DBRS Morningstar Finalizes Ratings on Freddie Mac Structured Pass-Through Certificates, Series K-158

DBRS, Inc. (DBRS Morningstar) finalized its ratings on the following classes of Structured Pass-Through Certificates (SPCs), Series K-158 issued by Freddie Mac Structured Pass-Through Certificates, Series K-158 (Freddie Mac SPCs K-158 or the Issuer):

-- Class A-1 at AAA (sf)
-- Class A-2 at AAA (sf)
-- Class X1 at AAA (sf)

All trends are Stable.

The Class X1 is notional.

The collateral consists of 31 fixed-rate loans secured by 31 commercial properties, including 24 garden-style multifamily properties, two high-rise properties, two mid-rise properties, two manufactured housing community properties, and one age-restricted property. All loans in the pool have 10-year loan terms. The transaction is a sequential-pay pass-through structure. DBRS Morningstar analyzed the pool to determine the ratings, reflecting the long-term probability of loan default within the term, and its liquidity at maturity. When the cut-off date balances were measured against DBRS Morningstar’s net cash flow (NCF) and their respective actual constants, there were only two loans, representing 5.5% of the pool, with a DBRS Morningstar Term Debt Service Coverage Ratio (DSCR) at or above 1.75 times (x), a threshold indicative of a lower likelihood of midterm default.

Classes A-1, A-2, A-M, X1, and XAM of the FREMF 2023-K158 Mortgage Trust, Series 2023-K158 (FREMF 2023-K158) transaction will be 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, confirmation, upgrade, or downgrade by DBRS Morningstar after the date of issuance. DBRS Morningstar assigned the initial ratings to the FREMF 2023-K158 Certificates and the Freddie Mac Structured Pass-Through Certificates, Series K-158 (Freddie Mac SPCs K-158) without giving effect to the Freddie Mac guarantee.

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 0.21% as of June 30, 2023. This compares favorably with the delinquency rate of approximately 1.59% for commercial mortgage-backed securities (CMBS) multifamily loans over the same period. From the inception of its K-Program through June 30, 2023, Freddie Mac has securitized 25,592 loans, totaling approximately $530.04 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 $55.16 million in total losses, representing less than 1.0 basis point (0.01%) of total issuance.

The pool exhibits DBRS Morningstar Weighted Average (WA) Issuance and Balloon Loan-to-Value Ratios (LTVs) of 61.5% and 60.2%, respectively. These credit metrics are comparable, but slightly lower, relative to recent FREMF transactions rated by DBRS Morningstar and are indicative of lower leverage. There are 24 loans, representing 83.7% of the total pool balance, that have a DBRS Morningstar Issuance LTV of 67.1% or below, resulting in a decreased probability of default.
Collectively, there are six loans, representing 40.5% of the deal, that were assessed with favorable property quality. Backing all these loans are Class A multifamily properties that were built from 2019 to 2022. DBRS Morningstar considered one loan, representing 6.8% of the pool, to be Above Average property quality, and five loans, representing 33.7% of the pool, to be Average+ property quality based on physical attributes and/or a desirable location within their respective markets. Higher-quality properties are more likely to retain existing tenants and more easily attract new tenants, resulting in a more stable performance.

Twenty-seven loans, representing 81.3% of the pool, had a DBRS Morningstar sponsor strength of Strong, which is credit positive. Four loans collectively representing 19.7% of the pool, are associated with the same sponsorship group. The properties are not cross-collateralized, so negative performance at one asset will have no bearing on the performance of the remaining properties. The properties are spread out across three different states: Florida, Texas, and Colorado and four different cities and submarkets.

The average haircut was 8.1% across the 15 loans that DBRS Morningstar sampled, representing 76.2% of the pool. The sampled average NCF variance is lower than the recent Freddie Mac transactions rated by DBRS Morningstar and generally low when compared with that of other CMBS multiborrower transactions.

