DBRS Morningstar Finalizes Provisional Ratings on LCCM 2021-FL3 Trust

DBRS, Inc. (DBRS Morningstar) finalized provisional ratings on the following classes of Offered Notes issued by LCCM 2021-FL3 Trust (LCCM 2021-FL3 or the Trust):

-- Class A at AAA (sf)
-- Class A-S at AAA (sf)
-- Class B at AA (low) (sf)
-- Class C at A (low) (sf)
-- Class D at BBB (sf)
-- Class E at BBB (low) (sf)
-- Class F at BB (low) (sf)
-- Class G at B (low) (sf)

All trends are Stable.

The initial collateral consists of 35 floating-rate mortgage loans secured by 48 mostly transitional real estate properties with a cut-off balance totaling $729.4 million, excluding $116.3 million of remaining future funding commitments and $209.6 million of pari passu debt. The debt transaction is a managed vehicle, which includes a 24-month reinvestment period, ending November 2023. The eligibility criteria, among other things, include minimum debt service coverage ratios (DSCRs) and loan-to-value ratios (LTVs), a 14.0 Herfindahl score, and property type limitations. Additionally, the aggregate principal balance of the collateral interest secured by multifamily properties is not less than 35% of the aggregate outstanding portfolio balance and the aggregate principal balance of the collateral interest secured by multifamily, industrial and office properties is not less than 60.0% of the aggregate outstanding portfolio balance. The transaction is not structured with a replenishment period. The transaction stipulates that any acquisition of any companion participation or ramp-up mortgage asset will require a rating agency confirmation (RAC) if the balance is greater than $1.0 million.

The loans are mostly secured by cash flowing assets, many of which are in a period of transition with plans to stabilize and improve the asset value. In total, 27 loans, representing 76.2% of the pool, have remaining future funding participations totaling $114.4 million, which the Issuer may acquire in the future.

For the floating-rate loans, DBRS Morningstar used the one-month Libor index, which is based on the lower of a DBRS Morningstar stressed rate that corresponded to the remaining fully extended term of the loans or the strike price of the interest rate cap with the respective contractual loan spread added to determine a stressed interest rate over the loan term. When the debt service payments were measured against the DBRS Morningstar As-Is NCF, 29 loans, comprising 81.9% of the initial pool balance, had a DBRS Morningstar As-Is DSCR of 1.00 times (x) or below, a threshold indicative of default risk. However, the DBRS Morningstar Stabilized DSCR of only eight loans, comprising 31.2% of the initial pool balance, was 1.00x or below, which is indicative of elevated refinance risk. The properties are often transitioning with potential upside in cash flow; however, DBRS Morningstar does not give full credit to the stabilization if there are no holdbacks or if other structural features in place are insufficient to support such treatment. Furthermore, even with the structure provided, DBRS Morningstar generally does not assume the assets to stabilize above market levels.

The majority of the pool comprises primarily multifamily (40.9%) and industrial (13.2%) properties. These property types have historically shown lower defaults and losses. Multifamily properties benefit from staggered lease rollover and generally low expense ratios compared with other property types. While revenue is quick to decline in a downturn because of the short-term nature of the leases, it is also quick to respond when the market improves.

Sixteen loans, representing 54.3% of the cut-off date pool balance, are secured by properties in areas with a DBRS Morningstar Market Rank of 6, 7, or 8, which are characterized as urbanized locations. These markets generally benefit from increased liquidity that is driven by consistently strong investor demand. Such markets therefore tend to benefit from lower default frequencies than less dense suburban, tertiary, or rural markets. Areas with a DBRS Morningstar Market Rank of 7 or 8 are especially densely urbanized and benefit from significantly elevated liquidity. Twelve loans, comprising 37.1% of the cut-off date pool balance, are secured by collateral in such areas. Urban markets represented in the deal include New York, Miami, Pittsburgh, Los Angeles, and Oakland.

Fifteen loans, representing 42.4% of the pool balance, have collateral in MSA Group 3, which is the best-performing group in terms of historical CMBS default rates among the top 25 MSAs. MSA Group 3 has a historical default rate of 17.2%, which is nearly 10.8 percentage points lower than the overall CMBS historical default rate of 28.0%.

DBRS Morningstar has analyzed the loans to a stabilized cash flow that is, in some instances, above the in-place cash flow. It is possible that the sponsors will not successfully execute their business plans and that the higher stabilized cash flow will not materialize during the loan term, particularly with the ongoing Coronavirus Disease (COVID-19) pandemic and its impact on the overall economy. A sponsor’s failure to execute the business plan could result in a term default or the inability to refinance the fully funded loan balance. DBRS Morningstar made relatively conservative stabilization assumptions and, in each instance, considered the business plan to be rational and the future funding amounts to be sufficient to execute such plans. In addition, DBRS Morningstar analyzes loss given default (LGD) based on the DBRS Morningstar As-Is LTV, assuming the loan is fully funded.

Given the nature of the assets, DBRS Morningstar sampled 66.7% of the cut-off date pool balance. While physical site inspections were generally not performed because of health and safety constraints associated with the ongoing coronavirus pandemic, DBRS Morningstar notes that, in the future, when DBRS Morningstar analysts visit the markets, they may actually visit properties more than once to follow the progress (or lack there) toward stabilization. The servicer is also in constant contact with the borrowers to track progress.

Based on the initial pool balances, the overall DBRS Morningstar weighted-average (WA) As-Is DSCR of 0.62x and WA As-Is LTV of 75.6% generally reflect high-leverage financing.

Most of the assets are generally well positioned to stabilize, and any realized cash flow growth would help to offset a rise in interest rates and improve the overall debt yield of the loans. DBRS Morningstar associates its LGD based on the assets’ as-is LTV, which does not assume that the stabilization plan and cash flow growth will ever materialize. The DBRS Morningstar As-Is DSCR at issuance does not consider the sponsor’s business plan as the DBRS Morningstar As-Is NCF was generally based on the most recent annualized period. The sponsor’s business plan could have an immediate impact on the underlying asset performance that the DBRS Morningstar As-Is NCF does not account for. When measured against the DBRS Morningstar Stabilized NCF, the DBRS Morningstar WA DSCR is estimated to improve to 1.16x, suggesting that the properties are likely to have improved net cash flows (NCFs) once the sponsor’s business plan has been implemented.

Eight loans, representing 34.7% of the initial pool comprise office (24.9%), retail (6.1%), and hospitality (3.7%) properties, which have experienced considerable disruption as a result of the coronavirus pandemic, with mandatory closures, stay-at-home orders, retail bankruptcies, and consumer shifts to online purchasing. Five of the eight loans, representing 60.7% of the concentration and 21.1% of the initial pool balance, are in areas with DBRS Morningstar Market Ranks of 6, 7, or 8, which are generally characterized as dense urbanized areas that benefit from increased liquidity driven by consistently strong investor demand, even during times of economic distress. Additionally, three of these loans, representing 30.9% of the concentration, have collateral in DBRS Morningstar MSA Group 3, which is the best-performing group in terms of historic CMBS default rates among the top 25 MSAs. One loan in the pool is backed by a hotel. The property was significantly renovated in 2018–19 and delivered shortly before the onset of the coronavirus pandemic. The property’s quality score is Average + and the loan has a low initial appraiser LTV of 54.7%, both of which are good characteristics. Still, the loan was modeled with an expected loss above the pool average, which reflects the additional risk of a hotel in the current environment. One loan, 17 West 60th Street, is designated as an office property; however, it requires significant construction to convert the property to a private school from a vacant shell. DBRS Morningstar noted that this additional execution risk is a concern.

The transaction is managed and includes a 24-month reinvestment period, which could result in negative credit migration and/or an increased concentration profile over the life of the transaction. The risk of negative migration is partially offset by eligibility criteria that outline minimum DSCR, LTV, and Herfindahl scores and property type and loan size limitations for reinvestment assets. A No Downgrade Confirmation is required from DBRS Morningstar for all reinvestment loans and companion participations of more than $1.0 million.

All loans have floating interest rates and are interest only (IO) during their entire initial loan term, creating interest rate risk should interest rates increase. For the floating-rate loans, DBRS Morningstar used the one-month Libor index, which is based on the lower of a DBRS Morningstar stressed rate that corresponded to the remaining fully extended term of the loans or the strike price of the interest rate cap with the respective contractual loan spread added to determine a stressed interest rate over the loan term. Additionally, all loans have extension options and, in order to quality for these options, the loans must meet minimum DSCR, debt yield, and/or LTV requirements. All loans are short-term and, even with extension options, have a fully extended maximum loan term of five years. The borrowers for all loans, except one (17 West 60th Street) have purchased Libor cap rates that range from 1.00% to 3.00% to protect against rising interest rates over the term of the loan. 17 West 60th Street, representing 6.0% of the trust balance, is not required to purchase a cap rate at closing; however, once Libor reaches 1.50%, the borrower shall be required to obtain an interest rate cap for the remaining initial term and may extended pursuant to extension options.

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/373262.

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.

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 (March 26, 2021), 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.

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 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. The DBRS Morningstar long-term rating scale definition indicates that ratings of CCC or lower are assigned when the bond is highly likely to default or default is imminent, thereby prevailing over a sensitivity analysis.

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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