DBRS Assigns Provisional Ratings to Atrium Hotel Portfolio Trust 2018-ATRM

DBRS, Inc. (DBRS) assigned provisional ratings to the following classes of Commercial Mortgage Pass-Through Certificates, Series 2018-ATRM to be issued by Atrium Hotel Portfolio Trust 2018-ATRM:

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

All trends are Stable.

The Class X-CP, Class X-FP and Class X-NCP balances are notional.

The $635.0 million mortgage loan is secured by the fee and leashold interest in 24 limited-service, extended-stay and full-service hotels, totaling 5,734 keys, located in 12 different states across the United States. While geographically diverse, the portfolio has a high exposure to properties located in markets deemed tertiary by DBRS. All hotels, except for one, operate as Hilton Hotels & Resorts (Hilton) or Marriott International branded hotels under six different flags, the majority of which, or 68.9% of the allocated loan balance, operate as Embassy Suites by Hilton. The 24 collateral assets are being acquired by the sponsor, Atrium Holding Company (Atrium), as part of a 35-hotel portfolio and with other various assets, out of a bankruptcy reorganization of the John Q Hammons Revocable Trust, JQH Entities and its affiliates (collectively, JQH). In 2005, JD Holdings, LLC (JD Holdings), an affiliate of Atrium, acquired properties from JQH and as part of the agreement was given a right of first refusal (ROFR) applicable to additional properties held by JQH Entities. Commencing in 2015, JD Holdings and JQH had engaged in litigation over the validity of the ROFR to purchase the 35 hotels, including the 24 collateral assets and the other various assets valued by JQH at approximately $400.0 million. To halt proceedings, JQH filed for Chapter 11 bankruptcy protection in June 2016. After a number of motions and proceedings, a reorganization plan was confirmed by the court on May 11, 2018, whereby JD Holdings, one of the largest unsecured creditors to JQH, would acquire all of JQH’s assets out of bankruptcy, repay existing creditors and assume certain liabilities. On May 17, 2018, trustees on behalf of four commercial mortgage-backed security (CMBS) lenders filed an appeal of the reorganization confirmation as the CMBS lenders held mortgage loans made to JQH Entities that were secured by liens on nine of the properties. While the liens have been released, the appeal by the CMBS lenders is primarily additional claims on default interest summing to approximately $77.6 million and not to the reorganization itself. As part of the proceedings. JD Holdings has filed a commitment letter to fund up to $200 million, if required to fund plan distributions, with $90.0 million designated for the CMBS disputed claims. In addition, as part of the confirmation, the bankruptcy court required JD Holdings to deposit an additional $25.0 million for disputed claims in an escrow account that cannot be released without further order by the bankruptcy court. In addition to the CMBS disputed claims, there are approximately $54.0 million in other disputed claims that have been asserted against JQH and remain subject to resolution and, pursuant to the plan, payment in full to extent such claims are allowed. The CMBS lenders have until June 6, 2018, to file the Statement of Issues and Designation of Record on Appeal. As part of this financing, JD Holdings was required to contribute its $495.9 million claim, in addition to the $635.0 million mortgage loan and $112.4 million sponsor equity contribution, to purchase JQH. In conjunction with the acquisition of the assets, all franchise agreements for all flagged properties were extended to at least 2028 and are required to go through an estimated $101.0 million ($4.4 million per flagged hotel or $18,481 per flagged key).

The subject financing of $635.0 million along with a $112.4 million equity infusion from the sponsor will go to retire $672.2 million of existing debt, establish $61.9 million of upfront reserves and cover closing costs of $13.3 million. Included in the upfront reserves are a $16.0 million ($2,790 per key) upfront property improvement plan (PIP) reserve and a $44.6 million delayed advance holdback for the allocated loan amount of the Embassy Suites – San Marcos. The delayed advance holdback is in relation to a $1.5 million mortgage loan held by the City of San Marco and secured by the property. The funds will be released upon the delivery of a subordination agreement from the City of San Marco in respect to the $1.5 million outstanding loan. Once the funds are released, the sponsor is required to establish a $1.5 million San Marco Reserve to repay the full amount. If a subordination agreement is not received, the reserve will be used to pay down the loan. The loan is a two-year floating-rate (one-month LIBOR plus 2.29% per annum) interest-only mortgage loan with five one-year extension options.

