DBRS Morningstar Finalizes Provisional Ratings on Freddie Mac Structured Pass-Through Certificates, Series K-739

DBRS, Inc. (DBRS Morningstar) finalized provisional ratings on the following classes of Structured Pass-Through Certificates, Series K-739 (Freddie Mac SPCs K-739) issued by Freddie Mac Structured Pass-Through Certificates, Series K-739 (the Issuer):

-- Class A-1 at AAA (sf)
-- Class A-2 at AAA (sf)
-- Class X1 at AAA (sf)

All trends are Stable.

The Class X1 balance is notional.

The collateral consists of 47 fixed-rate loans secured by 47 multifamily properties. Two loans (The Solow Townhouses and 265 East 66th loan and the Rivers Bend loan) are associated with the same sponsorship and are both located in New York’s Upper East Side submarket. DBRS Morningstar’s analysis of this transaction incorporates these two loans as a single loan, resulting in a modified loan count of 46. Thirty-seven loans, representing 89.7% of the pool balance, are structured with seven-year loan terms. Seven loans within the transaction are structured with 60-month loan terms, one loan is structured with a 90-month loan term, and one is structured with a 96-month loan term. The transaction is a sequential-pay pass-through structure. DBRS Morningstar analyzed the pool to determine the ratings, reflecting the long-term risk that the Issuer will default and fail to satisfy its financial obligations in accordance with the terms of the transaction. When the cut-off loan balances were measured against DBRS Morningstar’s Net Cash Flow (NCF) and their respective actual constants, 17 loans, representing 53.3% of the pool balance, had a DBRS Morningstar Term Debt Service Coverage Ratio (DSCR) at or above 1.80 times (x), a threshold indicative of a lower likelihood of midterm default.

Freddie Mac has conveyed Classes A-1, A-2, A-M, X1, XAM, and X3 of the FREMF 2020-K739 Mortgage Trust, Series 2020-K739 (FREMF 2020-K739) transaction into a trust to issue corresponding classes of Freddie Mac SPCs K-739 guaranteed by Freddie Mac. All DBRS Morningstar-rated classes will be subject to ongoing surveillance, confirmations, upgrades, or downgrades by DBRS Morningstar after the date of issuance. DBRS Morningstar assigned the ratings to the FREMF 2020-K739 Multifamily Mortgage Pass-Through Certificates, Series 2020-K739 and the Freddie Mac SPCs K-739 without giving effect to the Freddie Mac guarantee.

Four loans, representing 28.8% of the pool balance, are in areas identified with DBRS Morningstar Market Ranks of 7 or 8, which are generally characterized as highly dense urbanized areas that benefit from increased liquidity driven by consistently strong investor demand, even during times of economic stress. Markets with DBRS Morningstar Market Ranks of 7 and 8 benefit from lower default frequencies than less dense suburban, tertiary, and rural markets. Urban markets represented in the transaction include New York and Chicago. The 28.8% of the pool in areas with DBRS Morningstar Market Ranks of 7 or 8 compares favorably, with DBRS Morningstar Market Rank 7 and 8 concentrations totaling 0.0%, 3.8%, 0.0%, and 1.7% exhibited by FREMF 2020-K738, FREMF 2020-K118, FREMF 2020-K117, and FREMF 2020-K115, respectively, which were previously rated by DBRS Morningstar.

The transaction exhibits favorable credit metrics as evidenced by a weighted-average (WA) DBRS Morningstar Issuance and Balloon Loan-to-Value (LTV) Ratio of 68.5% and 65.0%, respectively. These metrics are comparable or better than recent FREMF transactions rated by DBRS Morningstar, including FREMF 2020-K118 with a WA DBRS Morningstar Issuance and Balloon LTV of 69.4% and 63.4%, respectively, and FREMF 2020-K117 with a WA DBRS Morningstar Issuance and Balloon LTV of 70.0% and 62.6%, respectively. Additionally, the WA DBRS Morningstar Term DSCR of 1.89x is slightly higher than that of FREMF 2020-K738 at 1.86x. This is because 15 loans, representing 52.8% of the cut-off date loan balance, are structured with full-term interest-only (IO) periods, which is lower relative to FREMF 2020-K738 at 59.8%. This DSCR cushion provided by the full-term IO structure could prove beneficial, given current economic conditions and the uncertainty surrounding the ultimate impact of the Coronavirus Disease (COVID-19) pandemic on the economy, though it does come at a cost of not deleveraging the loans modestly over time. Six loans, representing 21.1% of the pool by loan balance, exhibit issuance LTVs of less than 59.3%, a threshold historically indicative of relatively low-leverage financing and generally associated with below-average default frequency.

