DBRS Morningstar Finalizes Provisional Ratings on STWD 2022-FL3, Ltd.; Assigns Ratings to Six Classes

DBRS, Inc. (DBRS Morningstar) finalized its provisional ratings on the following classes of notes issued by STWD 2022-FL3, Ltd. (the Issuer):

-- Class A at AAA (sf)
-- Class X-A at AAA (sf)
-- Class A-S at AAA (sf)
-- Class B at AA (low) (sf)
-- Class C at A (low) (sf)
-- Class D at BBB (sf)
-- Class E at BBB (low) (sf)
-- Class F at BB (low) (sf)
-- Class G at B (low) (sf)

Additionally, DBRS Morningstar assigned new ratings to the following classes of notes:

-- Class E-E at BBB (low) (sf)
-- Class E-X at BBB (low) (sf)
-- Class F-E at BB (low) (sf)
-- Class F-X at BB (low) (sf)
-- Class G-E at B (low) (sf)
-- Class G-X at B (low) (sf)

All trends are Stable.

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. The trust’s initial collateral consists of 24 floating-rate mortgage loans secured by 36 mostly transitional real estate properties, with a cut-off date pool balance totaling $1.0 billion (participation of $3.0 billion whole loan cut-off date balance). The loans in the trust have approximately $188.9 million of future funding commitments that can be acquired into the trust subject to eligibility and replenishment criteria. The initial pool includes eight combination loans, made up of a senior loan and related mezzanine loan.

The 24-month reinvestment period allows the Issuer (as directed by the Collateral Manager) to acquire whole loans and future fundings participations. The future funding participations are subject to eligibility criteria, acquisition criteria, acquisition and disposition requirements and replenishment criteria, which, among other things, have a minimum debt service coverage ratio (DSCR) and loan-to-value ratio (LTV) for each respective property type, Herfindahl score greater than or equal to 14.0, loan size limitations, and property type concentration limits. The eligibility criteria stipulates the receipt of a No Downgrade Confirmation from DBRS Morningstar on reinvestment loans (except in the case of the acquisition of companion participations if a portion of the underlying loan is already included in the pool and less than $1,000,000). The No Downgrade Confirmation allows DBRS Morningstar to review the new collateral interest and any potential impact on the overall ratings. The transaction does not include a ramp-up period and all loans as of the Closing Date are closed. The transaction will have a sequential-pay structure whereby interest and principal payments will be prioritized in order of note seniority. In the event that a note protection test is not satisfied, payments that would have otherwise been applied to the Class F and G Notes (Retained Notes) will instead be redirected to redeem the Offered Notes until the note protection tests are satisfied. Interest may also be deferred for Class C Notes (Offered Note), Class D Notes (Offered Note), Class E Notes (Offered Note), Class F Notes (Retained Note), and Class G Notes (Retained Note).

All of the loans in the pool have floating interest rates initially indexed to Libor and are interest only (IO) through their initial and extended terms. As such, to determine a stressed interest rate over the loan term, DBRS Morningstar took the contractual loan spread and added the lower of DBRS Morningstar’s stressed rates that corresponded to the remaining fully extended term of the loans and the strike price of the interest rate cap.

The credit metrics of the pool are generally stronger than most of the recent commercial real estate collateralized loan obligation (CRE CLO) transactions DBRS Morningstar has rated. However, the pool has a relatively large office property concentration (28.6% of pool balance) and low average stabilized DSCR of 1.13 times (x), with 31.3% of all loans in the pool at or below a stabilized DSCR of 1.00x. The properties are often transitional with potential upside in cash flow. However, DBRS Morningstar does not give full credit to the stabilization if there are no holdbacks or if other loan structural features are insufficient to support such treatment. Furthermore, even with the structure provided, DBRS Morningstar generally does not assume the assets will stabilize above market levels.