There are five loans, representing 22.8% of the pool, in a DBRS Morningstar metropolitan statistical area (MSA) of 3, which is the best-performing group in terms of historic CMBS default rates among the top 25 MSAs. Nineteen loans, representing 55.4% of the pool balance, are secured by a property with a DBRS Morningstar Market Rank of 3 or 4, which, although generally suburban in nature, have historically had higher default and loss rates. Additionally, six loans, representing 23.8% of the pool balance, are secured by a property with a DBRS Morningstar Market Rank of 1 or 2, which are more rural or tertiary. The pool’s DBRS Morningstar WA Market Rank of 3.5 indicates a high concentration of properties in less densely populated areas.

The increase in both fixed and floating interest rates over the past year has led to an increase in loans displaying negative leverage, in which the interest rate charged by the lender is higher than the property’s capitalization rate, a measure of the property’s return based upon its income-generating potential. The increase in rates is likely to result in lower property values and reduced leverage when refinancing a loan. DBRS Morningstar identified 25 loans, representing 77.3% of the pool, exhibiting negative leverage, and adjusted the issuer’s implied cap rate upwards for the respective properties to be in alignment with the respective mortgage interest rates. This increases the LTV and the DBRS Morningstar expected loss in some cases.

DBRS Morningstar’s credit ratings on the Certificates address the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents. The associated financial obligations are listed at the end of this press release.

DBRS Morningstar’s credit ratings do not address nonpayment risk associated with contractual payment obligations contemplated in the applicable transaction document(s) that are not financial obligations (for example, Yield Maintenance Charges and Static Prepayment Premiums).

DBRS Morningstar’s long-term credit ratings provide opinions on risk of default. DBRS Morningstar considers risk of default to be the risk that an issuer will fail to satisfy the financial obligations in accordance with the terms under which a long-term obligation has been issued.

The DBRS Morningstar short-term debt rating scale provides an opinion on the risk that an issuer will not meet its short-term financial obligations in a timely manner.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

There was one relevant climate and weather risk environmental factor that had a relevant effect on the credit analysis, but not a significant effect. DBRS Morningstar increased the loss given default for Canal House Apartments, representing 1.0% of the pool, because the property’s flood insurance coverage does not exceed the lender’s required excess flood insurance.

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/416784 (July 4, 2023).

Classes X1 and XAM 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.

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

The principal methodology is the North American CMBS Multi-Borrower Rating Methodology (March 16, 2023; https://www.dbrsmorningstar.com/research/410913).

Other methodologies referenced in this transaction are listed at the end of this press release.

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 credit ratings referenced herein.

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.

The credit rating was initiated at the request of the rated entity. The rated entity or its related entities did participate in the credit rating process for this credit rating action. DBRS Morningstar had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action. This is a solicited rating.

Please see the related appendix for additional information regarding the sensitivity of assumptions used in the rating process.

DBRS, Inc.
22 West Washington Street
Chicago, IL 60602 USA
Tel. +1 312 332-3429

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

Rating North American CMBS Interest-Only Certificates (December 19, 2022) https://www.dbrsmorningstar.com/research/407577

Legal Criteria for U.S. Structured Finance (December 7, 2022) https://www.dbrsmorningstar.com/research/407008

DBRS Morningstar North American Commercial Real Estate Property Analysis Criteria (September 12, 2022) https://www.dbrsmorningstar.com/research/402646

North American Commercial Mortgage Servicer Rankings (September 8, 2022) https://www.dbrsmorningstar.com/research/402499

North American CMBS Insight Model v 1.1.0.0
https://www.dbrsmorningstar.com/research/410913

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

Financial Obligations of the issuer are listed as follows:

-- Class A-1 Optimal Interest Distribution Amount
-- Class A-1 Principal Balance
-- Class A-2 Optimal Interest Distribution Amount
-- Class A-2 Principal Balance
-- Class X1 Optimal Interest Distribution Amount