DBRS Morningstar Finalizes Provisional Ratings on Velocity Commercial Capital Loan Trust 2021-2

DBRS, Inc. (DBRS Morningstar) finalized its provisional ratings on the Mortgage-Backed Certificates, Series 2021-2 (the Certificates) issued by Velocity Commercial Capital Loan Trust 2021-2 (VCC 2021-2 or the Issuer) as follows:

-- $148.3 million Class A at AAA (sf)
-- $148.3 million Class A-S at AAA (sf)
-- $148.3 million Class A-IO at AAA (sf)
-- $15.4 million Class M-1 at AA (low) (sf)
-- $15.4 million Class M1-A at AA (low) (sf)
-- $15.4 million Class M1-IO at AA (low) (sf)
-- $7.2 million Class M-2 at A (low) (sf)
-- $7.2 million Class M2-A at A (low) (sf)
-- $7.2 million Class M2-IO at A (low) (sf)
-- $14.0 million Class M-3 at BBB (sf)
-- $14.0 million Class M3-A at BBB (sf)
-- $14.0 million Class M3-IO at BBB (sf)
-- $4.3 million Class M-4 at BB (sf)
-- $4.3 million Class M4-A at BB (sf)
-- $4.3 million Class M4-IO at BB (sf)
-- $3.1 million Class M-5 at B (sf)
-- $3.1 million Class M5-A at B (sf)
-- $3.1 million Class M5-IO at B (sf)

Classes A-IO, M1-IO, M2-IO, M3-IO, M4-IO, and M5-IO are interest-only certificates. The class balances represent notional amounts.

Classes A, M-1, M-2, M-3, M-4, and M-5 are exchangeable certificates. These classes can be exchanged for combinations of initial exchangeable certificates as specified in the offering documents.

The AAA (sf) ratings on the Certificates reflect 27.70% of credit enhancement provided by subordinated certificates. The AA (low) (sf), A (low) (sf), BBB (sf), BB (sf), and B (sf) ratings reflect 20.20%, 16.70%, 9.90%, 7.80%, and 6.30% of credit enhancement, respectively.

Other than the classes specified above, DBRS Morningstar does not rate any other classes in this transaction.

VCC 2021-2 is a securitization of a portfolio of newly originated fixed- and adjustable-rate, first-lien residential mortgages collateralized by investor properties with one to four units (residential investor loans) and small-balance commercial mortgages (SBC) collateralized by various types of commercial, multifamily rental, and mixed-use properties. The securitization is funded by the issuance of the Certificates, which are backed by 541 mortgage loans with a total principal balance of $205,177,758 as of the Cut-Off Date (July 1, 2021).

Approximately 53.7% of the pool is comprised of residential investor loans and about 46.3% of SBC loans. All but one of the loans in this securitization (99.5% of the pool) were originated by Velocity Commercial Capital, LLC (Velocity or VCC), and one loan (0.5% of the pool) was acquired by Velocity from a third-party originator. The loans were underwritten to program guidelines for business-purpose loans where the lender generally expects the property (or its value) to be the primary source of repayment (No Ratio). The lender reviews mortgagor's credit profile, though it does not rely on the borrower's income to make its credit decision. However, the lender considers the property-level cash flows or minimum debt-service coverage (DSCR) ratio in underwriting SBC loans with balances over $750,000 for purchase transactions and over $500,000 for refinance transactions. Since the loans were made to investors for business purposes, they are exempt from the Consumer Financial Protection Bureau’s Ability-to-Repay rules and TILA-RESPA Integrated Disclosure rule.

The pool is about one-month seasoned on a weighted average (WA) basis, although seasoning may span from zero up to 15 months. Except for seven loans (1.0% of the pool) that have missed one or more payments, the loans have been performing since origination. Of the seven loans that were delinquent, two have cured the delinquency as of the Cut-Off Date and become current.