The loans benefit from strong origination practices. Loans on Freddie Mac’s balance sheet, which are originated according to the same policies as those for securitization, had an extremely low delinquency rate of 0.01% as of July 2020. This compares favorably with the delinquency rate for commercial mortgage-backed security (CMBS) multifamily loans of approximately 3.89% as of July 2020. As of July 2020, Freddie Mac had securitized 18,779 loans, totaling approximately $377.99 billion in guaranteed issuance balance. To date, Freddie Mac has not realized any credit losses on its guaranteed issuances, although B-piece investors have realized a combined $18.8 million in total losses, representing fewer than 1.0 basis points of total issuance.

The loans in the transactions benefit from experienced and financially strong borrowers compared with typical CMBS multifamily loans, with all 47 loans receiving Strong DBRS Morningstar sponsor strength scores. Additionally, many of the borrowers are repeat clients of Freddie Mac that have performed as agreed.

The pool has a WA expected loss of 1.81%, which is below the WA expected loss of 2.38%, 2.29%, 2.66%, 2.53%, and 2.86% exhibited by FREMF 2020-K738, FREMF 2020-K118, FREMF 2020-K117, FREMF 2020-K115, and FREMF 2020-K114, respectively, which were previously rated by DBRS Morningstar.

The underlying collateral analysis is prudent, as an average DBRS Morningstar NCF variance of -6.9% on the sampled loans underscores. In general, revenue has been set to levels similar to the recent trailing 12-month amount and lower than a recent annualized rent roll.

The DBRS Morningstar property quality is better than FREMF transactions previously rated by DBRS Morningstar. The Excellent, Above Average, and Average + property quality as a percentage of the pool were 8.2%, 10.3%, and 44.8%, respectively. Properties with better than average property quality tend to attract better tenants and premium rents and are generally more resilient during a downturn.

CORONAVIRUS-RELATED RISKS
In response to the ongoing pandemic, Freddie Mac made changes to its standard servicing practices to permit a temporary deferral of loan payments and forbearance of various remedies, which could, among other things, adversely affect cash flow. While DBRS Morningstar views the inclusion of coronavirus-related upfront debt service reserves (DSRs) for a portion of the loans as a positive mitigant of some of the potential coronavirus-related disruptions, the economic fallout from the ongoing pandemic continues to evolve. While DBRS Morningstar generally expects multifamily properties to fare better than hospitality and retail, short- and medium-term challenges still exist in this sector. In addition to imposing various containment-related restrictions, certain jurisdictions have also placed temporary moratoriums on the eviction of tenants that may be continued, extended, or expanded. Furthermore, government programs such as the Coronavirus Aid, Relief, and Economic Security Act, which provided, among other things, supplemental unemployment benefits to displaced employees, expired on July 31, 2020. This could result in additional stress on properties whose residents have been disproportionately affected by furloughs and layoffs. The resurgence of coronavirus cases has also created additional uncertainty and increased stress on the planned reopening of businesses. Also, in its “Global Macroeconomic Scenarios: September Update,” DBRS Morningstar projected generalized commercial real estate asset value declines of approximately 15% under its moderate scenario and 30% under its adverse scenario for the U.S.

The pool contains seven loans, representing 16.1% of the pool balance, that were originated prepandemic (from January 2019 to January 2020). These loans are not structured with a coronavirus DSR. The seven loans are: Amberglen West, The Park at Forest Hill Apartments, University Suites at Centennial, Pavilion Towers, Little Traverse Village, Anchor Bay Townhomes, and Royale Glen Townhomes. All seven loans show strong occupancy levels, ranging from 92.4% to 100.0%, as of their latest rent rolls.

The pool is concentrated by property type, as multifamily properties represent 88.3% of the collateral, which excludes seven loans (11.7% of the pool) that are secured by nontraditional multifamily property types (i.e., manufactured housing community (MHC) and student housing) including University Suites at Centennial, representing 2.6% of the pool balance, which is a student-housing property. Advenir at Polos East, representing 3.5% of the pool balance, is a multifamily property with a student concentration of 30.0%. The remaining 5.6% of the pool consist of MHC properties. Compared with other property types, multifamily assets generally benefit from staggered lease rollover and lower expense ratios. While revenue is quick to decline in a downturn because of the short-term nature of the leases, it is also quick to respond when the market improves. DBRS Morningstar’s analysis on the 23 sampled loans indicates that most markets are displaying strong occupancy and rent growth figures with positive year-over-year trends established. Student-housing properties are modeled with higher probabilities of default (PODs) than traditional multifamily properties, and MHCs have historically performed very well, despite not being a core asset class.

