DBRS Morningstar Confirms Ratings on Real Estate Asset Liquidity Trust, Series 2019-HBC; Maintains Ratings Under Review with Negative Implications

DBRS Limited (DBRS Morningstar) confirmed the ratings on the Commercial Mortgage Pass-Through Certificates, Series 2019-HBC issued by Real Estate Asset Liquidity Trust, Series 2019-HBC as follows:

-- Class A at AAA (sf)
-- Class X at AA (high) (sf)
-- Class B at AA (sf)
-- Class C at A (sf)

Class C was privately placed. The Class X balance is notional.

DBRS Morningstar also maintained all classes Under Review with Negative Implications, given the negative impact of the Coronavirus Disease (COVID-19) 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 April 24, 2020, DBRS Morningstar placed the ratings on its outstanding SASB transactions secured by retail properties Under Review with Negative Implications as the global shelter-in-place and mandatory retail closures related to the coronavirus have contributed to retail bankruptcies and anticipated vacancies in retail centers. For further information on these rating actions, please see the DBRS Morningstar press release dated April 24, 2020, at www.dbrsmorningstar.com.

During its review of 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 retail 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 additional reductions in net cash flow (NCF) to account for exposure to bankrupt or closed tenants. This resulted in stressed collateral value declines 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 greater range of value decline for retail properties, ranging from 10% to 45% based on the type of tenant composition, exposure to bankrupt or challenged retailers, asset sponsorship, and asset location. DBRS Morningstar expects that lower-tier regional malls with in-line sales generally less than $300 per square foot will be the most affected.

LOAN/PROPERTY OVERVIEW
The transaction includes two cross-collateralized and cross-defaulted loans secured by Hudson’s Bay (The Bay) flagship stand-alone department stores in downtown Montréal (the Montréal property) and Ottawa (the Ottawa property).

The sponsor acquired the properties in 2015 as part of a five-property portfolio sale-leaseback transaction with an allocated purchase price of approximately $535.0 million. The vendor, Hudson’s Bay Company (HBC), retains an 87.5% ownership interest in the properties through RioCan-HBC Limited Partnership, the purchaser of the properties, which is a joint venture between HBC and RioCan Real Estate Investment Trust (RioCan; rated BBB (high) with a Stable trend by DBRS Morningstar). Although HBC signed 20-year absolute-net leases that include five six-year renewal options, DBRS Morningstar considers the net cash flow (NCF) from these properties to be more volatile than typical multitenant properties, given that the rental revenue stream is closely linked to HBC’s retail operating business; however, The Bay is Canada’s largest department store chain with a dominant market share. The Montréal and Ottawa properties are flagship stores of The Bay that have been operating in both locations for more than 50 years; its parent company and tenant, HBC, will likely continue to fulfill its debt service obligation along with its partner, RioCan, even in a downturn to maintain its presence in these two desirable downtown locations. While the current property-level performance is not available, the Montréal property was the second-best performer within The Bay department store chain in Canada in 2018 with reported annual sales of over $135.0 million and a gross profit margin of 42.6% as at November 3, 2018, which was higher than HBC’s companywide margin of 39.9% for the same period. Although the Ottawa property was an underperforming asset in 2018, it benefits from cross-collateralization with the Montréal property. On a consolidated basis, the properties demonstrated a gross profit margin of 41.2%, which was still higher than the companywide ratio, and generated sufficient EBITDA to pay rent and cover realty taxes and property insurances. As HBC continues to improve business efficiency by reducing operating expenses and improving inventory management and cost structure, DBRS Morningstar expects its cash flow to improve, which should improve the affordability of rental payments. Furthermore, the properties are well located in primary urban markets fronting prominent commercial streets where retail spaces are in high demand; therefore, if The Bay downsizes or closes down, the properties should generate good sublease demand. Additionally, there is significant cash equity of $252.0 million behind the subject loan, resulting in a current loan-to-cost-basis ratio of only 45.7% based on the 2015 allocated purchase price. Furthermore, at issuance, the loan sponsor had invested over $31.7 million in capital expenditures (capex) to improve the properties since the acquisition and had reportedly committed to invest at least $20.0 million in additional capex over the subsequent few years. The loans benefit from a full-recourse guarantee from a strong sponsor with reported equity of $1.2 billion as at September 30, 2018, that is required to maintain minimum equity of $750.0 million throughout the loan terms.

According to the September 2020 remittance report, the loans are current and have been performed as agreed. Both stores are now open after the initial mandatory closure caused by the coronavirus. Current in-store sales figures are not available.

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 $25.6 million and DBRS Morningstar applied a cap rate of 6.94%, which resulted in a pre-coronavirus DBRS Morningstar Value of $370.0 million, a variance of -37.1% from the appraised value of $588.3 million at issuance. The pre-coronavirus DBRS Morningstar Value implies an LTV of 66.0% compared with the LTV of 41.5% on the appraised value at issuance.

The cap rate DBRS Morningstar applied is at the lower end of the range of DBRS Morningstar Cap Rate Ranges for retail properties, reflecting the properties’ strong locations and positions in their respective markets.

DBRS Morningstar made positive qualitative adjustments to the final LTV sizing benchmarks used for this rating analysis, totalling 2.5% to account for market fundamentals.

CORONAVIRUS IMPACT ANALYSIS
DBRS Morningstar overlaid various scenarios incorporating higher NCF declines, resulting in stressed collateral value declines 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 deducting cash flow for reduced productivity expected at the assets to arrive at a coronavirus DBRS Morningstar Value under the moderate scenario, a 15.0% reduction from the pre-coronavirus DBRS Morningstar Value. Because of the more permanent value impairment resulting from the lost tenancy revenue stream, DBRS Morningstar’s analysis considered this value for this review.

Under the moderate scenario, the cumulative rated debt was insulated from loss.

After applying the Coronavirus Impact Analysis, DBRS Morningstar had ratings that were generally higher than those results implied by the LTV sizing benchmarks for all classes. The variation is warranted due to going concerns with the impact of the coronavirus pandemic on the collateral assets and, as a result, DBRS Morningstar placed these classes Under Review with Negative Implications.

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 Canadian 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.

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, rent rolls, 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].

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577