DBRS Morningstar Downgrades Ratings on Seven Classes of CFCRE 2018-TAN, Maintains Under Review with Negative Implications

DBRS Limited (DBRS Morningstar) downgraded the ratings on the following classes of Commercial Mortgage Pass-Through Certificates, Series 2018-TAN issued by CFCRE Trust 2018-TAN (the Trust):

-- Class B to AA (sf) from AAA (sf)
-- Class C to A (high) (sf) from AA (low) (sf)
-- Class D to A (low) (sf) from A (high) (sf)
-- Class E to BB (sf) from BBB (low) (sf)
-- Class F to BB (low) (sf) from BB (high) (sf)
-- Class HRR to B (high) (sf) from BB (sf)
-- Class X to A (sf) from AA (low) (sf)

DBRS Morningstar also confirmed the rating on the following class:

-- Class A at AAA (sf)

The trends for Classes A and B are Negative because the underlying collateral continues to face performance challenges associated with the Coronavirus Disease (COVID-19) global pandemic. Classes A and B have been removed from Under Review with Negative Implications, where they were placed on March 27, 2020.

DBRS Morningstar has also maintained Classes C, D, E, F, HRR, and X Under Review with Negative Implications, given the negative impact of the coronavirus on the underlying collateral.

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, at www.dbrsmorningstar.com. On March 27, 2020, DBRS Morningstar placed the ratings on its outstanding SASB transactions secured by hospitality properties Under Review with Negative Implications as the global shelter-in-place and travel restrictions related to the coronavirus have had an extreme impact on the short-term performance of this asset class. For further information on these rating actions, please see the DBRS Morningstar press release dated March 27, 2020.

As it reviewed the ratings for this transaction, DBRS Morningstar considered both the impact of the updated NA SASB Methodology and its scenarios attributable to the ongoing coronavirus pandemic on the ratings.

Because of the coronavirus’ significant impact on hospitality performance, DBRS Morningstar first considered the application of the updated NA SASB Methodology in conjunction with the “North American CMBS Surveillance Methodology” to arrive at a baseline result, which incorporated qualitative assumptions, capitalization rates, and loan-to-value (LTV) ratio sizing benchmark quality/volatility adjustments and excluded any potential changes in current or future expected asset performance resulting from the coronavirus.

DBRS Morningstar then overlaid scenarios incorporating market value declines (MVDs) consistent with the projections in its “Global Macroeconomic Scenarios: September Update” published on September 10, 2020, on top of the baseline result to determine the impact of coronavirus-related changes in asset performance on the subject transaction on a tranche-by-tranche basis. For more information on these stress scenarios, please refer to the Coronavirus Impact Analysis section of this document. The global macroeconomic scenarios include a moderate decline of 15% for all commercial real estate (CRE), which acts as an average for all CRE property types. However, DBRS Morningstar expects a higher stress for hospitality properties, ranging from 25% to 45% based on the type of demand segmentation and asset location, and expects corporate demand and remote fly-to locations to be at the higher end of the value decline.

LOAN/PROPERTY OVERVIEW
The subject loan is secured by a 411-key oceanfront hotel located on the island of Aruba. The hotel is situated on a 10.1-acre site on the northern end of the island along Palm Beach, a two-mile strip of beach known for its white sand and turquoise waters where the majority of upscale hotels on the island reside. The subject is part of a larger Marriott campus that includes the Marriott Aruba Surf Club, Marriott Aruba Ocean Club, and two timeshare projects totalling 1,200 keys. The collateral includes nine food and beverage outlets, 93,269 square feet (sf) of meeting space, two outdoor pools, a fitness centre, and four retail stores. Additionally, included in the collateral is the 17,000-sf Stellaris Casino, the largest casino on the island, featuring 523 slot machines and 27 gaming tables. The property has undergone $51.9 million ($126,192 per key) in renovations since 2010, including a complete overhaul of the property to comply with Marriott brand standards.

Mortgage loan proceeds of $195.0 million and sponsor equity of $10.0 million refinanced existing debt of $159.5 million and funded the sponsor buyout of Five Mile Capital Partners LLC (Five Mile) and Caribbean Property Group (CPG) for $38.5 million. The subject is currently encumbered by a ground lease with the Government of Aruba, which has an initial expiration date in 2052; however, the lessor has a statutory obligation to enter into a new lease when the ground lease expires. The sponsor for this loan represents a joint venture between DLJ Real Estate Investment Partners (DLJ) and MetaCorp International (MetaCorp). DLJ is a private equity real estate investment firm and MetaCorp is a real estate company based in Aruba. After a loan maturity default in October 2012, when total outstanding debt was approximately $230.0 million, Five Mile, DLJ, and MetaCorp converted their respective mezzanine debt into a majority equity interest in February 2013. The property was previously 100.0% owned by CPG, which retained its remaining equity stake (11.6%) when ownership took over the property and refinanced the senior and mezzanine loan of $160.0 million with a $160.0 million mortgage in December 2013. Given the need to liquidate their funds, both Five Mile and CPG were forced to sell their positions in the property at a valuation significantly below the as-is concluded market value at the time.

