DBRS Morningstar Finalizes Provisional Ratings on Freddie Mac Structured Pass-Through Certificates, Series K-118

DBRS, Inc. (DBRS Morningstar) finalized its provisional ratings on the following classes of Structured Pass-Through Certificates, Series K-118, issued by Freddie Mac Structured Pass-Through Certificates, Series K-118:

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

All trends are Stable.

The Class X1 balances are notional.

With regard to the Coronavirus Disease (COVID-19) pandemic, the magnitude and extent of performance stress posed to global structured finance transactions remain highly uncertain. This considers the fiscal and monetary policy measures and statutory law changes that have already been implemented or will be implemented to soften the impact of the crisis on global economies. Some regions, jurisdictions, and asset classes are, however, feeling more immediate effects. DBRS Morningstar continues to monitor the ongoing coronavirus pandemic and its impact on both the commercial real estate sector and the global fixed-income markets. Accordingly, DBRS Morningstar may apply additional short-term stresses to its rating analysis, for example by front-loading default expectations and/or assessing the liquidity position of a structured finance transaction with more stressful operational risk and/or cash flow timing considerations.

The collateral consists of 55 fixed-rate loans secured by 45 garden-style, midrise, or townhome multifamily properties, seven manufactured housing community properties, one co-op property, one student housing property, and one assisted-living facility. All loans within the transaction are structured with 10-year loan terms, except for Magnolia Lane, which is structured with a 10.5-year loan term. The transaction is a sequential-pay pass-through structure. The pool was analyzed to determine the DBRS Morningstar ratings, reflecting the long-term probability of loan default within the term and its liquidity at maturity. When the cut-off loan balances were measured against the DBRS Morningstar’s net cash flow (NCF) and their respective actual constants, 19 loans (representing 42.1% of the trust balance) had a DBRS Morningstar Term Debt Service Coverage Ratio (DSCR) at or above 1.80 times (x), a threshold indicative of a lower likelihood of midterm default.

In response to the ongoing coronavirus pandemic, Freddie Mac made changes to its standard servicing practices to permit a temporary deferral of loan payments and forbearance of various remedies that could, among other things, adversely affect cash flow. While DBRS Morningstar views the inclusion of coronavirus-related upfront debt service reserves (DSRs) for a majority of the loans as a positive mitigant of some of the potential coronavirus-related disruptions, the economic fallout from the ongoing pandemic continues to evolve. DBRS Morningstar generally expects multifamily properties to fare better than hospitality and retail properties; however, short- and medium-term challenges still exist in this sector. In addition to imposing various containment-related restrictions, certain jurisdictions have also placed temporary moratoriums on the eviction of tenants that may be continued, extended, or expanded. Furthermore, government programs, such as the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), which provided, among other things, supplemental unemployment benefits to displaced employees, expired on July 31, 2020. This could result in additional stress on properties whose residents have been disproportionately affected by furloughs and layoffs. In addition, the resurgence of coronavirus cases has created additional uncertainty and increased stress on the planned re-opening of businesses. DBRS Morningstar also published its “Global Macroeconomic Scenarios: September Update” and is projecting generalized commercial real estate (CRE) asset value declines for the U.S. of approximately 15% under its moderate scenario and 30% under its adverse scenario.

The pool has a weighted average (WA) expected loss of 2.29%, which is below the WA expected loss of 2.66%, 2.53%, 2.86%, 2.86%, and 2.91% exhibited by FREMF 2020-K117, FREMF 2020-K115, FREMF 2020-K114, FREMF 2020-K113, and FREMF 2020-K112, respectively, all of which were previously rated by DBRS Morningstar. The loans in the transactions benefit from more experienced and financially strong borrowers compared with those of typical CMBS multifamily loans, as evidenced by 51 loans (representing 85.9% of the cut-off date pool balance) receiving Strong DBRS Morningstar sponsor strength scores. Additionally, many of the borrowers are repeat clients of Freddie Mac that have performed as agreed. Underlying collateral cash flow analysis is prudent, as evidenced by an average DBRS Morningstar NCF variance of -5.2% on the sampled loans. In general, revenue has been set to levels similar to the recent trailing 12 months amount and lower than a recent annualized rent roll.

The deal has favorable overall credit metrics as evidenced by a WA DBRS Morningstar Issuance and Balloon Loan to Value (LTV) of 69.4% and 63.4%, respectively. These metrics are comparable with the FREMF 2020-K117 transaction WA DBRS Morningstar Issuance LTV of 70.0% and WA DBRS Morningstar Balloon LTV of 62.6% as well as the FREMF 2020-K114 WA DBRS Morningstar Issuance LTV of 73.9% and WA DBRS Morningstar Balloon LTV of 68.1%, FREMF 2020-K113 WA DBRS Morningstar Issuance LTV of 69.9% and WA DBRS Morningstar Balloon LTV of 64.5%, and the FREMF 2020-K112 WA DBRS Morningstar Issuance LTV of 70.1% and WA DBRS Morningstar Balloon LTV of 64.9%. Additionally, the DBRS Morningstar Term DSCR of 2.00x is substantially higher than FREMF 2020-K117 at 1.78x, FREMF 2020-K114 at 1.52x, FREMF 2020-K113 at 1.64x, and FREMF 2020-K112 at 1.58x. Forty-four loans, representing 79.7% of the pool by balance, are structured with an upfront debt service reserve designed to mitigate any potential impact of the ongoing coronavirus pandemic. Freddie Mac is generally requiring coronavirus-related reserves, based on the property subtype and loan metrics at origination, which can be released back to the borrower if certain conditions are met.

