DBRS Morningstar Assigns Provisional Ratings to SCMT 2021-SBC10

DBRS, Inc. (DBRS Morningstar) assigned provisional ratings to the following classes of the Commercial Mortgage Pass-Through Certificates to be issued by SCMT 2021-SBC10:

-- Class A 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 (low) (sf)
-- Class F at B (low) (sf)

All trends are Stable.

RATING DESCRIPTION
The collateral consists of 297 individual loans and three crossed loan pools secured by 316 commercial and multifamily properties with an average loan balance of $775,329. DBRS Morningstar analyzed the transaction as a 300-loan pool because of cross-collateralization in the pool, and all metrics within this report reflect this pool size. 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 Morningstar 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 300 loans, 172 loans, representing 71.3% of the pool, have a fixed interest rate with a straight average of 6.6%. The floating-rate loans have interest rate floors (excluding rate margins) ranging from 0.00% to 5.50% with a straight average of 1.45% and interest rate margins ranging from 0.75% to 5.20% with a straight average of 3.20%. To determine the probability of default (POD) and loss given default (LGD) inputs in the CMBS Insight Model, DBRS Morningstar 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 Morningstar looked to the greater of the interest rate floor or the DBRS Morningstar stressed index rate when calculating stressed debt service. The weighted-average (WA) modeled coupon rate was 6.50%. The loans have original term lengths of five to 386 months and amortize over periods of 120 to 429 months. When the cut-off loan balances were measured against the DBRS Morningstar Net Cash Flow (NCF) and their respective actual constants or stressed interest rates, there were 80 loans, representing 33.2% of the pool, with term DSCRs below 1.15x, a threshold indicative of a higher likelihood of term default.

The pool has a WA original term length of 207 months, or 17.3 years, with a WA remaining term of 77 months, or 6.4 years. Based on the current loan amount, which reflects 47.4% amortization, and the current valuation, the pool has a WA loan-to-value ratio (LTV) of 39.1%. DBRS Morningstar applied a pool average LTV of 47.6%, which reflects a recent appraised value for four loans, a more recently obtained BOV for loans in more urban markets, and the lesser of the updated broker’s opinion of value (BOV) or the original appraised value for loans in all other markets. Furthermore, DBRS Morningstar made LTV adjustments to 34 loans that had an implied capitalization rate more than 200 basis points lower than a set of minimal capitalization rates established by DBRS Morningstar Market Rank. The DBRS Morningstar minimal capitalization rates range from 5.0% for properties in Market Rank 8 to 8.0% for properties in Market Rank 1. Lastly, 196 loans fully amortize over their respective remaining loan terms, resulting in a 56.6% expected amortization; this amount of amortization is greater than typical of commercial mortgage-backed securities (CMBS) conduit pools. DBRS Morningstar’s research indicates that, for CMBS conduit transactions securitized between 2000 and 2019, average amortization by year has ranged between 7.50% to 21.09%, with an overall median of 18.80%.

As contemplated and explained in DBRS Morningstar’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 Morningstar 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 Morningstar recognizes the muted impact of refinance risk on IOs by adjusting the IO rating up by one notch from the Reference Obligation rating. When using the 10-year Idealized Default Table default probability to derive a POD for a CMBS bond from its rating, DBRS Morningstar 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 Morningstar to reduce the POD in the CMBS Insight Model by one notch because refinance risk is largely absent for this pool of loans. DBRS Morningstar reduced this one notch adjustment by 43.5%, reflecting the portion of the pool that does not fully amortize.

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

DBRS Morningstar calibrated the CMBS predictive model using loans that have prepayment lockout features. Those loans’ historical prepayment performance is close to 0 constant prepayment rate (CPR). If the CMBS predictive model had an expectation of prepayments, DBRS Morningstar 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. DBRS Morningstar expects that this pool will continue to have some prepayments over the remainder of the transaction. DBRS Morningstar applied the following to calculate a default rate prepayment haircut: using Intex Dealmaker, DBRS Morningstar calculated a lifetime constant default rate (CDR) that approximated the default rate for each rating category. While applying the same lifetime CDR, DBRS Morningstar 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 before 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 Morningstar CMBS Insight Model. DBRS Morningstar then applied these severity figures to the RMBS Cash Flow Model, which is adept at modeling pro rata structures. Historically, pools similar to this have had a CPR ranging from a low of approximately 5% to just above 25%, with a linear trend between 10% and 15%. As part of the RMBS Cash Flow Model, DBRS Morningstar incorporated three CPR stresses: 5.0%, 10.0%, and 15.0%.

Additional assumptions in the RMBS Cash Flow Model include a six-month recovery lag period, 100% servicer advancing, and three default curves (uniform, front, and back). DBRS Morningstar based the shape and duration of the default curves on the RMBS seasoned loss curves; however, it adjusted the timing to consider the recovery lag period. Lastly, DBRS Morningstar stressed interest rates, both upward and downward, based on their respective loan indexes, including the one-, three-, five-, and seven-year Constant Maturity Treasury, one-month commercial paper, prime, five-year swap, and 10-year swap.

Overall, the pool has a WA expected loss of 4.66%, which is lower than recently analyzed comparable small balance transactions. Contributing factors to the low expected loss include pool diversity, low leverage, and relatively strong markets. Furthermore, the pool is relatively diverse based on loan size, with an average balance of $775,329, a concentration profile equivalent to that of a pool with 132 equal-size loans, and a top-10 loan concentration of 18.0%. Increased pool diversity helps insulate the higher-rated classes from event risk. Additionally, the loans are mostly secured by traditional property types (i.e., retail, multifamily, office, and industrial) with only 7.0% exposure to higher-volatility property types, such as hotels, self-storage, or MHCs. There are also two individual marina properties, amounting to 1.7% of the pool, that were part of a portfolio that was analyzed as industrial. Also, the pool has a low cut-off WA LTV of 39.1% based on the appraisal and BOVs dated between May 2020 and March 2021. One hundred ninety-six loans in the pool (representing 48.1% of the pool balance) fully amortize over their respective remaining loan terms between eight and 213 months, reducing refinance risk. Finally, on average, the loans have a term of 17.3 years with 10.9 years of seasoning. Seasoned loans typically have a lower default rate because of market value appreciation.

