DBRS Assigns Provisional Ratings to CHT 2017-COSMO Mortgage Trust

DBRS, Inc. (DBRS) assigned provisional ratings to the following classes of Commercial Mortgage Pass-Through Certificates, Series 2017-COSMO (the Certificates) to be issued by CHT 2017-COSMO Mortgage Trust. The trends are Stable.

-- Class A at AAA (sf)
-- Class X-CP at AAA (sf)
-- Class X-EXT at AAA (sf)
-- Class B at AA (high) (sf)
-- Class C at A (high) (sf)
-- Class D at BBB (high) (sf)
-- Class E at BBB (low) (sf)
-- Class F at BB (high) (sf)

All classes will be privately placed.

The Class X-CP and X-EXT balances are notional.

The subject property is a 3,027-room luxury hotel and casino completed in 2010 and situated in an excellent mid-strip location between Bellagio and CityCenter. The subject is one of the newest hotel casinos in Las Vegas and compares favorably with the higher-end properties on The Strip. The collateral amenities include, but are not limited to, over 250,000 sf of convention and banquet space facilities, 111,500 sf of casino space, 96,000 sf of entertainment space (including a 3,200-capacity multi-use entertainment venue), 23,500 sf of retail space, 50,000 sf of spa and fitness facilities and a five-level underground parking garage. The original developer defaulted on its construction loan with Deutsche Bank, which ultimately foreclosed on the property in 2008 and brought in the related companies to reposition the asset, manage the development process and assist in retail leasing. Deutsche Bank’s reported cost basis in the subject property was $3.8 billion, which equates to $1.3 million per key (and over $612 psf), which seems extremely high, though it is supported by the appraiser’s estimate of replacement cost (including furniture, fixtures and equipment (FF&E)) of $4.10 billion. The construction cost was high, in part due to the fact that the property was originally intended to be a hotel-condo with condominium-quality finishes. Of the condo units, 1,821 were originally put under contract to individuals, with all but 17 such contracts cancelled. There are currently 14 condominiums owned by separate individual third parties unaffiliated with the borrower, as three have been purchased in the past few years. These 14 units are not part of the collateral and are not included in the overall key count. The borrower owns all other residential units, the hotel unit and the podium parcel (which is a five-story component containing the casino, retail space and convention/meeting space, among other things).

The condo-quality build-out is evident within the guest rooms, which are extremely spacious and showed very well on the site inspection. While the non-renovated keys inspected appeared modern and DBRS did not note any deferred maintenance to any of the soft goods or hard goods, the sponsor began a $135.0 million ($46,632 per key) renovation in June 2017 on 2,895 keys, which excludes the newly constructed rooms and penthouses. As of August 2017, the sponsor has spent $34,700,000 ($117,627 per key) on renovations for 295 keys. The sponsor is budgeting to spend the remaining $103.0 million budgeted for room renovations ($39,615 per key) on renovating 2,600 keys. The renovated rooms feature new carpeting, wall coverings, soft goods, hard goods, artwork, televisions, lighting controls and complete LED conversion. While the sponsor invested $117,627 per key renovating 295 keys, which is more than the $39,615 per key renovation budget for the remaining 2,600 keys, the scope of the renovation for the remaining 2,600 keys is expected to be in line with the quality and upgrades to the previously renovated keys. The sponsor expects the room renovations to be completed by the end of 2018, and is minimizing disruption to hotel operations by completing two floors at a time. With consideration to these upgrades, the management on the site inspection conveyed that the property will continue offering the newest and highest-quality product on The Strip. Of the large hotel casinos on The Strip, the traditional room product at the subject is, in DBRS’s opinion, the best, which is reflected in the subject’s high $300.13 RevPAR for the T-12 period ending August 2017, a level which puts it at the top of its competitive set. Keeping guest room quality at this high standard will be quite expensive, given occupancy rates in excess of 90% and the high cost of the furnishings, but the DBRS FF&E allocated to non-gaming revenue is also high at $28.2 million ($9,329 per key).