According to the Aruba Hotel and Tourism Authority (AHATA), the government of Aruba announced that as of June 10, 2020, the country re-opened its borders as it was closed in early March 2020 given the ongoing coronavirus pandemic. The country followed a phased re-opening plan that permitted entrants from different countries and regions throughout June and July 2020. According to data compiled by the AHATA for 19 hotels in Aruba through August 2020, year-to-date occupancy and revenue per available room (RevPAR) were reported at 29.1% and $101, respectively, with those figures down 57.2% and 60.0%, respectively. Occupancy was reported at less than 1.0% for April through June 2020.

According to an update from June 2020, the hotel was scheduled to open in July 2020. The property was expected to achieve an occupancy of around 30% for the months of August through October 2020, with that performance largely dependent on the borders re-opening for the United States of America on July 10, 2020. Per the March 2020 STR report, the subject reported a trailing three-month occupancy, average daily rate, and RevPAR of 73.0% (-20.9%), $633 (+1.9%) and $462 (-19.3%), respectively. From 2018 to 2019, the property reported a 5.7% increase in effective gross income that facilitated a 14.6% increase in net cash flow (NCF) year over year.

DBRS Morningstar reanalyzed the NCF derived at issuance 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 was $26.2 million and DBRS Morningstar applied a cap rate of 10.50%, which resulted in a DBRS Morningstar Value of $249.4 million, a variance of 20.8% from the appraised value of $$315.0 million at issuance. The DBRS Morningstar Value implies an LTV of 78.2% compared with the LTV of 61.9% on the appraised value at issuance.

The cap rate DBRS Morningstar applied is at the higher end of the range of DBRS Morningstar Cap Rate Ranges for lodging properties. At issuance, DBRS Morningstar applied a stressed cap rate in its analysis to account for the sovereign risk associated with Aruba. Key challenges that exist in the market include weak growth prospects, limited economic diversification, and relatively high debt levels for a small island economy. Aruba’s credit rating does benefit from its long-standing institutional relationship with the Netherlands (rated AAA with a Stable trend by DBRS Morningstar). Given that an internal assessment performed by DBRS Morningstar showed Aruba as having low investment-grade characteristics, DBRS Morningstar maintained its cap rate stress with the October 2020 surveillance review. Additionally, DBRS Morningstar considered the high barriers to entry that exist in Aruba and historically strong performance relative to its competitive set.

DBRS Morningstar made positive qualitative adjustments to the final LTV sizing benchmarks used for this rating analysis, totalling 2.50% to account for cash flow volatility, property quality, and market fundamentals.

CORONAVIRUS IMPACT ANALYSIS
DBRS Morningstar overlaid various scenarios incorporating MVDs consistent with the projections in the “Global Macroeconomic Scenarios: September Update” (https://www.dbrsmorningstar.com/research/366542) to estimate the impact of coronavirus-related changes in asset performance on a tranche-by-tranche basis for the subject transaction. The scenarios included subjecting the most recent appraised collateral value to generalized CRE asset value decline projections with an assumption of approximately 45% under the moderate scenario. In cases where the rated debt exceeded the scenario value, DBRS Morningstar assumed that a principal writedown had occurred to account for the difference. Because of the reverse-sequential allocation of losses in commercial mortgage-backed security (CMBS) transactions, DBRS Morningstar’s analysis considered the most subordinate certificate first and, if a complete principal writedown of the certificate had occurred during the scenario, DBRS Morningstar repeated the analysis for the second-most subordinate certificate and so on until the rated debt no longer exceeded the scenario value.

Under the moderate scenario, the cumulative rated debt through Class F exceeded the value under the Coronavirus Impact Analysis and therefore DRS Morningstar presumes that the economic stress from coronavirus had affected the class.

The DBRS Morningstar ratings assigned to Classes C, D, E, F, and HRR had variances that were generally higher than those results implied by the LTV Sizing Benchmarks when market value declines are assumed under the Coronavirus Impact Analysis. These classes remain Under Review with Negative Implications as DBRS Morningstar continues to monitor the evolving economic impact of coronavirus-induced stress on the transaction.

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 X is an interest-only (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 (March 1, 2020) and North American CMBS Surveillance Methodology (March 6, 2020), 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.

For more information regarding the structured finance rating approach and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/359905.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at [email protected].

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.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are monitored.

DBRS Morningstar’s North American CMBS analytical team will continue to monitor the transaction to evaluate the increased risk factors related to the coronavirus pandemic. As information (e.g., updated property-level financials, Smith Travel Research Reports, new valuations for specially serviced loans, and workout and/or modification specifics, if applicable) becomes available, DBRS Morningstar will address the Under Review with Negative Implications rating actions over the near to moderate term. DBRS Morningstar typically endeavors to resolve an Under Review rating action within 90 days, but the circumstances surrounding these rating actions (i.e., the unknown length of the pandemic-related downturn) may result in a prolonged resolution period.

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

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