Individual loan information provided generally included monthly collection reports through June 30, 2020, which may not fully reflect any reductions to income as a result of coronavirus-related economic conditions. The DBRS Morningstar NCF analysis generally applied a vacancy loss that reflected projected submarket vacancy rates through 2024. These rates were either in line with or 100 basis points (bps) to 200 bps higher than current submarket vacancy rates, adding a marginal amount of conservatism to the NCFs. Additionally, for loans that DBRS Morningstar did not sample, DBRS Morningstar conservatively applied a 10.0% reduction to the issuer’s cash flow. This reduction was greater than the sample average NCF variance of -5.2%. Forty-four loans, representing 79.7% of the pool by balance, are structured with an upfront DSR designed to mitigate any potential impact of the ongoing coronavirus pandemic.

Fourteen loans, representing 12.1% of the pool, are secured by properties in DBRS Morningstar Market Ranks 1 or 2, which are considered more rural or tertiary in nature. One of these loans, representing 2.5% of the pool, is in the top 15 (Waters Edge Phase 2). Only four loans, representing 6.3% of the cut-off date pool balance, are located in areas with a DBRS Morningstar Market Rank of 6 or higher. One of these loans, representing 2.5% of the pool, is in the top 15 (Post Oak Park). Areas with a DBRS Morningstar Market Rank of 6 or higher are generally characterized as urbanized locations. These markets benefit from lower default frequencies than less dense suburban, tertiary, and rural markets. Areas with a DBRS Morningstar Market Rank of 7 or 8 are especially densely urbanized and benefit from significantly elevated liquidity. DBRS Morningstar analyzed properties in tertiary and rural markets with higher loss severities than those in urban markets.

Sixteen loans, representing 41.2% of the pool, are structured with full-term interest-only (IO) payments, and an additional 34 loans, representing 50.8% of the pool, have partial-IO periods ranging from 12 to 96 months. Only five loans, representing 8.0% of the pool, have full-term amortizing payments, two of which are in the top 15. For partial IO loans, the probability of default (POD) is calculated using a DSCR that includes amortizing debt service. Furthermore, the DBRS Morningstar POD factors in loan balloon LTVs and, in cases where the loan lacks amortization, the balloon LTV will be penalized with a higher POD. Lastly, partial-IO loans are penalized in the model.

The pool contains 11 loans, representing 20.3% of the cut-off date pool balance, that were not structured with a coronavirus DSR. Only one of these loans was originated pre-pandemic in August 2019. The 11 loans include The Porter Del Ray, Folio, Montevista Apartments, Post Oak Park, Cypress Grand Apartments, 25 Tudor City Place, Hollandale Apartments, Magnolia Lane, Estates Of Fernview, The Lux, and Spruce Village II Apartments. Four of these loans, representing 14.0% of the cut-off date pool balance, are in the top 15. The assets securing the loans exhibited strong occupancy rates ranging from 89.3% to 100.0% as of their most recent rent rolls with a WA occupancy of 93.6%. The loans also exhibited favorable appraised LTVs ranging from 9.9% to 67.9% with a WA appraised LTV of 47.3%. Two of the loans, representing 3.8% of the cut-off date pool balance, are located in more urbanized markets with a DBRS Morningstar Market Rank of 6 or higher. Specifically, Post Oak Park is located in Houston, Texas, and 25 Tudor City Place is located in New York City.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

Class X1 is an IO certificate that references 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.

DBRS Morningstar provides updated analysis and in-depth commentary in the DBRS Viewpoint platform for the following loans in the transaction:

-- Eagle Rock At Woodbury (9.6% of the pool)
-- Ridge Gardens (5.6% of the pool)
-- Bear Run Village Apartments (4.6% of the pool)
-- The Porter Del Ray (4.4% of the pool)
-- Arzano (4.2% of the pool)
-- Folio (4.2% of the pool)
-- Circuit Apartments (3.6% of the pool)
-- Casa Del Monte MHP (3.5% of the pool)
-- The Reserve At Gwinnett (2.9% of the pool)
-- Waterford Landing (2.8% of the pool)
-- Montevista Apartments (2.8% of the pool)
-- The Lumberyard Apartments (2.7% of the pool)
-- Waters Edge Phase 2 (2.5% of the pool)
-- Tower At Tropicana Luxury Apartments (2.5% of the pool)
-- Post Oak Park (2.4% of the pool)
-- Carmel Pointe (2.4% of the pool)
-- Gloria Park Villas Luxury Apartments (2.3% of the pool)
-- LeSarra Apartments (2.0% of the pool)
-- Lakeside MHP (1.3% of the pool)
-- Medley MHP (1.2% of the pool)
-- Regency Place (0.8% of the pool)
-- Grove At Seabrook (0.8% of the pool)
-- The Forum Apartments (0.7% of the pool)
-- The Lux (0.5% of the pool)
-- Dalewood Townhomes (0.5% of the pool)

For complimentary access to this content, please register for the DBRS Viewpoint platform at www.viewpoint.dbrsmorningstar.com. The platform includes issuer and servicer data for most outstanding CMBS transactions (including non-DBRS Morningstar rated), as well as loan-level and transaction-level commentary for most DBRS Morningstar-rated and -monitored transactions.

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 (August 7, 2020), 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.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

For more information regarding structured finance methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/358308.

For more information regarding the structured finance rating approach and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/359905.

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.

The full report providing additional analytical detail is available by clicking on the link under Related Documents below or by contacting us at info@dbrsmorningstar.com.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

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