Fifteen loans, representing 52.8% of the cut-off date pool balance and including six of the top 15 loans, are structured with full-term IO periods. An additional 24 loans, representing 45.4% of the cut-off date pool balance and including seven top 15 loans, are structured with partial-IO periods ranging from 12 months to 48 months. The POD is calculated using a DSCR that includes amortizing debt service. Balloon LTV is also incorporated into the POD. Furthermore, partial-IO loans are penalized in the DBRS Morningstar model.

According to the Exceptions to the Representation and Warranties – 6 (Condition of Mortgage Property), the mortgage loan seller did not perform, or cause to perform, certain customary due diligence for seven loans with respect to the condition of the mortgaged property in connection with the origination of the loans. DBRS Morningstar did not obtain a complete property condition report or physical risk report, as applicable, and/or an in-person inspection of the mortgaged property was not conducted at origination of the loans. Of these seven loans, five loans were either not included in the DBRS Morningstar sample, not inspected by DBRS Morningstar, or generally appeared to be of lower property quality per third-party reports. To mitigate any issues resulting from the absence of the customary due diligence, DBRS Morningstar applied a POD penalty to these five loans: Eagles Crossing, Arrowhead MHC, Lindsay Commons Apartments, Hillside MHC, and Purdum Woods Apartments.

Individual loan information provided generally included monthly collection reports from June 2020 through September 2020, which may not fully reflect any reductions to income as a result of coronavirus-related economic conditions. Additionally, for loans that DBRS Morningstar did not sample, DBRS Morningstar conservatively applied a 10.0% reduction to the Issuer’s cash flow. This reduction was greater than the sample average NCF variance of -6.9%. Twenty-five loans, representing 68.4% of the pool balance, have an upfront coronavirus DSR designed to mitigate any potential impact of the ongoing coronavirus pandemic.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

Class X1 is an IO certificate that references a single rated tranche or multiple rated tranches. The IO rating mirrors the lowest-rated applicable reference obligation tranche adjusted upward by one notch if senior in the waterfall.

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

For supporting data and more information on this transaction, please log into www.viewpoint.dbrsmorningstar.com DBRS Morningstar provides analysis and in-depth commentary in the DBRS Viewpoint platform.

DBRS Morningstar provides updated analysis and in-depth commentary in the DBRS Viewpoint platform for the following loans in the transaction:

-- Prospectus ID#1 – Solow Rollup (19.3% of the pool)
-- Prospectus ID#2 – Optima Signature (A-1) (8.2% of the pool)
-- Prospectus ID#3 – Amberglen West (5.8% of the pool)
-- Prospectus ID#4 – Runaway Bay Apartments (4.8% of the pool)
-- Prospectus ID#5 – The Park at Forest Hill Apartments (4.4% of the pool)
-- Prospectus ID#6 – Crosstown Walk (4.3% of the pool)
-- Prospectus ID#7 – Citrus Village (3.8% of the pool)
-- Prospectus ID#8 – Advenir at Polos East (3.5% of the pool)
-- Prospectus ID#9 – Mira Loma (3.2% of the pool)
-- Prospectus ID#10 – Advenir on Addison (3.2% of the pool)
-- Prospectus ID#11 – Avenues at Northpointe (3.1% of the pool)
-- Prospectus ID#12 – University Suites at Centennial (2.6% of the pool)
-- Prospectus ID#13 – Avenues at Cypress (2.6% of the pool)
-- Prospectus ID#14 – Park at Rialto (2.6% of the pool)
-- Prospectus ID#15 – Pavilion Towers (2.4% of the pool)
-- Prospectus ID#16 – Vantage at Waco (1.9% of the pool)
-- Prospectus ID#17 – Haven at liberty Hills (1.9% of the pool)
-- Prospectus ID#18 – Columbus Greens (1.6% of the pool)
-- Prospectus ID#19 – Del Sol Apartments (1.6% of the pool)
-- Prospectus ID#20 – The Park at Messina (1.5% of the pool)
-- Prospectus ID#22 – Woodcrest Apartments (1.3% of the pool)

For complimentary access to this content, please register for the DBRS Viewpoint platform at www.viewpoint.dbrsmorningstar.com. The platform includes issuer and servicer data for most outstanding CMBS transactions (including non-DBRS Morningstar rated), as well as loan-level and transaction-level commentary for most DBRS Morningstar-rated and -monitored transactions.

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

With regard to due diligence services, DBRS Morningstar 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 Morningstar’s methodology, DBRS Morningstar used the data file outlined in the independent accountant’s report in its analysis to determine the ratings referenced herein.

The principal methodology is the North American CMBS Multi-Borrower Rating Methodology (August 7, 2020), which can be found on dbrsmorningstar.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 Morningstar Global Structured Finance Related Methodologies document, which can be found on dbrsmorningstar.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.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

For more information regarding structured finance methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/358308.

For more information regarding the structured finance rating approach and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/359905.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar 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 [email protected].

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at [email protected].

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