loans with an average FICO score of 736. While the CMBS Methodology does not contemplate FICO scores, the RMBS Methodology does and would characterize a FICO score of 736 as ”near-prime,” where prime is considered greater than 750. A borrower with a FICO score of 736 could generally be described as potentially having had previous credit events (foreclosure, bankruptcy, etc.) but, if they did, it is likely that these credit events were cleared about two to five years ago.

All ratings are subject to surveillance, which could result in ratings being upgraded, downgraded, placed under review, confirmed or discontinued by DBRS.

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 a description of the information that a third party reviewed in conducting the due diligence services and a summary of the findings and conclusions. While due diligence services outlined in Form-15E do not constitute part of DBRS’s methodology, DBRS used the data file outlined in the independent accountant’s report in its analysis to determine the ratings referenced herein.

The principal methodologies are the North American CMBS Multi-borrower Rating Methodology and RMBS Insight 1.3: U.S. Residential Mortgage-Backed Securities Model and Rating Methodology, which can be found on www.dbrs.com under Methodologies & Criteria. 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, which can be found on www.dbrs.com in the Commentary tab under Regulatory Affairs. 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.

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

Please see the related appendix for additional information regarding the sensitivity of assumptions used in the rating process.

The full report providing additional analytical detail is available by clicking on the link under Related Documents below or by contacting us at info@dbrs.com.

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

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