DBRS Morningstar Finalizes Provisional Ratings on Freddie Mac Structured Pass-Through Certificates, Series K-742

DBRS, Inc. (DBRS Morningstar) finalized its provisional ratings on the following classes of Structured Pass-Through Certificates (SPCs), Series 2021-K742 issued by Freddie Mac Structured Pass-Through Certificates, Series K-742 (Freddie Mac SPCs K-742):

-- 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.

With regard to the Coronavirus Disease (COVID-19) pandemic, the magnitude and extent of performance stress posed to global structured finance transactions remains highly uncertain. This considers the fiscal and monetary policy measures and statutory law changes that have already been implemented or will be implemented to soften the impact of the crisis on global economies. Some regions, jurisdictions, and asset classes are, however, feeling more immediate effects. DBRS Morningstar continues to monitor the ongoing coronavirus pandemic and its impact on both the commercial real estate sector and the global fixed income markets. Accordingly, DBRS Morningstar may apply additional short-term stresses to its rating analysis, for example by front-loading default expectations and/or assessing the liquidity position of a structured finance transaction with more stressful operational risk and/or cash flow timing considerations.

The collateral consists of 24 fixed-rate loans secured by 24 commercial properties, including 20 garden-style multifamily properties, two mid-rise apartment complexes, one manufactured housing community, and one nontraditional multifamily property that has a military concentration. Three loans (Villages at Decoverly, Pavilions at Arrowhead, and Springs at Alta Mesa), representing 19.5% of the trust balance, are associated with the same sponsorship group. However, these loans are neither cross-collateralized nor cross-defaulted and are in different metropolitan areas. All 24 loans in the trust have five-, seven- or eight-year loan terms. The transaction is a sequential-pay pass-through structure. DBRS Morningstar analyzed the pool to determine the provisional ratings, reflecting the long-term probability of loan default within the term and its liquidity at maturity.

Classes A-1, A-2, A-M, X1, XAM, and X3 of the FREMF 2021-K742 Mortgage Trust, Series 2021-K742 (FREMF 2021-K742) transaction have been conveyed into a trust by Freddie Mac to issue corresponding classes of Structured Pass-Through Certificates (SPCs) 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 initial ratings to the FREMF 2021-K742 Certificates and the Freddie Mac SPCs K-742 without giving effect to the Freddie Mac guarantee. Please see the FREMF 2021-K742 Structural and Collateral Term Sheet for more information about the structure of the Freddie Mac SPCs K-742.

Freddie Mac has strong origination practices, and the K-Program exhibits strong historical loan performance. Loans on Freddie Mac's balance sheet, which it originates according to the same policies as those for securitization, have an extremely low delinquency rate of 0.01% as of March 2021. This compares favorably with the delinquency rate for commercial mortgage-backed securities (CMBS) multifamily loans of approximately 3.89%. Since the inception of the K-Program through March 2021, Freddie Mac has securitized 21,125 loans, totaling approximately $433.3 billion in issuance balance. To date, Freddie Mac has not realized any credit losses on its guaranteed issuances, although B-piece investors have realized a combined $30.2 million in total losses, representing fewer than 1.0 basis points of total issuance.

The pool has a weighted-average (WA) expected loss of 2.05%, which compares favorably with recent Freddie Mac transactions rated by DBRS Morningstar, specifically FREMF 2021-K741 and FREMF 2020-K738. All of the loans had a DBRS Morningstar sponsor strength of Strong, which is credit positive. Sponsors generally represent large, financially capable individuals or companies led by experienced professionals with minimal prior credit issues. In many cases, sponsors are repeat borrowers of Freddie Mac and have a proven credit record with no performance issues. The average haircut was 5.6% across the DBRS Morningstar sample of loans. The average compares favorably with recent transactions and is probability of default (POD) positive. About 49.7% of the loans are in DBRS Morningstar Metropolitan Statistical Area (MSA) Group 3, which is credit positive and results in a lower POD than other MSA groups. The MSAs in Group 3 cover cities including Los Angeles; Washington, D.C.; Seattle; and Portland, Oregon. DBRS Morningstar identified two assets that exhibited superior quality and had Above Average property quality scores. These two loans, West 38 Apartments and Green Leaf Apartments, represent 9.0% of the total pool balance, which is higher than recent transactions and POD positive. Higher quality assets retain better tenancy, achieve higher rental rates, and have superior occupancy. Conversely, no loan received Below Average or Poor property quality scores. The pool exhibits a relatively strong WA DBRS Morningstar Term Debt Service Coverage Ratio of 2.23x. This is higher than recent Freddie Mac transactions rated by DBRS Morningstar, specifically FREMF 2020-K739 and FREMF 2020-K738.

Twenty-one loans, representing 89.3% of the trust balance, have a debt service reserve (DSR) that can be used if the property experiences performance declines attributable to the coronavirus pandemic. Reserves were generally three to nine months of debt service, and borrowers may request disbursement from the reserve to cover a shortfall upon submission of rental collection, current rent schedule, and a current trailing 12 months operating statement. The reserves will be released at least 90 days following the lifting of all governmental actions related to the coronavirus affecting the property.