PHH Mortgage Corporation will service all loans within the pool for a servicing fee of 0.30% per annum. In addition, Velocity will act as a Special Servicer servicing the loans that defaulted or became 60 or more days delinquent under the Mortgage Bankers Association (MBA) method and other loans, as defined in the transaction documents (Specially Serviced Loans). The Special Servicer will be entitled to receive compensation based on an annual fee of 0.75% and the balance of Specially Serviced Loans. Also, the Special Servicer is entitled to a liquidation fee equal to 2.00% of the net proceeds from the liquidation of a Specially Serviced Loan, as described in the transaction documents.

The Servicer will fund advances of delinquent principal and interest (P&I) until the advances deemed unrecoverable. Also, the Servicer is obligated to make advances with respect to taxes, insurance premiums, and reasonable costs incurred in the course of servicing and disposing properties.

U.S. Bank National Association (rated AA (high) with a Stable trend by DBRS Morningstar) will act as the Trustee, Paying Agent, and Custodian.

The Sponsor, directly or indirectly through a majority-owned affiliate, is expected to retain an eligible horizontal residual interest consisting of the Class P and Class XS Certificates, and, to the extent required, the Class M-7 Certificates, collectively representing at least 5% of the fair value of all Certificates, to satisfy the credit risk-retention requirements under Section 15G of the Securities Exchange Act of 1934 and the regulations promulgated thereunder.

On or after the later of the (1) three-year anniversary of the Closing Date or (2) date when the aggregate stated principal balance of the mortgage loans is reduced to 30% of the Closing Date balance, the Depositor may purchase all outstanding Certificates (Optional Purchase) at a price equal to the sum of the remaining aggregate balance of the Certificates plus accrued and unpaid interest, and any fees, expenses, and indemnity payments due and unpaid to the transaction parties, including any unreimbursed P&I and servicing advances, and other amounts due as applicable. The Optional Purchase will be conducted concurrently with a qualified liquidation of the Issuer.

Additionally, if on any date on which the unpaid mortgage loan balance and the value of real estate owned (REO) properties has declined to less than 10% of the initial mortgage loan balance as of the Cut-off Date, the Directing Holder, the Special Servicer, or the Servicer, in that order of priority, may purchase all of the mortgages, REO properties, and any other properties from the Issuer (Optional Termination) at a price specified in the transaction documents. The Optional Termination will be conducted as a qualified liquidation of the Issuer. The Directing Holder (initially, the Seller) is the representative selected by the holders of more than 50% of the outstanding subordinate certificates with the lowest priority of principal distributions.

The transaction uses a structure sometimes referred to as a modified pro rata structure. Prior to the Class A credit enhancement (CE) falling below 10.0% of the loan balance as of the Cut-off Date (Class A Minimum CE Event), the principal distributions allow for amortization of all senior and subordinate bonds based on CE targets set at different levels for performing (same CE as at issuance) and nonperforming (higher CE than at issuance) loans. Each Class's target principal balance is determined based on the CE targets and the performing and nonperforming (those that are 90 or more days MBA delinquent, in foreclosure and REO, and subject to a servicing modification within the prior 12 months) loan amounts. As such, the principal payments are paid on a pro rata basis, up to each Class's target principal balance, so long as no loans in the pool are nonperforming. If the share of nonperforming loans grows, the corresponding CE target increases. Thus, the principal payment amount increases for the senior and senior subordinate classes and falls for the more subordinate bonds. The goal is to distribute the appropriate amount of principal to the senior and subordinate bonds each month, to always maintain the desired level of CE, based on the performing and nonperforming pool percentages. After the Class A Minimum CE Event, the principal distributions are made sequentially.

Relative to the sequential pay structure, the modified pro rata structure is more sensitive to the timing of the projected defaults and losses as the losses may be applied at a time when the amount of credit support is reduced as the bonds' principal balances amortize over a life of the transaction. That said, the excess spread can be used to cover realized losses after being allocated to the unpaid net WA coupon shortfalls.

