Morningstar DBRS Requests Comments on Proposed European Granular CMBS Appendix to European CMBS Rating and Surveillance Methodology

Morningstar DBRS is requesting comments on the proposed "Appendix G: European Granular CMBS" (Appendix G) to the "European CMBS Rating and Surveillance Methodology", (the Methodology), which may, upon the close of the request for comment period, supersede the version published on 4 March 2025. Morningstar DBRS is also requesting comments on the corresponding European Granular CMBS Model (the Model) described in Appendix G.

The proposed Appendix G will apply to transactions that are secured by a diverse pool of European commercial real estate (CRE) loans. Morningstar DBRS considers CRE loan portfolios with an adjusted Herfindahl Hirschmann Index of 10 or higher (i.e., at least as granular as a portfolio with 10 equally sized loans) to be the granularity threshold above which transactions secured by CRE loans will be rated with this proposed addition to the Methodology.

Compared with the analysis of more concentrated CRE loan pools, the proposed analysis of granular European commercial mortgage-backed securities (CMBS) transactions has three main features:
-- A sampling of the CRE loans in the portfolio to determine which loans are underwritten in detail and a more generic loan underwriting approach for nonsampled loans, which complements and builds on the detailed manual underwriting described in the Methodology.
-- The European Granular CMBS Model that models the interdependence amongst the loans' credit risk to arrive at portfolio-level risk metrics for each credit rating stress scenario;
-- A cash flow analysis that considers the transaction's cash flows over its term in different credit rating stress scenarios and assesses the adequacy of the available credit enhancement for each rated tranche.

Although Morningstar DBRS would analyse each loan in a granular European CMBS transaction's portfolio, it would do so with a holistic, portfolio-level risk assessment in mind. Appendix G of the Methodology combines the thorough, manual property and loan underwriting logic of more concentrated European CMBS with a more rules-based, generic approach. In this generic approach, property quality and capitalisation rate assessment will be based on the properties that have been manually underwritten and are of similar type and location.

From the transaction's entire portfolio, loans for manual underwriting are selected so that the portfolio is represented comprehensively. Loans that merit further analysis and that are influential from the portfolio's risk perspective are also included. This process aims to ensure that the portfolio's main characteristics are captured with detailed loan-level underwriting and its most relevant and influential loans are analysed in detail, while the risk of loans with less contribution to the pool or with fewer specificities is approximated using the pool's analysed features and an assessment of the respective submarkets.

For each property within the pool, whether manually underwritten or not, the Morningstar DBRS Net Cash Flow and the Morningstar DBRS Value are determined and translated into loan-level loan-to-value ratio (LTV) and debt service coverage ratio (DSCR) metrics. In addition, large loan sizing hurdles (derived from Morningstar DBRS LTV and/or DSCR) are selected for each loan. These hurdles imply for each loan the probabilities of credit rating stress scenarios and the loan's implied losses in them. These are then used in the portfolio-level (pooling) analysis.

At portfolio level, the European Granular CMBS Model analyses the common sources of risk for the pool's loans. Their modelled shocks depend on a risk factor that affects all loans. In addition, the model features risk factors that make those loans whose collaterals share the same property types and/or (country-level) markets more correlated. The correlation between loans backed by lower-quality properties is increased in highly adverse stress scenarios. Taking these dependencies into account and applying the selected hurdles for each loan, the European Granular CMBS Model calculates pool-level default and loss rates for each credit rating stress scenario.

The transaction's cash flow analysis incorporates the transaction's structural features and the expected cash flows from the collateral pool, as well as default and loss rates for the various credit rating stress scenarios. It assesses the transaction's cash flows dynamically, also considering prepayment, default timing, recovery lag, and interest rates assumptions. Often, several combinations of stresses are analysed to assess the notes' resilience at a given credit rating level.

Morningstar DBRS deems the addition of Appendix G to the Methodology to be material but determined that no outstanding credit ratings are expected to be affected.

Comments should be received on or before 28 May 2025. Please submit your comments to the following email address: sfcomments@morningstar.com

Morningstar DBRS publishes on its website all comments received, except in cases where confidentiality is requested by the respondent.

Notes:
Morningstar DBRS methodologies are publicly available on its website http://dbrs.morningstar.com under Methodologies & Criteria.

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