The pool contains a significant exposure to retail (31.3% of the pool) and a smaller exposure to hospitality (3.4% of the pool), which are two of the higher-volatility asset types. Combined, they represent over one third of the pool balance. Retail, which has struggled because of the Coronavirus Disease (COVID-19) pandemic, comprises the largest asset type in the transaction. DBRS Morningstar applied a 20.0% reduction to the NCF for retail properties and a 40.0% reduction for hospitality assets in the pool, which is above the average NCF reduction applied for comparable property types in CMBS analyzed deals. Multifamily comprises the second-largest property type concentration in the pool (19.3%); based on DBRS Morningstar’s research, multifamily properties securitized in conduit transactions have had lower default rates than most other property types. DBRS Morningstar did not perform site inspections on properties within its sample for this transaction. Instead, DBRS Morningstar relied upon analysis of third-party reports and online searches to determine property quality assessments. Of the 39 loans DBRS Morningstar sampled, 10.7% were Average + quality, 58.6% were Average quality, and 30.7% were Average –, Below Average, or Poor quality. DBRS Morningstar applied a 20.0% reduction to the NCF for retail properties and a 40.0% reduction for hospitality assets in the pool, which is above the average NCF reduction applied for comparable property types in CMBS analyzed deals. Multifamily comprises the second-largest property type concentration in the pool (19.3%); based on DBRS Morningstar’s research, multifamily properties securitized in conduit transactions have had lower default rates than most other property types.

DBRS Morningstar performed site inspections on 23 loans that were initially securitized as part of the SCMT 2018-SBC7 transaction. DBRS Morningstar applied the property quality assessments from those site inspections, which ranged from Average + to Poor, with the majority having Average property quality. DBRS Morningstar assumed unsampled loans were Average – quality, which has a slightly increased POD level. This is more conservative than the assessments from sampled or previously sampled loans and is consistent with other small balance commercial transactions. Limited property-level information was available for DBRS Morningstar to review. Asset summary reports, property condition reports (PCRs), Phase I/II environmental site assessment (ESA) reports, appraisals, and historical financial cash flows were generally not available for review in conjunction with this securitization. DBRS Morningstar received a recent BOV or appraised value for all loans and the appraised value from origination for most loans. To calculate the LTV for the model, DBRS Morningstar relied on the BOV figure for assets in urban markets with a DBRS Morningstar Market Rank of 6, 7, or 8, which are more likely to experience value appreciation since loan origination. For all other loans, DBRS Morningstar assumed a value based on the lower of the original appraisal or BOV. For loans without an original appraised value, DBRS Morningstar assumed an original LTV of 65%. This hybrid assumption produced a WA LTV of 47.6% versus an LTV of 39.1% based solely on the most recent BOV or appraisal and the current loan amount.

No ESA reports were provided; however, 58 properties (18.5% of the pool) had desktop environmental assessments, including all industrial properties and several other office or retail properties. None of these reports reflected subject site risks. Because of the lack of traditional PCRs and property condition assessments typically performed on CMBS loans, DBRS Morningstar applied a LGD penalty to mitigate any potential future risk. DBRS Morningstar was able to perform a loan-level cash flow analysis on only six loans in the DBRS Morningstar sample. Based on cash flow analysis from comparable small balance commercial loan pools, DBRS Morningstar applied an average 20.4% blended reduction to the BOV-estimated NCF 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 Morningstar received limited borrower information, net worth or liquidity information, and credit history. DBRS Morningstar generally initially assumed loans had Weak sponsor strength scores, which increases the stress on the default rate. The initial assumption of Weak reflects the generally less sophisticated nature of small balance borrowers and assessments from past small balance transactions. Furthermore, DBRS Morningstar received a 24-month pay history on each loan as of March 31, 2021. If any loan had more than two late pays within this period or two consecutive late pays, DBRS Morningstar applied an additional stress to the default rate. This occurred for 33 loans, representing 11.0% of the pool balance. Additionally, DBRS Morningstar identified 153 loans, or 59.8% of the pool, as non-full-recourse loans, which, for small balance commercial transactions, DBRS Morningstar views as credit negative. DBRS Morningstar assumed these loans had elevated default levels to mitigate this risk. Finally, DBRS Morningstar received a borrower FICO score as of March 22, 2021, for 269 of the 304 loans, with an average FICO score of 743. While the CMBS Methodology does not contemplate FICO scores, the RMBS Methodology does and would characterize a FICO score of 743 as near-prime, where prime is considered greater than 750. Borrowers with a FICO score of 743 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.

ESG CONSIDERATIONS
DBRS Morningstar concluded that the environmental factor was applicable to the credit analysis. Limited to no property-level information was available for DBRS Morningstar to review, including engineer conducted PCR and Phase I/II ESA reports. Because of the absence of these reports, DBRS Morningstar applied a penalty to the LGDs that resulted in a significant effect on the credit analysis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

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 transaction is configured with a modified pro rata pay pass-through structure. Given the complexity of the structure and granularity of the pool, DBRS Morningstar applied its North American CMBS Multi-Borrower Rating Methodology (March 26, 2021) as its principal methodology and also included elements of the RMBS Insight 1.3: U.S. Residential Mortgage-Backed Securities Model and Rating Methodology (April 1, 2020). 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 rating 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.

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

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