COMMERCIAL MORTGAGE-BACKED SECURITIES (CMBS) METHODOLOGY
Of the 200 loans, 197 loans, representing 98.2% of the SBC portion of the pool, have a fixed interest rate with a straight average of 7.8%. The three floating-rate loans have interest rate floors (excluding rate margins) ranging from 3.88% to 3.99% with a straight average of 3.92% and interest rate margins ranging from 4.75% to 5.00% with a straight average of 4.92%. To determine the probability of default (POD) and loss given default 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 WA modeled coupon rate was 7.60%. Most of the loans have original term lengths of 30 years and fully amortize over 30-year schedules. However, one loan that comprises 1.1% of the SBC pool has a 10-year term and amortizes over a 30-year schedule. 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 154 loans, representing 85.6% of the SBC pool, with term DSCRs below 1.15 times (x), a threshold indicative of a higher likelihood of term default.

All SBC loans were originated between March 2020 and June 2021, resulting in minimal seasoning of 1.1 months on average. The SBC pool has a WA original term length of 357.3 months, or 29.8 years, with a WA remaining term of 356.1 months, or 29.7 years. Based on the current loan amount, which reflects approximately 8 basis points (bps) of amortization, and the current appraised values, the SBC pool has a WA LTV ratio of 66.1%. However, DBRS Morningstar made LTV adjustments to 37 loans that had an implied capitalization rate more than 200 bps 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 located in Market Rank 8 to 8.0% for properties located in Market Rank 1. This resulted in a higher DBRS Morningstar LTV of 74.5%. Lastly, all but one loan fully amortize over their respective remaining terms, resulting in a 99.8% expected amortization; this amount of amortization is greater than what is typical for 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% and 21.09%, with an overall medial rate 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 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 IO certificates by notching 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, 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 SBC pool of loans.

STRENGTHS – SBC LOANS
-- The CMBS pool has a WA expected loss of 4.37%, which is lower than recently analyzed comparable small balance transactions. Contributing factors to the low expected loss include pool diversity, moderate leverage, and fully amortizing loans.
-- The SBC pool is quite diverse based on loan size, with an average balance of $475,366, a concentration profile equivalent to that of a transaction with 117 equal-size loans, and a top-10 loan concentration of 18.9%. 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 communities.
-- All but one loan in the SBC pool fully amortize over their respective remaining loan terms between 352 and 360 months, reducing refinance risk.

CHALLENGES AND STABILIZING FACTORS – SBC LOANS
-- As classified by DBRS Morningstar for modeling purposes, the SBC pool contains a significant exposure to retail (19.1% of the SBC pool) and a smaller exposure to office (10.8% of the SBC pool), which are two of the higher-volatility asset types. Loans counted as retail include those identified as automotive and potentially commercial condo. Combined, they represent nearly one-third of the pool balance. Retail, which has struggled because of the pandemic, comprises the second-largest asset type in the transaction.
-- DBRS Morningstar applied a 20.0% reduction to the NCF for retail properties and a 30.0% reduction for office assets in the SBC pool, which is above the average NCF reduction applied for comparable property types in CMBS-analyzed deals.
-- Multifamily comprises the fourth-largest property type concentration in the SBC pool (18.3%); 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 loans 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 60 loans DBRS Morningstar sampled, 6.7% were Average, 81.2% were Average –, 11.0% were Below Average, and 1.0% were Poor 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 loans and is consistent with other SBC transactions.
-- Limited property-level information was available for DBRS Morningstar to review. Asset summary reports, property condition reports, Phase I/II environmental site assessment (ESA) reports, and historical financial cash flows were generally not available for review in conjunction with this securitization.
-- DBRS Morningstar received and reviewed appraisals for the top 30 loans, which represent 40.1% of the SBC pool balance. These appraisals were issued between November 2019 and June 2021 when the respective loans were originated. DBRS Morningstar was able to perform loan-level cash flow analysis on the top 30 loans, as well as the 32nd-largest loan in the SBC pool. The haircuts ranged from -2.5% to -100.0%, with an average of -24.5%; however, DBRS Morningstar generally applied more conservative haircuts on the unsampled loans.
-- No ESA reports were provided and are not required by the Issuer; however, all of the loans are placed onto an environmental insurance policy that provides coverage to the Issuer and the securitization trust in the event of a claim.
-- 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 12-month pay history on each loan as of July 16, 2021. If any loan had more than two late pays within this period or was currently 30 days past due, DBRS Morningstar applied an additional stress to the default rate. This occurred for only two loans, representing 0.7% of the SBC pool balance.
-- Finally, DBRS Morningstar received a borrower FICO score as of July 16, 2021, for 197 loans or 98.8% of the SBC pool balance, with an average FICO score of 724. While the CMBS Methodology does not contemplate FICO scores, the Residential Mortgage-Backed Securities (RMBS) Methodology does and would characterize a FICO score of 724 as near-prime, whereas prime is considered greater than 750. Borrowers with a FICO score of 724 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.