The pool reflects a weighted-average (WA) DBRS Morningstar Market Rank of 5.42, indicative of a higher concentration of properties in dense urban markets, which generally experience lower a probability of default (POD) and loss given default (LDG). The historical commercial mortgage-backed securities (CMBS) conduit loan data shows that POD increases in middle markets (Market Rank 3 or 4); moderates in tertiary and rural markets (Market Rank 1 or 2); and greatly improves in primary urban markets (Market Rank 6, 7, or 8). Historical loan data has shown that LGD increases in tertiary and rural markets, and the lowest LGDs were noted in Market Rank 8. Eighteen loans, representing 75.6% of the total pool balance, fall into Market Rank 5 or higher, resulting in a decreased POD and LGD, and two loans (12 Metrotech Center and Anthem Row), representing 12.1% of the total pool balance, fall into Market Rank 8, the strongest markets in the country. Additionally, 43.1% of loans are concentrated in MSA Group 3, which represents the best-performing metropolitan statistical areas (MSAs) nationally. When compared with recently rated CRE CLO transactions, this pool exhibits some of the highest Market Ranks and largest concentrations of loans in MSA Group 3.
The DBRS Morningstar WA Stabilized LTV is 66.4%. This credit metric compares favorably with the LTVs of recent CRE CLO transactions that DBRS Morningstar has rated, resulting in lower loan level PODs and LGDs. The WA in-place LTV of 72.1% is also quite low compared with those of recent CRE CLO transactions.

The pool exhibits a DBRS Morningstar WA Business Plan Score (BPS) of 2.06, which is lower than those of recent CRE CLO transactions DBRS Morningstar has rated. The low DBRS Morningstar BPS indicates that borrowers have the necessary funds to achieve their business plans, proper loan structures, and adequate upside cash flow potential. The DBRS Morningstar BPS also shows that many properties in the pool are near stabilization or have achieved the proposed stabilized operations.

All loans in the pool were modeled with Average property quality or higher and three loans, representing 13.2% of the pool balance, were modeled with Excellent property quality. These property quality metrics are considerably better than most recent CRE CLO transactions. Given that the majority of these properties are transitional, the property quality for the collateral is expected to further improve upon the successful completion of their business plans.

Starwood is a leading diversified real estate finance company with more than $21 billion in undepreciated assets, focusing on the origination, acquisition, financing, and management of real estate and infrastructure investments. The sponsor has roughly $100 billion in assets under management. Over the last 30 years, the sponsor has acquired more than $195 billion in real estate assets across almost all property types. The sponsor’s leadership team has an average of 29 years in the CRE industry individually. Starwood has completed one CRE CLO securitization with DBRS Morningstar (formerly DBRS, Inc.): STWD 2019-FL1. Starwood, as the retention holder, is anticipated to acquire and retain at least 100% of the Class F Notes, Class G Notes, and Preferred Shares, totaling $157.5 million or 15.75% of the pool.

Six loans, representing 20.1% of the pool balance, were originated in 2020 or earlier. Four loans, representing 14.1% of the pool, were originated in 2019 or earlier. The majority of these loans are office properties and have a DBRS Morningstar BPS above the pool average. While most of these loans are nearing maturity, only one loan, 700 Louisiana and 600 Prairie Street, requested any form of forbearance. The loan maturity was extended and reserves were allowed to be used for shortfalls in exchange for an additional equity contribution. 700 Louisiana and 600 Prairie Street, along with all other loans in the pool, are current on debt service payments as of the Closing Date. Two of the six properties were modeled with Strong sponsor strength, indicating the sponsor has the finance strength and real estate expertise to complete their business plan in a timely basis and secure future financing. Additionally, the average DBRS Morningstar Market Rank across the six properties is 5.33, reflecting a decreased POD and LGD to potentially offset the risk of dated origination.

Seven loans, representing 28.6% of the pool balance, are backed by office properties and, as a result of the eligibility criteria during the reinvestment period, the office component could shift up to 60.0% of the pool. Office properties have historically had elevated POD risk compared with other asset classes and have suffered considerable disruptions as a result of the coronavirus pandemic with mandatory closures and work-from-home strategies. The office properties exhibit an average Market Rank of 6.43, well above the pool average and generally higher than observed in recent CRE CLO transactions. The office properties also have a combined WA expected loss lower than the pool average, indicating that the loan metrics excluding property type are generally strong. Office properties are subject to eligibility criteria, including a maximum as-stabilized LTV of 75.0% and a stabilized net cash flow (NCF) DSCR of not less than 1.25x.

