DBRS Morningstar Finalizes Provisional Ratings on Velocity Commercial Capital Loan Trust 2021-4

DBRS, Inc. (DBRS Morningstar) finalized its provisional ratings on the Mortgage-Backed Certificates, Series 2021-4 (the Certificates) issued by Velocity Commercial Capital Loan Trust 2021-4 (VCC 2021-4 or the Issuer) as follows:

-- $214.9 million Class A at AAA (sf)
-- $214.9 million Class A-S at AAA (sf)
-- $214.9 million Class A-IO at AAA (sf)
-- $17.1 million Class M-1 at AA (low) (sf)
-- $17.1 million Class M1-A at AA (low) (sf)
-- $17.1 million Class M1-IO at AA (low) (sf)
-- $15.0 million Class M-2 at A (low) (sf)
-- $15.0 million Class M2-A at A (low) (sf)
-- $15.0 million Class M2-IO at A (low) (sf)
-- $27.1 million Class M-3 at BBB (low) (sf)
-- $27.1 million Class M3-A at BBB (low) (sf)
-- $27.1 million Class M3-IO at BBB (low) (sf)
-- $11.3 million Class M-4 at BB (high) (sf)
-- $11.3 million Class M4-A at BB (high) (sf)
-- $11.3 million Class M4-IO at BB (high) (sf)
-- $6.4 million Class M-5 at B (high) (sf)
-- $6.4 million Class M5-A at B (high) (sf)
-- $6.4 million Class M5-IO at B (high) (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 32.65% of credit enhancement provided by subordinated certificates. The AA (low) (sf), A (low) (sf), BBB (low) (sf), BB (high) (sf), and B (high) (sf) ratings reflect 27.30%, 22.60%, 14.10%, 10.55%, and 8.55% of credit enhancement, respectively.

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

VCC 2021-4 is a securitization of a portfolio of newly originated and seasoned fixed- and adjustable-rate, first-lien residential mortgages collateralized by investor properties with one to four units (residential investor loans) and small-balance commercial (SBC) mortgages 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 851 mortgage loans with a total principal balance of $319,116,255 as of the Cut-Off Date (November 1, 2021).

Approximately 52.9% of the pool is composed of residential investor loans and about 47.1% of SBC loans. All but four loans (98.4% by balance) in this securitization were originated by Velocity Commercial Capital, LLC (VCC). 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 a 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 ratio in underwriting SBC loans with balances above $750,000 for purchase transactions and above $500,000 for refinance transactions. Because the loans were made to investors for business purposes, they are exempt from the Consumer Financial Protection Bureau’s Ability-to-Repay rules and the TILA-RESPA Integrated Disclosure rule.
 
The pool is about 19 months seasoned on a weighted-average (WA) basis, although seasoning may span from zero up to 187 months.

In this transaction, 335 loans (174 residential investor and 161 SBC loans, together 26.9% of the total balance) were originated by VCC in 2017 or earlier and securitized (seasoned loans). Subsequently, the loans were culled from a few of the VCC-sponsored securitizations after those were collapsed.

PHH Mortgage Corporation will service all loans within the pool for a servicing fee of 0.30% per year. In addition, VCC 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, 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 (1) the three year anniversary of the Closing Date or (2) the 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 Class XS Certificates (the Controlling Class).

The transaction uses a structure sometimes referred to as a modified pro rata structure. Prior to the Class A 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' 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' 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. Therefore, 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. Please see the Cash Flow Structure and Features section of the report for more details.

COMMERCIAL MORTGAGE-BACKED SECURITIES (CMBS) METHODOLOGY
Of the 355 loans, 192 loans, representing 61.0% of the SBC portion of the pool, have a fixed interest rate with a straight average of 7.56%. The 163 floating-rate loans have interest rate floors ranging from 6.500% to 12.875% with a straight average of 8.54% and margins/spreads ranging from 1.00% to 5.25%. Excluding rate margins, the floating-rate loans exhibit a straight average interest rate floor of 4.49%. 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 8.05%. Most of the loans have original loan term lengths of 30 years and fully amortize over 30-year schedules. However, 18 loans that comprise 10.1% of the SBC pool have an initial IO period ranging from 36 months to 120 months and then fully amortize over shortened 20- to 27-year schedules.

The pool exhibits a range of origination dates spanning from March 2006 to October 2021, resulting in an average seasoning of 32.4 months (WA of 25.2 months). However, the seasoning is barbelled, with 288 loans or 83.8% of the pool being either less than one year seasoned or greater than five years seasoned. The SBC pool has a WA original term length of 351.0 months, or 29.2 years. Based on the current loan amount, which reflects approximately 344 basis points (bps) of amortization, and the current appraised values, the SBC pool has a WA loan-to-value (LTV) ratio of 55.7%, compared with an original LTV of 63.2%. However, DBRS Morningstar made LTV adjustments to 48 loans that had an implied capitalization rate more than 200 bps lower than a set of minimal capitalization rates established by the DBRS Morningstar Market Rank. The DBRS Morningstar minimum capitalization rates range from 5.0% for properties in Market Rank 8 to 8.0% for properties in Market Rank 1. This resulted in a higher DBRS Morningstar LTV of 67.6%. Lastly, most of the loans fully amortize over their respective remaining terms, resulting in 97.3% 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 7.5% and 21.1%, with an overall median rate of 18.8%.

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 defaults, 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.

