Morningstar DBRS Confirms and Upgrades Provisional Credit Ratings and Removes Under Review With Developing Implications Status on Certain Tranche Amounts of Kawartha CAD Ltd., Boreal 2021-1

DBRS, Inc. (Morningstar DBRS) confirmed and upgraded the following provisional credit ratings on the Tranche A Amount, Tranche B Amount, Tranche C Amount, and Tranche D Amount (collectively, the Tranche Amounts) of two unexecuted, unfunded financial guarantees (the Financial Guarantees) of Kawartha CAD Ltd., Boreal 2021-1 with respect to a portfolio of Canadian commercial real estate (CRE) secured loans originated or managed by the Bank of Montreal (BMO; rated AA with a Stable trend by Morningstar DBRS):

-- Tranche A Amount confirmed at AAA (sf)
-- Tranche B Amount upgraded to AA (high) (sf) from AA (sf)
-- Tranche C Amount upgraded to A (high) (sf) from A (sf)
-- Tranche D Amount confirmed at BBB (low) (sf)

The provisional credit ratings on the Tranche Amounts address the likelihood of a reduction to the respective tranche notional amounts resulting from obligor defaults within the guaranteed portfolio during the period from the Effective Date until the Scheduled Termination Date. For obligors within the guaranteed portfolio, default events are limited to payment default, insolvency, and restructuring events.

CREDIT RATING RATIONALE/DESCRIPTION
The credit rating actions are a result of Morningstar DBRS’ review of the transaction performance and application of the “Global Methodology for Rating CLOs and Corporate CDOs” (the CLO Methodology), including the Morningstar DBRS CLO Insight Model, initially released on October 22, 2023. On November 9, 2023, the credit ratings were placed Under Review with Developing Implications to allow Morningstar DBRS to review the credit ratings using the CLO Methodology.

Kawartha CAD Ltd., Boreal 2021-1 is a synthetic risk transfer transaction with BMO as Beneficiary. The Scheduled Termination Date is August 20, 2026. The Replenishment Cut-Off Date is February 20, 2024.

In its analysis, Morningstar DBRS considered the following:
(1) The Financial Guarantees dated as of June 15, 2021.
(2) The integrity of the transaction structure.
(3) Morningstar DBRS’ assessment of the portfolio quality.
(4) Adequate credit enhancement to withstand projected collateral loss rates.

Morningstar DBRS analyzed the transaction using its CMBS Insight Model and CLO Insight Model, based on certain reference portfolio characteristics, including Eligibility Criteria and Replenishment Criteria, as defined per the Financial Guarantees. As of January 30, 2024, certain Replenishment Criteria were not met. Morningstar DBRS considered these failures in its analysis. The reference portfolio consists of well-diversified CRE secured loans across various obligors. The analysis produced satisfactory results, which supported the respective confirmations and upgrades on the Tranche Amounts.

The provisional credit ratings take into consideration only the creditworthiness of the reference portfolio. The provisional credit ratings do not address counterparty risk nor the likelihood of any event of default or termination events under the agreement occurring. BMO bought protection under a similar executed financial guarantee for certain issued notes but has not executed contracts related to the tranche notional amounts.

The provisional credit ratings assigned by Morningstar DBRS are expected to remain provisional until the underlying agreements are executed. BMO may have no intention of executing the Financial Guarantees. Morningstar DBRS will maintain and monitor the provisional ratings throughout the life of the transaction or while it continues to receive performance information.

To assess portfolio credit quality, Morningstar DBRS may provide a credit estimate, internal assessment, or ratings mapping of BMO’s internal ratings model. Credit estimates, internal assessments, and ratings mappings are not ratings; rather, they represent an abbreviated analysis, including model-driven or statistical components of default probability for each obligor, that is used in assigning a credit rating to a facility sufficient to assess portfolio credit quality.

The transaction assumptions consider Morningstar DBRS’ baseline macroeconomic scenarios for rated sovereign economies, available in its commentary “Baseline Macroeconomic Scenarios for Rated Sovereigns March 2024 Update,” published on March 27, 2024 (https://dbrs.morningstar.com/research/430189). These baseline macroeconomic scenarios replace Morningstar DBRS’ moderate and adverse coronavirus pandemic scenarios, which were first published in April 2020.

For more information regarding Morningstar DBRS’ additional adjustment for select industries related to COVID-19, please see its May 18, 2020, commentary, “CLO Risk Exposure to the Coronavirus Disease (COVID-19)” at https://dbrs.morningstar.com/research/361112.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
Environmental (E) Factors
The following Environmental factor had a relevant effect on the credit analysis: The portfolio of 396 exposures includes nine loans, representing 3.6% of the total guaranteed obligation amount, backed by properties that have been flagged for environmental issues. This E factor has a relevant effect on the credit analysis of the transaction, because Morningstar DBRS includes a penalty for the loss given default (LGD) estimate for loans flagged with environmental issues, which increases the estimated required credit enhancement at each rating level. At transaction close, this E factor affected 12 out of 314 loans (3.6% of the total guaranteed obligation amount).

There were no Social or Governance factors that had a relevant or significant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) https://dbrs.morningstar.com/research/427030.

Notes:
The principal methodologies applicable to the credit ratings are Global Methodology for Rating CLOs and Corporate CDOs, including its Appendix II: Mapping Financial Institution Internal Ratings to Morningstar DBRS Credit Ratings for Global Structured Credit Transactions, and the CLO Insight Model version 1.0.1.0 (February 23, 2024) https://dbrs.morningstar.com/research/428544 and North American CMBS Multi-Borrower Rating Methodology and North American CMBS Insight Model 1.2.0.0 (March 1, 2024) https://dbrs.morningstar.com/research/428797.

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

Morningstar DBRS materially deviated from its principal methodologies when determining the credit ratings assigned to the Tranche Amounts. The LGD assumptions for the CRE Builder Developer portion of the guaranteed portfolio were derived via BMO’s LGD estimates and historical realized LGDs, rather than as part of any primary or related methodologies. The material deviation is warranted given that no primary or related methodology governs the application of LGD assumptions for CRE Builder Developer loans.

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.

Morningstar DBRS 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 credit rating.

DBRS, Inc.
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The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

Operational Risk Assessment for CLOs and CDOs (September 14, 2023)
https://dbrs.morningstar.com/research/420608

Legal Criteria for U.S. Structured Finance (December 7, 2023)
https://dbrs.morningstar.com/research/425081/legal-criteria-for-u.s.-structured-finance

Interest Rate Stresses for U.S. Structured Finance Transactions (February 26, 2024)
https://dbrs.morningstar.com/research/428623/interest-rate-stresses-for-u.s.-structured-finance-transactions

For more information on this credit or on this industry, visit dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.