DBRS Morningstar Assigns Ratings to Hudson Yards 2016-10HY Mortgage Trust

DBRS, Inc. (DBRS Morningstar) assigned ratings to the Hudson Yards 2016-10HY Mortgage Trust, Commercial Mortgage Pass-Through Certificates issued by Hudson Yards 2016-10HY Mortgage Trust as follows:

-- Class A at AAA (sf)
-- Class X-A at AAA (sf)
-- Class B at AA (sf)
-- Class C at A (low) (sf)
-- Class D at BBB (sf)
-- Class E at BBB (sf)

All trends are Stable.

These certificates are currently also rated by DBRS Morningstar’s affiliated rating agency, Morningstar Credit Ratings, LLC (MCR). In connection with the ongoing consolidation of DBRS Morningstar and MCR, MCR previously announced that it had placed its outstanding ratings of these certificates Under Review–Analytical Integration Review and that MCR intended to withdraw its outstanding ratings; such withdrawal will occur on or about May 20, 2020. In accordance with MCR’s engagement letter covering these certificates, upon withdrawal of MCR’s outstanding ratings, the DBRS Morningstar ratings will become the successor ratings to the withdrawn MCR ratings. Information about the MCR ratings, including the history of the MCR ratings, can be found at www.morningstarcreditratings.com.

On March 1, 2020, DBRS Morningstar finalized its “North American Single-Asset/Single-Borrower Ratings Methodology” (the NA SASB Methodology), which presents the criteria for which ratings are assigned to and/or monitored for North American single-asset/single-borrower (NA SASB) transactions, large concentrated pools, rake certificates, ground lease transactions, and credit tenant lease transactions. For further information on the NA SASB Methodology, please see the press release dated March 1, 2020, on the DBRS Morningstar website at www.dbrsmorningstar.com.

The subject rating actions are the result of the application of the NA SASB Methodology in conjunction with the “North American CMBS Surveillance Methodology,” as applicable. Qualitative adjustments were made to the final loan-to-value (LTV) sizing benchmarks used for this rating analysis.

DBRS Morningstar believes that the 10 Hudson Yards trust loan represents low-to-moderate risk based on the high quality of the collateral property, the strength of the property’s tenants, and good loan metrics. DBRS Morningstar expects the property to generate sustainable cash flow that adequately covers its obligations, and DBRS Morningstar’s refinance risk assessment is moderate for the subject loan.

The 10 Hudson Yards first mortgage loan is secured by the fee-simple interest in a Class A, 52-story, 1.8 million-square-foot (sf) office building in midtown Manhattan, New York. Completed in 2016, the property benefits from its location adjacent to the new 7 Line train station at Hudson Yards.

The loan metrics on DBRS Morningstar’s net cash flow (NCF) and value are favorable and suggest low term default risk. The $900.0 million portion of the financing, which includes the senior notes and junior notes, is 72.7% of DBRS Morningstar’s revised property value. DBRS Morningstar’s interest-only (IO) coverage at issuance on this portion of the debt was strong at 2.96 times (x), and the debt yield was moderate at 9.0%. The all-in financing—mortgage debt plus mezzanine debt—pushes DBRS Morningstar’s LTV ratio, however, to 96.9%. The appraised value is $2.15 billion ($1,155 per sf (psf)), indicating a 43.9% loan-to-appraised value on the trust loan and 58.5% on the total debt stack. The wide gap between DBRS Morningstar’s value and the appraised value is primarily due to the appraiser’s 3.75% capitalization rate versus DBRS Morningstar’s revised 6.5% capitalization rate.

DBRS Morningstar also views the investment-grade tenancy as a significant enhancement to the credit quality of the transaction. At issuance nearly 70% of the net rentable area (NRA) was leased to investment-grade tenants with long-term leases and leases representing less than 5.0% of the NRA expire during the loan term. However, DBRS Morningstar has not granted long-term credit tenant status to Coach, Inc., now known as Tapestry, Inc. The 10 Hudson Yards property serves as the new corporate headquarters for Tapestry, Inc. and is also the U.S. headquarters for L'Oreal USA, Inc. and SAP America, Inc. Finally, the property’s in-place rents are 18.4% below the appraiser’s concluded market rent, indicating future upside to the property’s income.

New construction projects are planned or underway within the Hudson Yards development that, when completed, will increase the office supply in the area by about 10 million sf. Each of these developments represents potential competition for 10 Hudson Yards. Some of that new development has been completed since 2016, including 30 Hudson Yards. The risk associated with new supply is partially mitigated by the fact that nearly 70% of the NRA is leased to tenants with long-term leases and low roll during the loan term. In addition, much of this new development is preleased. There is currently very little speculative office space being built.

Two other important considerations in DBRS Morningstar’s analysis were the lack of operating history at the time of the original analysis, since the building was then recently constructed, and the IO loan structure. The lack of operating history makes it difficult to estimate operating expenses over the loan’s 10-year term. However, it is important to note that DBRS Morningstar’s total concluded operating expenses of $24.93 psf is well above the range of total operating expenses of the appraiser’s expense comparables, which ranged from $11.05 psf to $21.31 psf. Of note, DBRS Morningstar’s analysis relied heavily on the operating budget. The IO loan structure precludes amortization during the loan term, thus increasing refinance risk in the event of rising interest rates. This concern is mitigated by a DBRS Morningstar debt service coverage ratio of 2.96x and an LTV of 72.7% on the trust portion of the loan.

The DBRS Morningstar NCF derived at issuance was re-analyzed for the subject rating action to confirm its consistency with the “DBRS Morningstar North American Commercial Real Estate Property Analysis Criteria.” The resulting NCF figure of $80.5 million and a cap rate of 6.5% was applied, resulting in a DBRS Morningstar Value of $1.24 billion, a variance of -42.4% from the appraised value at issuance of $2.15 billion. The DBRS Morningstar Value implies an LTV of 72.7%, as compared with the LTV on the issuance appraised value of 41.9%. The NCF figure applied as part of the analysis represents a -10.2% variance from the Issuer’s NCF, primarily driven by much lower present value of rent steps, lower other income, higher management fees, and higher tenant improvements. As of YE2019, the servicer reported a NCF figure of $89.7 million, a 11.5% variance from the DBRS Morningstar NCF figure, primarily a factor of higher rental revenue and higher reimbursements.

The cap rate applied is at the lower end of the range of DBRS Morningstar Cap Rate Ranges for office properties, reflective of the good location on the West Side of Manhattan, solid tenant roster, and long-term leases in place. In addition, the 6.5% cap rate applied is substantially above the implied cap rate of 4.2% based on the Issuer’s concluded NCF and appraised value.

DBRS Morningstar made positive qualitative adjustments to the final LTV sizing benchmarks used for this rating analysis, totaling 6.0% to account for cash flow volatility, property quality, and market fundamentals. DBRS Morningstar also made other negative adjustments to account for mezzanine debt and high LTV, totaling -1.25%.

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 XA 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.

DBRS Morningstar provides updated analysis and in-depth commentary in the DBRS Viewpoint platform for this transaction.

For complimentary access to this content, please register for the DBRS Viewpoint platform at www.viewpoint.dbrsmorningstar.com. The platform includes loan-level 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.

The principal methodologies are the North American Single-Asset/Single-Borrower Ratings Methodology and North American CMBS Surveillance Methodology, which can be found on www.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 www.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 rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/358308.

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.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at [email protected].

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