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. The CMBS predictive model was calibrated using loans that have prepayment lockout features. Those loans’ historical prepayment performance is close to 0 conditional 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, and DBRS Morningstar expects that this pool will have prepayments over the remainder of the transaction. DBRS Morningstar applied the following to calculate a default rate prepayment haircut: using Intex Dealmaker, a lifetime constant default rate (CDR) was calculated that approximated the default rate for each rating category. While applying the same lifetime CDR, DBRS Morningstar applied a 2.0% CPR prepayment rate. When holding the CDR constant and applying 2.0% CPR, the cumulative default amount declined. The percentage change in the cumulative default prior to and after applying the prepayments, subject to a 10.0% maximum reduction, was then applied to the cumulative default assumption to calculate a fully adjusted cumulative default assumption.

The SBC pool is quite diverse based on loan size, with an average Cut-Off Date loan balance of $423,007, a concentration profile equivalent to that of a transaction with 163 equal-size loans, and a top-10 loan concentration of 16.2%. Increased pool diversity helps insulate the higher-rated classes from event risk.

The loans are mostly secured by traditional property types (i.e., multifamily, retail, office, and industrial), with no exposure to higher-volatility property types, such as hotels or other lodging facilities.

The SBC pool has a WA expected loss of 5.51%, which is higher than recently analyzed comparable VCC small-balance transactions. Contributing factors to the higher expected loss include a higher percentage of loans marked as Bad (Litigious) for sponsor strength and slightly weaker/less urban locations in terms of MSA grouping and DBRS Morningstar Market Ranks.

As classified by DBRS Morningstar for modeling purposes, the SBC pool contains a significant exposure to retail (30.5% of the SBC pool) and a smaller exposure to office (14.3% of the SBC pool), which are two of the higher-volatility asset types. Loans counted as retail include those identified as automotive, daycare facilities, and potentially commercial condominium. Combined, they represent close to half of the SBC 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 25.0% reduction to the net cash flow (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 third-largest property type concentration in the SBC pool (16.1%); 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 65 loans DBRS Morningstar sampled, 14 were Average quality (27.1%), 31 were Average – (48.2%), 16 were Below Average (22.1%), and four were Poor (2.6%).

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 small balance commercial 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 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 29.1% of the SBC pool balance. These appraisals were issued between March 2016 and October 2021 when the respective loans were originated. DBRS Morningstar was able to perform loan-level cash flow analysis on the top 30 loans, along with five additional loans in the top 45. The haircuts ranged from +46.9% to -70.7%, with an average of -15.5%; 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 sponsorship 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 October 31, 2021, and an extended pay history for seasoned loans. If any loan had more than two late pays within this 12-month period or was currently 30 days past due, DBRS Morningstar applied an additional stress to the default rate. Additionally, any seasoned loan that experienced a high number of delinquencies over its longer history received an additional stress to the default rate. This occurred for 36 loans, representing 8.9% of the SBC pool balance.

Finally, DBRS Morningstar received a borrower FICO score as of various dates in 2021, for all loans except for four, 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.

Forbearance and rent deferrals spiked during the coronavirus pandemic. DBRS Morningstar analyzed Issuer-provided data that showed 20 loans (4.6% of SBC pool balance) had forbearances granted and 20 loans (4.2% of SBC pool balance) had rent deferrals granted. A total of 22 loans (5.1% of SBC pool balance) had payments deferred with an average deferral amount of $12,026. Additionally, there are 16 loans or 2.9% of the SBC pool with a listed status of 30 days delinquent.

There are no loans remaining with active forbearances or rent deferrals, with repayment plans having ended at various dates in 2020 and 2021. All 30-day delinquent loans made their October 2021 payment following the Cut-Off Date. As aforementioned, DBRS Morningstar applied an additional stress to the default rate to loans listed as not-current.

RMBS METHODOLOGY
The collateral pool consists of 496 mortgage loans with a total balance of approximately $169.0 million collateralized by one- to four-unit investment properties. The mortgage loans were underwritten by VCC to No Ratio program guidelines for business-purpose loans.

The coronavirus pandemic and the resulting isolation measures caused an immediate economic contraction, leading to sharp increases in unemployment rates and income reductions for many consumers. DBRS Morningstar saw increases in delinquencies for many RMBS asset classes shortly after the onset of the pandemic.

Such mortgage delinquencies were mostly in the form of forbearances, which are generally short-term payment reliefs that may perform very differently from traditional delinquencies. At the onset of the pandemic, the option to forbear mortgage payments was so widely available that it drove forbearances to a very high level. When the dust settled, coronavirus-induced forbearances in 2020 performed better than expected, thanks to government aid, low LTVs, and good underwriting in the mortgage market in general. Across nearly all RMBS asset classes, delinquencies have been gradually trending down in recent months as the forbearance period comes to an end for many borrowers.

As of the Cut-Off Date, no borrower within the pool is currently subject to a coronavirus-related forbearance plan with the Servicer. In the event a borrower requests or enters into a coronavirus-related forbearance plan after the Cut-Off Date but prior to the Closing Date, the Sponsor will remove such loan from the mortgage pool and remit the related Closing Date substitution amount. Loans that enter a coronavirus-related forbearance plan on or after the Closing Date will remain in the pool.

For more information regarding the economic stress assumed under its baseline scenario, please see the following DBRS Morningstar commentary: Baseline Macroeconomic Scenarios For Rated Sovereigns, dated December 9, 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.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. DBRS Morningstar analysis considered impacts consistent with the baseline scenarios as set forth in the following report: https://www.dbrsmorningstar.com/research/389454/baseline-macroeconomic-scenarios-application-to-credit-ratings.

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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