Promotions (discounted/free rooms, F&B, etc.) are used at all casinos to entice customers to gamble at specific properties, and the amount of promotions as a percent of gaming revenue is a commonly used metric to evaluate performance. At the subject, promotions represented 56.8% of gaming revenue during the T-12 period ending August 2017. According to management, and verified by DBRS research, properties on The Strip typically operate in the 25.0% to 35.0% range on this metric. As such, the subject is significantly underperforming its competitors, but has been able to reduce promotions percentages down from 85.0%, 69.5% and 65.7% in 2014, 2015 and 2016, respectively. This reduction in promotions expense is a primary driver of the substantial NCF margin expansion from 15.2% in YE2014 to 26.0% as of the T-12 period. Such margin growth has resulted in a 94.4% increase in NCF during a time frame where revenue only grew by 9.5%. Further, while promotions expense as a percentage of gaming revenue has dropped substantially, it is still approximately double the average for The Strip.

The sponsor representative conveyed that one of the Cosmopolitan’s highest-paid employees is their baccarat marketer, who has significant ties to a circle of high-net worth baccarat players in China. The addition of the high-roller suites and The Reserve, as well as the baccarat marketing professional hire, are expected to increase gaming revenue at the property. DBRS believes that this figure will remain above competitors that are part of larger gaming companies with loyalty programs, but there could still be further upside. The property has exposure to a substantial amount of revenue derived from international guests, which could be potentially more volatile than domestic guests. While there is not a consistent measure for the property to accurately access the amount of revenue and room nights from international guests, the sponsor uses baccarat revenue relative to non-baccarat revenue as an indicator for international guests. As of the T-12 period ending August 2017, baccarat win revenue, at $82.3 million, comprised 41.2% and 24.8% of gross table game wins and gross table game and slot wins combined, respectively. The property representative relayed on the site inspection that he would estimate that approximately 30.0% of guests at the Cosmopolitan are international. If DBRS were to reduce its occupancy assumption by 30.0%, from 91.5% to 61.5%, the resulting DBRS NCF would still result in a DBRS Term DSCR of 1.72 times (x) on the mortgage debt, which is a fairly high DSCR given the conservative hypothetical assumption.

With a 2.73x DBRS Term DSCR there is low term-default risk, even though hotels typically exhibit high cash flow volatility compared to other property types. The DBRS Refi DSCR is adequate at 1.28x, considering the rating assigned, with the lowest-rated class of debt below investment grade at BB (high), with such DSCR based on an implied refinance interest rate of 11.50%. This allows for significant reversion to the mean in market interest rates, as the refinance rate is 831 basis points (bps) greater than the assumed interest rate based on a 1.25% LIBOR. In addition, the DBRS cap rate of 11.25% is 360 bps above the cap rate implied by the $2.92 billion August 2017 appraised value and the Issuer’s UW NCF of $223.3 million, allowing for significant reversion to the mean in lodging valuation metrics. DBRS LTV at BBB (low) is considered quite low at 64.8%, and the cumulative debt of $1.17 billion at that rating category represents a small fraction of the appraiser’s estimated $4.1 billion replacement cost. Total leverage, inclusive of the $420 million of mezzanine debt, is 104.0% of the sponsor’s initial purchase price in May 2014, but just 61.7% of the August 2017 appraised value. Given the property’s excellent quality and location, limited new supply anticipated in the coming years and sponsorship’s continued emphasis and investment in improving gaming performance, DBRS expects loan performance to be strong during the seven-year fully extended term, and the ability to refinance the mortgage loan at maturity should be high

All classes will be subject to ongoing surveillance, which could result in upgrades or downgrades by DBRS after the date of issuance.

For more information on this transaction and supporting data, please log into viewpoint.dbrs.com. DBRS will continue to monitor this transaction with periodic updates provided in the DBRS Viewpoint platform.

The ratings assigned to Class C, Class D and Class E differ from the higher rating implied by the DBRS direct sizing hurdles. DBRS considers these differences to be a material deviation from the methodology caused by the issuer’s final determined capital structure and class sizes.

Notes:
All figures are in U.S. dollars unless otherwise noted.

With regard to due diligence services, DBRS was provided with the Form ABS Due Diligence-15E (Form-15E), which contains the description of the information that the third party reviewed in conducting the due diligence services and a summary of the findings and conclusions. While DBRS did not require due diligence services outlined in Form-15E, DBRS did use the Data File outlined in the Independent Accountant’s Report in its analysis to determine the ratings.

The principal methodology is North American Single-Asset/Single-Borrower Methodology, which can be found on dbrs.com under Methodologies.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The rated entity or its related entities did participate initially, in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.

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

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