Since 2011, prior ownership invested $119.5 million ($20,836 per key) of capital expenditures (capex) across the collateral portfolio, including $29.2 million ($5,099 per key) and $30.4 million ($5,308 per key) injected in the portfolio in 2016 and 2017, respectively. Recently completed capital improvements include upgrades to guest rooms, lobbies, meeting spaces, public spaces, amenities and exteriors. Furthermore, all assets except for one will be required to go through PIP renovations as a result of the change in ownership estimated at $101.0 million for the portfolio. In addition to the $16.0 million upfront PIP reserve, the sponsor is required to deposit an additional $51.0 million over the first five years ($40.0 million in the first 12 months) and make ongoing furniture, fixtures and equipment reserve deposits equal to 4.0% of gross revenue. The properties were built between 1983 and 2009, averaging 14 years. DBRS assessed the overall portfolio quality to be Average based on the site inspections, but individual property quality assessments ranged from Average (+) to Average (-). While the portfolio does not consist of old assets, a common theme amongst the properties inspected by DBRS was that the properties were dated, but still well maintained.

The portfolio is concentrated by property type, as all properties are hotels. Hotels have the highest cash flow volatility of all property types because of the relatively short lease/length of stay compared with commercial properties, as well as higher operating leverage. These dynamics can lead to rapidly deteriorating cash flow in a declining market and, with nationwide revenue per available room (RevPAR) in its eighth consecutive year of growth, relatively easy RevPAR gains appear to be gone. The portfolio has reported only modest gains in average daily rates and occupancy, resulting in RevPAR gains at the T-12 February 2018 period of only 12.2% since 2012, which is underwhelming compared to the nationwide hotel RevPAR growth of 28.2% from 2012 to 2017, according to the U.S. Lodging Industry Overview. The portfolio has experienced recent cash flow declines which can be attributed to a number of factors including rooms being taken offline during renovations, a number of aging properties with a lack of capital investment and decreasing cash flow margins; however, it may also be a signal of a late phase of the lodging cycle. While the $59.7 million invested in 2016 and 2017 combined is a substantial amount of capex for the portfolio’s property types in their respective markets, $47.8 million, or 80.2% of the total renovations, is attributed to only ten properties with 2,792 keys, or 48.7% of the total keys, and the remaining properties on average received only $2,209 per key annually over the past seven years.

The as-is portfolio appraised value is $1.0 billion, assuming a bulk sale, based on an applied cap rate of 7.2%, which equates to a moderate appraised loan-to-value (LTV) ratio of 63.2%. The DBRS-concluded value of $634.2 million ($100,612 per key) represents a significant 36.9% discount to the bulk sale appraised value and results in a DBRS LTV of 100.1%, which is indicative of high-leverage financing; however, the DBRS value is based on a reversionary cap rate of 11.50%, which represents a significant stress over current prevailing market cap rates. Furthermore, the loan’s DBRS Debt Yield and DBRS Term DSCR at 11.5% and 2.04 times, respectively, are moderate considering the portfolio is primarily securitized by suburban full- and limited-service hotels and the portfolio’s insurable replacement cost of $1.2 billion (excluding land value) is substantially higher than the whole loan amount of $635.0 million.

Classes X-CP, X-FP and X-NCP are interest-only (IO) certificates that reference a single rated tranche or multiple rated tranches. The IO rating mirrors the lowest-rated refrence tranche adjusted upward by one notch if senior in the waterfall.

All ratings will be subject to ongoing surveillance, which could result in ratings being upgraded, downgraded, placed under review, confirmed or discontinued by DBRS.

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.

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 the North American Single-Asset/Single-Borrower Methodology, which can be found on dbrs.com under Methodologies. For a list of the Structured Finance related methodologies that may be used during the rating process, please see the DBRS Global Structured Finance Related Methodologies document on www.dbrs.com. 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.

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

The rated entity or its related entities did participate in the rating process for this rating action. DBRS 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 or by contacting us at info@dbrs.com.