RESIDENTIAL MORTGAGE-BACKED SECURITIES (RMBS) METHODOLOGY
The collateral pool consists of 341 mortgage loans with a total balance of approximately $110.1 million collateralized by one- to four-unit investment properties. The mortgage loans were underwritten by Velocity to No Ratio program guidelines for business-purpose loans.

The Coronavirus Disease (COVID-19) pandemic and the resulting isolation measures caused an immediate economic contraction, leading to sharp increases in unemployment rates and income reductions for many consumers. Shortly after the onset of the pandemic, DBRS Morningstar saw an increase in the delinquencies for many residential mortgage-backed securities (RMBS) asset classes.

Such mortgage delinquencies were mostly in the form of forbearances, which are generally short-term periods of payment relief that may perform very differently from traditional delinquencies. At the onset of the pandemic, the option to forbear mortgage payments was widely available, driving forbearances to an elevated level. When the dust settled, loans with coronavirus-induced forbearance in 2020 performed better than expected, thanks to government aid, low loan-to-value ratios (LTVs), and acceptable underwriting in the mortgage market in general. Across nearly all RMBS asset classes in recent months delinquencies have been gradually trending downward, as forbearance periods come to an end for many borrowers.

In connection with the economic stress assumed under its moderate scenario (see Global Macroeconomic Scenarios - June 2021 Update, published on June 18, 2021), DBRS Morningstar may assume higher loss expectations for pools with loans on forbearance plans.

For more information regarding rating methodologies and the coronavirus, please see the following DBRS Morningstar press releases and commentary: "DBRS Morningstar Provides Update on Rating Methodologies in Light of Measures to Contain Coronavirus Disease (COVID-19)," dated March 12, 2020; "DBRS Morningstar Global Structured Finance Rating Methodologies and Coronavirus Disease (COVID-19)," dated March 20, 2020; and Global Macroeconomic Scenarios - June 2021 Update, dated June 18, 2021.

The ratings reflect transactional strengths that, for residential investor loans, include the following:
-- Improved underwriting standards,
-- Robust loan attributes and pool composition, and
-- Satisfactory third-party due-diligence review.

The transaction also includes the following challenges:
-- Residential investor loans underwritten to no ratio lending programs, and
-- Representations and warranties framework.

The full description of the strengths, challenges, and mitigating factors is detailed in the related report.

DBRS Morningstar incorporates a dynamic cash flow analysis in its rating process. A baseline of four prepayment scenarios, two default timing curves, and two interest rate stresses were applied to test the resilience of the rated classes. DBRS Morningstar ran a total of 16 cash flow scenarios at each rating level for this transaction. Additionally, WA coupon deterioration stresses were incorporated in the runs.

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 principal methodologies are North American CMBS Multi-Borrower Rating Methodology (March 26, 2021) and RMBS Insight 1.3: U.S. Residential Mortgage-Backed Securities Model and Rating Methodology (April 1, 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 rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/358308.

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. Please note a sensitivity analysis is not performed for CMBS bonds rated CCC or lower. The DBRS Morningstar 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 [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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