Multifamily properties may encounter weaker performance and softer market conditions if the pandemic leads to further financial fallout. Apartment tenants could be affected by higher unemployment, lifting of eviction moratoriums, and a reduction in unemployment benefits. In response to the ongoing coronavirus pandemic, Freddie Mac made changes to its standard servicing practices to permit a temporary deferral of loan payments and forbearance of various remedies that could, among other things, adversely affect cash flow. While DBRS Morningstar views the inclusion of coronavirus-related upfront DSRs for a majority 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. DBRS Morningstar generally expects multifamily properties to fare better than hospitality and retail properties; however, 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 (CARES Act), provided, among other things, supplemental unemployment benefits to displaced employees. An additional coronavirus relief bill was signed in March 2021 that extended supplemental unemployment benefits to displaced employees until September 2021. This could result in additional stress on properties whose residents have been disproportionately affected by furloughs and layoffs. In addition, the resurgence of coronavirus cases has created additional uncertainty and increased stress on the planned reopening of businesses. DBRS Morningstar also published its “Global Macroeconomic Scenarios: March 2021 Update” and is projecting generalized commercial real estate asset value declines for the U.S. of approximately 15% under its moderate scenario and 30% under its adverse scenario.

Villages at Decoverly ($106.8 million and 12.8% of the pool) does not have a nonconsolidation opinion or a carveout guarantor. Freddie Mac typically requires a nonconsolidation opinion for loans above $40.0 million, and the opinion ensures that the borrower entity would not be consolidated with the borrower’s estate in a bankruptcy. Furthermore, the sponsor for the largest loan is also the sponsor on two additional loans in the pool (totals 19.5% of the pool), which adds further sponsor concentration risk to the pool. For the largest of the three loans, Villages at Decoverly, DBRS Morningstar applied a penalty to the POD to account for the lack of a nonconsolidation opinion. These loans are neither cross-collateralized nor cross-defaulted and are in different metropolitan areas. The sponsor for these loans is a private real estate investment management company with expertise and presence in major metropolitan markets throughout the United States. The company has a strong track record of investing in the multifamily sector, having completed more than $7 billion in multifamily transactions. Furthermore, the sponsorship group is a repeat Freddie Mac borrower and reported ownership of nearly 17,000 multifamily units. All of the sponsor’s Freddie Mac loans have performed as agreed.

Eighteen loans, representing 87.2% of the pool, are secured by properties with a DBRS Morningstar Market Rank of 3 or 4, which, although generally suburban in nature, have historically had higher PODs. Only one loan (3.9% of the pool) is secured by a property with a DBRS Morningstar Market Rank of 7 or 8, which are considered dense urban in nature and benefit from increased liquidity with consistently strong investor demand, even during times of economic stress. DBRS Morningstar analyzed properties in less densely populated markets with higher PODs and loss severity given defaults than those in more urban markets.

The pool is split between multifamily properties, which encompass 99.3% of the pool, and manufactured housing properties, encompassing 0.7% of the pool. One property in the pool, representing 4.3% of the total pool balance, disclosed a military tenant concentration of approximately 60.0%. 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. Sixteen loans, representing 60.1% of the pool, exhibited a recent occupancy rate above 95.0%, and another seven loans, representing 35.9% of the pool, exhibited an occupancy rate between 90.0% and 94.9%. Only one loan, representing approximately 4.0% of the pool, exhibited an occupancy less than 90.0%. DBRS Morningstar analyzes properties with high percentages of military personnel as student housing in its model, which has a small POD penalty compared with the multifamily property type.

ESG CONSIDERATIONS
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.

Class X1 is an interest-only (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 – Villages At Decoverly (12.8% of the pool)
-- Prospectus ID#2 – Westchester At The Pavilions (11.7% of the pool)
-- Prospectus ID#3 – Maplewood Park Apartments (7.3% of the pool)
-- Prospectus ID#4 – The Harrison At Sandy Springs (6.3% of the pool)
-- Prospectus ID#5 – Overlook Pointe (5.2% of the pool)
-- Prospectus ID#6 – Hinton Heights (5.0% of the pool)
-- Prospectus ID#7 – West 38 Apartments (4.6% of the pool)
-- Prospectus ID#8 – Green Leaf Apartments (4.4% of the pool)
-- Prospectus ID#9 – Beaumont Grand Apartments (4.3% of the pool)
-- Prospectus ID#10 – Bell Columbia (4.1% of the pool)
-- Prospectus ID#11 – The Whitney At Sandy Springs (4.0% of the pool)
-- Prospectus ID#12 – Borealis North Loop (3.9% of the pool)
-- Prospectus ID#13 – Pavilions At Arrowhead (3.4% of the pool)
-- Prospectus ID#14 – Springs At Alta Mesa (3.3% of the pool)
-- Prospectus ID#15 – Villa Bugambilias (3.1% of the pool)
-- Prospectus ID#16 – Agave at Twenty Two (3.0% of the pool)
-- Prospectus ID#17 – Keyway Apartments (2.5% of the pool)
-- Prospectus ID#20 – Wildflower Villas (2.0% of the pool)
-- Prospectus ID#23 – Prospect Apartments (0.9% 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 (March 26, 2021), 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 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.

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

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