DBRS Assigns Provisional Ratings to M360 2019-CRE2

DBRS, Inc. (DBRS) assigned provisional ratings to the following classes of Floating-Rate Notes, Series 2019-CRE2 (the Notes) to be issued by M360 2019-CRE2, Ltd. (the Issuer):

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

All trends are Stable. Classes A, A-S, B, C, D and E represent the offered certificates. Classes F and G are non-offered certificates and will be retained by the Issuer.

The initial collateral consists of 32 floating-rate mortgages secured by 32 mostly transitional properties with a cut-off balance totaling $306.0 million, excluding approximately $71.7 million of future funding commitments. Included in the loan count and cut-off balance are two Targeted Mortgage Assets, representing $18.8 million, which have not yet closed. In addition, there is a 90-day Ramp-Up Period during which the Issuer may acquire additional eligible loans subject to the Eligibility Criteria, resulting in a maximum pool balance of $360.0 million. Most loans are in a period of transition with plans to stabilize and improve the asset value. During the Reinvestment Period, the Issuer may acquire future funding commitments and additional eligible loans subject to the Eligibility Criteria. The transaction stipulates a $1.0 million threshold on pari-passu participation acquisitions before a Rating Agency Condition (RAC) is required if there is already a participation of the underlying loan in the trust.

For the floating-rate loans, DBRS used the one-month LIBOR index, which is based on the lower of a DBRS stressed rate that corresponded with the remaining fully extended term of the loans or 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 As-Is net cash flow, 27 loans, comprising 87.6% of the initial pool, had a DBRS As-Is debt service coverage ratio (DSCR) below 1.00 times (x), a threshold indicative of default risk. Additionally, the DBRS Stabilized DSCR for 13 loans, comprising 45.5% of the initial pool balance, is below 1.00x, which is indicative of elevated refinance risk. The properties are often transitioning with potential upside in 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 the structure provided, DBRS generally does not assume the assets to stabilize above market levels. The transaction will have a sequential-pay structure.

The pool is fairly diverse by commercial real estate collateralized loan obligation (CRE CLO) standards with a diversity profile equivalent to that of a pool with 25 equally sized loans (including three projected ramp-up loans). The loans are generally secured by traditional property types (i.e., retail, multifamily, office and industrial) with only 7.5% of the pool secured by hotels. Additionally, only one of the multifamily loans (Lafayette University Place, representing 3.1% of initial pool balance) in the pool is currently secured by a student-housing property, which often exhibit higher cash flow volatility than traditional multifamily properties. Six loans, representing 19.2% of initial pool balance, are represented by properties which are primarily located in core markets with a DBRS Market Rank of 5 to 7. These higher DBRS Market Ranks correspond with zip codes that are more urbanized or densely suburban in nature. Four loans in the pool, totaling 22.5% of the DBRS sample by cut-off date pool balance, are backed by a property with a quality deemed to be Average (+) by DBRS.

The weighted-average (WA) DBRS As-Is loan-to-value (LTV) ratio, which includes all future funding in the calculation, is high at 9.5%, reflecting the highly transitional nature of the pool with substantial future funding as well as the general high leverage. The high LTV results in a very high WA DBRS expected loss of 9.5% for the pool, which translates to credit enhancement levels at each rating category that are relatively high compared with other CRE CLOs.

The pool consists of mostly transitional assets. Given the nature of the assets, DBRS determined a sample size, representing 74.9% of the pool cut-off date balance. Physical site inspections were also performed, including management meetings. DBRS also notes that, when DBRS analysts are visiting the markets, they may actually visit properties more than once to follow the progress (or lack thereof) toward stabilization.

Nine of the sampled loans, comprising 31.4% of the pool balance, were analyzed with Weak or Bad (Litigious) sponsorship strengths. Three of the loans – Brushy Creek Corporate Center, Hughes Plaza Office and The Park at Riverwoods – are among the pool’s top ten largest loans. DBRS applied a probability of default (POD) penalty to loans analyzed with Weak or Bad (Litigious) sponsorship strength. Additionally, for all non-sampled loans in the pool, DBRS applied a Weak sponsorship strength to account for the pool’s overall exposure. In total, 23 loans, representing 60.8% of the pool cut-off date balance, were analyzed with Weak or Bad (Litigious) sponsorship and received POD adjustments.

All 32 loans have floating interest rates and all loans are interest only (IO) during the original term with original terms ranging from 12 months to 36 months, creating interest rate risk. All loans are short-term loans and, even with extension options, they have a fully extended maximum loan term of five years. Additionally, for the floating-rate loans, DBRS used the one-month LIBOR index, which is based on the lower of a DBRS stressed rate that corresponded with the remaining fully extended term of the loans or 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. Additionally, all have extension options and, in order to qualify for these options, the loans must meet minimum leverage requirements.

The participations conveyed to the Issuer will not include record title to the underlying mortgage in the name of the Issuer, but instead will include help from the Seller. This is contrary to standard CRE CLO structures, where the issuer or institutional custodian generally holds title to the participation loans. In the case of a bankruptcy, the issuer has a lesser claim to the loan since it does not own the title. As a result, the issuer’s ability to recover under such participation is subject to the credit risk of the entity that holds legal title to the underlying collateral. Payments to the issuer will be affected if the legal title holder of the participated assets files bankruptcy or is declared insolvent. The Issuer informed DBRS that the risk of M360 2019-CRE2 Seller, LLC becoming involved in a bankruptcy is diminished because the entity will be limited to only acquiring mortgage loans and participations therein and not engaging in other business. Furthermore, it will be limited on indebtedness to only that debt arising in connection with the loan participations.

DBRS has analyzed the loans 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, DBRS analyzes loss given default based on the As-Is LTV, assuming the loan is fully funded.

Twenty-six loans, totaling only 89.3% of the initial pool balance, represent refinance financing. The refinance financings within this securitization generally do not require the respective sponsor(s) to contribute material cash equity as a source of funding in conjunction with the mortgage loan, resulting in a lower sponsor cost basis in the underlying collateral. Of the 26 refinance loans, 13 loans, representing 39.8% of the pool, have a current occupancy of less than 80.0% and four of the refinance loans account for $26.6 million of the $71.7 million of future funding (37.1%). This suggests that at least one-third of the refinance loans are near stabilization, which would partially mitigate the higher risk associated with a sponsor’s lower cost basis.

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

For supporting data and more information on this transaction, please log into www.viewpoint.dbrs.com.

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 methodology is North American CMBS Multi-borrower 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. Please note a sensitivity analysis is not performed for CMBS bonds rated CCC or lower. The DBRS long-term rating scale definition indicates that ratings of CCC or lower are assigned when the bond is highly likely to default or default is imminent, thereby prevailing over a sensitivity analysis.

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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