DBRS Morningstar Takes Rating Actions on Eight Small-Balance Commercial Real Estate Transactions

DBRS Limited (DBRS Morningstar) conducted its surveillance review of eight small-balance commercial real estate (CRE) transactions, which included 108 classes. DBRS Morningstar confirmed its ratings on 74 classes across all of the transactions, upgraded its ratings on 33 classes across four transactions, and discontinued its rating on one class as the bond had fully repaid with the February 2023 remittance. All trends are Stable.

The ratings have been removed from Under Review with Developing Implications where they were placed on November 4, 2022, when DBRS Morningstar finalized its “North American CMBS Multi-Borrower Rating Methodology” (the NA Multiborrower Methodology) and North American CMBS Insight Model Version 1.1.0.0 (the CMBS Model). As small-balance CRE structures are typically more complex and granular, the Under Review designation was used to allow for the additional time necessary to complete the full analysis (inclusive of the cash flow modeling for certain deals) following the adoption of the CMBS Model. For further information on the NA Multiborrower Methodology and CMBS Model, please see the press release dated November 4, 2022, at https://www.dbrsmorningstar.com/research/404889.

The rating confirmations reflect the overall stable performances of these transactions, which have generally remained in line with DBRS Morningstar’s expectations. The rating upgrades were primarily the result of increased credit support as a result of loan payoffs, amortization, and prepayments.

The full list of the ratings of the classes in these transactions can be found at the end of this press release.

Per the February 2023 reporting, 2,490 loans are secured across the small-balance CRE transactions (excluding BVRT 2021-5F, which is a resecuritization of Silver Hill Trust 2019-SBC1), with an aggregate outstanding balance of $1.06 billion. There are 111 loans, representing 4.7% of the aggregate outstanding balance, that were 30+ days delinquent, 38 of which, representing 2.0% of the aggregate outstanding balance, were listed as either 120+ days delinquent, in foreclosure, real estate owned, or with borrowers in bankruptcy. In determining the probability of default (POD) and loss severity given default (LGD) levels in the CMBS Model as part of its review, DBRS Morningstar elevated the POD for all delinquent loans, with incrementally more punitive treatment based on the length of delinquency or workout strategy to appropriately reflect the increased credit risk. Certain POD adjustments were also considered for loans secured by non-traditional property types, as well as amortization and prepayment, in addition to certain LGD adjustments considered for the lack of environmental reporting.

Most of the loans that have been repaid since issuance across all transactions were paid in advance of their respective maturity dates, with most repayments including applicable prepayment penalties. Based on the most recent reporting available, these pools had weighted-average life, trailing-12-month, and trailing-three-month constant prepayment (CPR) rates of 12.3%, 12.2%, and 8.5%, respectively. Given the increasing interest rate environment and related property trade disruption in the CRE market, CPR rates have recently begun to slow, excluding the Cherrywood SB Commercial Mortgage Loan Trust 2016-1, which has a more significant concentration of recent/near-term maturities leading to higher CPR rates.

The DBRS Morningstar CMBS Model does not contemplate the ability to prepay loans, which is generally seen as credit positive because a prepaid loan cannot default. As a result, DBRS Morningstar applied the fully adjusted default assumptions and model-generated severity figures from the DBRS Morningstar CMBS Model to the RMBS Insight 1.3: U.S. Residential Mortgage-Backed Securities Model (the RMBS Model; excluding AOMT 2020-SBC1 and Cherrywood 2016-1), which is adept at modeling sequential and pro rata structures.

As part of the RMBS Model, DBRS Morningstar incorporated four CPR stresses: 5.0%, 10.0%, 15.0%, and 20.0%. Additional assumptions in the RMBS Model generally included a 22-month recovery lag period (excluding Sutherland Commercial Mortgage Trust 2021-SBC10 (SCMT 2021-SBC10), which assumed a recovery lag of six months given the seasoning of the deal), 100% servicer advancing, and three default curves (uniform, front, and back). The shape and duration of the default curves were based on the RMBS loss curves. Lastly, rates were also stressed, both upward and downward, based on their respective loan indices.

Generally, these pools are well-diversified, a factor that combines with the increased credit support to the rated classes from issuance (excluding the SCMT 2019-SBC8 and SCMT 2021-SBC10 deals, which have pro rata structures) to generally reduce the loan-level event risk of the transaction. There are noteworthy risks for the transactions, however, in that property quality is generally considered to be Average-/Below Average based on those properties sampled and that the loan sponsors are generally less sophisticated operators of CRE with limited real estate portfolios and experience. These risks are partially mitigated by borrower or guarantor recourse, regardless of credit history. DBRS Morningstar notes that ongoing property financials are not provided as part of the surveillance reviews.

ESG CONSIDERATIONS
Excluding the SCMT 2021-SBC10 transaction, there were no environmental, social, and governance factors that had a significant or relevant effect on the credit analysis for these rating actions.

DBRS Morningstar concluded that the environmental factor was applicable to the credit analysis for SCMT 2021-SBC10. At issuance, limited to no property-level information was available for review, including property condition reports and Phase I/II environmental site assessment reports. As a result, DBRS Morningstar applied an LGD penalty that resulted in a significant effect on the credit analysis. There were no social or governance factors that had a significant or relevant 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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022).

DBRS Morningstar also notes material deviations, defined as three or more notches from the respective Models applied, for five classes across five transactions, as the quantitative results suggested directionally higher and lower ratings for these classes.

Classes B2 and B2 from the AOMT 2020-SBC1 and Cherrywood 2016-1 deals, respectively, reported material deviations from the CMBS Model. These material deviations were warranted given the uncertain loan level event risk not captured in the CMBS Model.

Classes B3, F, and E from the OMLT 2020-SBC1, SCMT 2019-SBC8, and SCMT 2021-SBC10 deals, respectively, reported material deviations from the RMBS Model. These material deviations were warranted given that certain risks were not fully reflected in the RMBS Model.

Classes that are interest-only (IO) certificates 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.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal methodology is North American CMBS Surveillance Methodology (October 3, 2022), which was updated on March 16, 2023 (the updates were deemed to be not material) and can be found on dbrsmorningstar.com under Methodologies & Criteria. Given the complexity, granularity and modified pro rata pay pass-through structure for certain transactions, DBRS Morningstar also included elements of the RMBS Insight 1.3: U.S. Residential Mortgage-Backed Securities Model and Rating Methodology (March 3, 2023) as a related methodology. 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 related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at [email protected].

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.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact 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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