The transaction is managed and includes a reinvestment period, which could result in negative credit migration and/or an increased concentration profile over the life of the transaction. The risk of negative migration is partially offset by eligibility criteria (detailed in the transaction documents) that outline DSCR, LTV, Herfindahl score minimum, property type, and loan size limitations for reinvestment assets. New reinvestment loans and companion participations of $1,000,000 or greater require a No Downgrade Confirmation from DBRS Morningstar. DBRS Morningstar will analyze these loans for potential impacts on ratings. Deal reporting also includes standard monthly CREFC reporting and quarterly updates. DBRS Morningstar will monitor this transaction on a regular basis. DBRS Morningstar performed a paydown analysis which simulated low expected loss loans paying off and increasing loan balances for high expected loss loans with future fundings (subject to the RAC dollar amount).

DBRS Morningstar has analyzed the loans to a stabilized cash flow that is, in some instances, above the in-place cash flow. It is possible that the sponsors will not successfully execute their business plans and that the higher stabilized cash flow will not materialize during the loan term, particularly with the ongoing coronavirus pandemic and its impact on the overall economy. A sponsor’s failure to execute the business plan could result in a term default or the inability to refinance the fully funded loan balance. DBRS Morningstar sampled a large portion of the loans, representing 78.5% of the pool cut-off date balance. Nine physical site inspections, all of which sites were in the top 10, were also performed, including meetings with management. The transaction’s DBRS Morningstar WA BPS of 2.06 is generally on the low end of the range of those of CRE CLO transactions recently rated by DBRS Morningstar. DBRS Morningstar made relatively conservative stabilization assumptions and, in each instance, considered the business plan rational and the loan structure sufficient to execute such plans. In addition, DBRS Morningstar analyzes LGD based on the as-is credit metrics, assuming the loan is fully funded with no NCF or value upside. Future Funding companion participations have been structured to provide the sponsor with sufficient funds to execute the business plan. Affiliates of Starwood will hold the future funding companion participations and have the obligation to make future advances. Starwood agrees to indemnify the Issuer against losses arising out of the failure to make future advances when required under the related participated loan. Furthermore, Starwood will be required to meet certain segregated liquidity requirements on a quarterly basis.

The eligibility criteria allow for a maximum stabilized LTV of 80.0% on multifamily loans; 75.0% on loans for office, industrial, retail, and mixed-use properties; and 70.0% on loans for hospitality properties. The higher maximum leverage is considerably more aggressive than the current pool’s as-stabilized WA LTV of 66.4%. The current pool has favorable LTV metrics compared with previously rated Starwood transactions. The WA as-is and stabilized LTVs in the STWD 2019-FL1 transaction were 76.8% and 65.3%, respectively. Before the collateral manager can acquire new loans, those loans will be subject to a No Downgrade Confirmation by DBRS Morningstar. DBRS Morningstar lowered the stabilized value on 10 loans, representing 41.8% of the pool, for modeling purposes, further stressing the modeled LTVs.

All 24 loans have floating interest rates and original terms of 24 months to 66 months, which create interest rate risk. All loans are IO throughout the original term and through extension options. All loans are short-term loans and, even with extension options, they have a fully extended maximum loan term of 36 to 76 months. For the floating-rate loans, DBRS Morningstar used the one-month Libor index, which is based on the lower of a DBRS Morningstar stressed rate that corresponded to the remaining fully extended term of the loans or the strike price of the interest rate cap with the respective contractual loan spread added to determine a stressed interest rate over the loan term. The borrowers of 12 of the loans in the pool, representing 52.9%, have purchased interest rate caps.

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.

Classes X-A, E-X, F-X, and G-X are IO certificates that reference 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.

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 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.

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/384482/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.

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

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