DBRS Morningstar Downgrades Three Classes of Wells Fargo Commercial Mortgage Trust 2016-LC25

DBRS Limited (DBRS Morningstar) downgraded the ratings on three classes of Commercial Mortgage Pass-Through Certificates, Series 2016-LC25 issued by Wells Fargo Commercial Mortgage Trust 2016-LC25 as follows:

-- Class E to BB (high) (sf) from BBB (low) (sf)
-- Class F to B (high) (sf) from BB (high) (sf)
-- Class G to B (low) (sf) from B (sf)

DBRS Morningstar also confirmed the ratings on the following classes:

-- Class A-2 at AAA (sf)
-- Class A-3 at AAA (sf)
-- Class A-4 at AAA (sf)
-- Class A-S at AAA (sf)
-- Class A-SB at AAA (sf)
-- