DBRS, Inc. (DBRS Morningstar) finalized provisional ratings on the Mortgage-Backed Certificates, Series 2023-1 (the Certificates) issued by Velocity Commercial Capital Loan Trust 2023-1 (VCC 2023-1 or the Issuer) as follows:
-- $146.3 million Class A at AAA (sf)
-- $146.3 million Class A-S at AAA (sf)
-- $146.3 million Class A-IO at AAA (sf)
-- $5.9 million Class M-1 at AA (sf)
-- $5.9 million Class M1-A at AA (sf)
-- $5.9 million Class M1-IO at AA (sf)
-- $17.4 million Class M-2 at A (low) (sf)
-- $17.4 million Class M2-A at A (low) (sf)
-- $17.4 million Class M2-IO at A (low) (sf)
-- $14.1 million Class M-3 at BBB (sf)
-- $14.1 million Class M3-A at BBB (sf)
-- $14.1 million Class M3-IO at BBB (sf)
-- $30.0 million Class M-4 at BB (sf)
-- $30.0 million Class M4-A at BB (sf)
-- $30.0 million Class M4-IO at BB (sf)
-- $17.4 million Class M-5 at B (sf)
-- $17.4 million Class M5-A at B (sf)
-- $17.4 million Class M5-IO at B (sf)
Classes A-IO, M1-IO, M2-IO, M3-IO, M4-IO, and M5-IO are interest-only (IO) certificates. The class balances represent notional amounts.
Classes A, M-1, M-2, M-3, M-4, and M-5 are exchangeable certificates. These classes can be exchanged for combinations of initial exchangeable certificates as specified in the offering documents.
The AAA (sf) ratings on the Certificates reflect 39.10% of credit enhancement (CE) provided by subordinated certificates. The AA (sf), A (low) (sf), BBB (sf), BB (sf), and B (sf) ratings reflect 36.65%, 29.40%, 23.55%, 11.05%, and 3.80% of CE, respectively.
Other than the classes specified above, DBRS Morningstar does not rate any other classes in this transaction.
VCC 2023-1 is a securitization of a portfolio of newly originated and seasoned fixed-rate, first-lien residential mortgages collateralized by investor properties with one to four units (residential investor loans) and small-balance commercial mortgages (SBC) collateralized by various types of commercial, multifamily rental, and mixed-use properties. The securitization is funded by the issuance of the Certificates, which are backed by 695 mortgage loans with a total principal balance of $240,308,194 as of the Cut-Off Date (December 1, 2022).
Approximately 60.2% of the pool comprises residential investor loans and about 39.8% are SBC loans. All loans in this securitization were originated by Velocity Commercial Capital, LLC (Velocity or VCC). The loans were underwritten to program guidelines for business-purpose loans where the lender generally expects the property (or its value) to be the primary source of repayment (No Ratio). The lender reviews the mortgagor's credit profile, though it does not rely on the borrower's income to make its credit decision. However, the lender considers the property-level cash flow or minimum debt service coverage ratio (DSCR) when underwriting SBC loans with balances over $750,000 for purchase transactions and over $500,000 for refinance transactions. Because the loans were made to investors for business purposes, they are exempt from the Consumer Financial Protection Bureau’s Ability-to-Repay rules and TILA-RESPA Integrated Disclosure rule.
PHH Mortgage Corporation (PMC) will service all loans within the pool for a fee of 0.30% per annum. In addition, Velocity will act as a Special Servicer for loans that defaulted or became 60 or more days delinquent under the Mortgage Bankers Association (MBA) method and other loans, as defined in the transaction documents (Specially Serviced Loans). The Special Servicer will be entitled to receive compensation, including an annual fee of 0.75% and the balance of Specially Serviced Loans. Also, the Special Servicer is entitled to a liquidation fee equal to 2.00% of the net proceeds from the liquidation of a Specially Serviced Loan, as described in the transaction documents.
The Servicer will fund advances of delinquent principal and interest (P&I) until the advances deemed unrecoverable. Also, the Servicer is obligated to make advances with respect to taxes, insurance premiums, and reasonable costs incurred in the course of servicing and disposing properties.
U.S. Bank National Association (U.S. Bank; rated AA (high) with a Stable trend by DBRS Morningstar) will act as the Custodian. U.S. Bank Trust Company, National Association will act as the Trustee.
The Seller, directly or indirectly through a majority-owned affiliate, is expected to retain an eligible horizontal residual interest consisting of the Class P, Class XS, and Class M-7 Certificates, collectively representing at least 5% of the fair value of all Certificates, to satisfy the credit risk-retention requirements under Section 15G of the Securities Exchange Act of 1934 and the regulations promulgated thereunder. Such retention aligns Sponsor and investor interest in the capital structure.
On or after the later of (1) the three-year anniversary of the Closing Date or (2) the date when the aggregate stated principal balance of the mortgage loans is reduced to 30% of the Closing Date balance, the Depositor may purchase all outstanding Certificates (Optional Purchase) at a price equal to the sum of the remaining aggregate balance of the Certificates plus accrued and unpaid interest, and any fees, expenses, and indemnity payments due and unpaid to the transaction parties, including any unreimbursed P&I and servicing advances, and other amounts due as applicable. The Optional Purchase will be conducted concurrently with a qualified liquidation of the Issuer.
Additionally, if on any date on which the unpaid mortgage loan balance and the value of REO properties has declined to less than 10% of the initial mortgage loan balance as of the Cut-Off Date, the Directing Holder, the Special Servicer, or the Servicer, in that order of priority, may purchase all of the mortgages, REO properties, and any other properties from the Issuer (Optional Termination) at a price specified in the transaction documents. The Optional Termination will be conducted as a qualified liquidation of the Issuer. The Directing Holder (initially, the Seller) is the representative selected by the holders of more than 50% of the Class XS certificates (the Controlling Class).
The transaction uses a structure sometimes referred to as a modified pro rata structure. Prior to the Class A CE falling below 10.0% of the loan balance as of the Cut-Off Date (Class A Minimum CE Event), the principal distributions allow for amortization of all senior and subordinate bonds based on CE targets set at different levels for performing (same CE as at issuance) and nonperforming (higher CE than at issuance) loans. Each class' target principal balance is determined based on the CE targets and the performing and nonperforming (those that are 90 or more days MBA delinquent, in foreclosure and REO, and subject to a servicing modification within the prior 12 months) loan amounts. As such, the principal payments are paid on a pro rata basis, up to each class' target principal balance, so long as no loans in the pool are nonperforming. If the share of nonperforming loans grows, the corresponding CE target increases. Thus, the principal payment amount increases for the senior and senior subordinate classes and falls for the more subordinate bonds. The goal is to distribute the appropriate amount of principal to the senior and subordinate bonds each month, to always maintain the desired level of CE, based on the performing and nonperforming pool percentages. After the Class A Minimum CE Event, the principal distributions are made sequentially.
Relative to the sequential pay structure, the modified pro rata structure is more sensitive to the timing of the projected defaults and losses as the losses may be applied at a time when the amount of credit support is reduced as the bonds' principal balances amortize over a life of the transaction. That said, the excess spread can be used to cover realized losses after being allocated to the unpaid net weighted average coupon shortfalls (Net WAC Rate Carryover Amounts). Please see the Cash Flow Structure and Features section of the related report for details.
COMMERCIAL MORTGAGE-BACKED SECURITIES (CMBS) METHODOLOGY
The collateral for the SBC portion of the pool consists of 223 individual loans secured by 223 commercial and multifamily properties with an average Cut-Off Date loan balance of $429,364. None of the mortgage loans are cross-collateralized or cross-defaulted with each other. Given the complexity of the structure and granularity of the pool, DBRS Morningstar applied its North American CMBS Multi-Borrower Rating Methodology (the CMBS Methodology).
The loans have a fixed interest rate with a weighted average (WA) of 9.25%. This is nearly 100 basis points (bps) higher than the VCC 2022-4 transaction and about 245 bps higher than the interest rates of the VCC 2022-3, VCC 2022-2, and VCC 2022-1 transactions, highlighting the recent increase in interest rates. Most of the loans have original loan term lengths of 30 years and fully amortize over 30-year schedules. However, 10 loans, which represent 11.1% of the SBC pool, have an initial IO period ranging from 24 months to 120 months and then fully amortize over shortened 20- to 28-year schedules.
The CMBS loans have a WA fixed interest rate of 10.53%. This is approximately 127 bps higher than the VCC 2022-5 transaction, 221 bps higher than the VCC 2022-4 transaction, and more than 360 bps higher than the interest rates of the VCC 2022-3, VCC 2022-2, and VCC 2022-1 transactions, highlighting the recent increase in interest rates. Most of the loans have original loan term lengths of 30 years and fully amortize over 30-year schedules. However, 13 loans, which represent 9.3% of the SBC pool, have an initial IO period ranging from 60 months to 120 months and then fully amortize over shortened 20- to 25-year schedules.
Most SBC loans were originated between August 2022 and November 2022 (99.7% of cut-off pool balance), with one loan originated in September 2019 (0.3% of cut-off pool balance), resulting in a WA seasoning of 0.5 months. The SBC pool has a WA original term length of 360 months, or 30 years. Based on the current loan amount, which reflects approximately 5 bps of amortization, and the current appraised values, the SBC pool has a WA LTV of 63.2%. However, DBRS Morningstar made LTV adjustments to 29 loans that had an implied capitalization rate more than 200 bps lower than a set of minimal capitalization rates established by the DBRS Morningstar Market Rank. The DBRS Morningstar minimum capitalization rates range from 5.0% for properties in DBRS Morningstar Market Rank 8 to 8.0% for properties in DBRS Morningstar Market Rank 1. This resulted in a higher DBRS Morningstar LTV of 67.4%. Lastly, all loans fully amortize over their respective remaining terms, resulting in 100% expected amortization; this amount of amortization is greater than what is typical for CMBS conduit pools. DBRS Morningstar’s research indicates that, for CMBS conduit transactions securitized between 2000 and 2021, average amortization by year has ranged between 6.5% and 22.0%, with a median rate of 16.5%.
As contemplated and explained in DBRS Morningstar’s Rating North American CMBS Interest-Only Certificates methodology, the most significant risk to an IO cash flow stream is term default risk. As DBRS Morningstar noted in the methodology, for a pool of approximately 63,000 CMBS loans that had fully cycled through to their maturity defaults, the average total default rate across all property types was approximately 17%, the refinance default rate was 6% (approximately one third of the total default rate), and the term default rate was approximately 11%. DBRS Morningstar recognizes the muted impact of refinance risk on IO certificates by notching the IO rating up by one notch from the Reference Obligation rating. When using the 10-year Idealized Default Table default probability to derive a probability of default (POD) for a CMBS bond from its rating, DBRS Morningstar estimates that, in general, a one-third reduction in the CMBS Reference Obligation POD maps to a tranche rating that is approximately one notch higher than the Reference Obligation or the Applicable Reference Obligation, whichever is appropriate. Therefore, similar logic regarding term default risk supported the rationale for DBRS Morningstar to reduce the POD in the CMBS Insight Model by one notch because refinance risk is largely absent for this SBC pool of loans.
The DBRS Morningstar CMBS Insight Model does not contemplate the ability to prepay loans, which is generally seen as credit positive because a prepaid loan cannot default. The CMBS predictive model was calibrated using loans that have prepayment lockout features. Those loans’ historical prepayment performance is close to a 0% conditional prepayment rate (CPR). If the CMBS predictive model had an expectation of prepayments, DBRS Morningstar would expect the default levels to be reduced. Any loan that prepays is removed from the pool and can no longer default. This collateral pool does not have any prepayment lockout features, and DBRS Morningstar expects this pool will have prepayments over the remainder of the transaction. To calculate a default rate prepayment haircut, DBRS Morningstar used Intex DealMaker to calculate a lifetime constant default rate (CDR) that approximated the default rate for each rating category. While applying the same lifetime CDR, DBRS Morningstar applied a 2.0% CPR. When holding the CDR constant and applying a 2.0% CPR, the cumulative default amount declined. The percentage change in the cumulative default before and after applying the prepayments, subject to a 10.0% maximum reduction, was then applied to the cumulative default assumption to calculate a fully adjusted cumulative default assumption. For the VCC 2023-1 transaction, DBRS Morningstar capped the reduction to 5%, reflecting DBRS Morningstar’s opinion that, in a rising-interest-rate environment, fewer borrowers may elect to prepay their loan.
As a result of higher interest rates and lending spreads, the SBC pool has a significant increase in interest rates compared with prior VCC transactions. Consequently, more than two thirds of the deal has less than a 1.0x Issuer net operating income DSCR, which is a larger composition than previous VCC transactions in 2022. Additionally, although the DBRS Morningstar CMBS Insight Model does not contemplate FICO scores, it is important to point out that the WA FICO score for the SBC loans of 708 is lower than prior transactions. With regard to the aforementioned concerns, DBRS Morningstar applied a 5% penalty to the fully adjusted cumulative default assumption to account for risks given these factors. A comparison of the subject deal with previous VCC securitizations is shown on page 10 of the related report.
RESIDENTIAL MORTGAGE-BACKED SECURITIES (RMBS) METHODOLOGY
The collateral pool consists of 472 mortgage loans with a total balance of approximately $144.6 million collateralized by one- to four-unit investment properties. Velocity underwrote the mortgage loans to No Ratio program guidelines for business-purpose loans.
The transaction assumptions consider DBRS Morningstar's baseline macroeconomic scenarios for rated sovereign economics, available in its commentary: Baseline Macroeconomic Scenarios for Rated Sovereigns: December 2022 Update, dated December 21, 2022. These baseline macroeconomic scenarios replace DBRS Morningstar's moderate and adverse coronavirus pandemic scenarios, which were first published in April 2020.
The ratings reflect transactional strengths that, for residential investor loans, include the following:
-- Improved underwriting standards,
-- Robust loan attributes and pool composition, and
-- Satisfactory third-party due-diligence review.
The transaction also includes the following challenges:
-- Residential investor loans underwritten to No Ratio lending programs, and
-- Representations and warranties framework.
The full description of the strengths, challenges, and mitigating factors is detailed in the related report.
DBRS Morningstar incorporates a dynamic cash flow analysis in its rating process. A baseline of four prepayment scenarios and two default timing curves were applied to test the resilience of the rated classes. DBRS Morningstar ran a total of 8 cash flow scenarios at each rating level for this transaction. Additionally, WA coupon deterioration stresses were incorporated in the runs.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/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/396929 (May 17, 2022).
All ratings are subject to surveillance, which could result in ratings being upgraded, downgraded, placed under review, confirmed, or discontinued by DBRS Morningstar.
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 methodologies are North American CMBS Multi-Borrower Rating Methodology (March 26, 2021) and RMBS Insight 1.3: U.S. Residential Mortgage-Backed Securities Model and Rating Methodology (April 1, 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.
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 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 firstname.lastname@example.org.
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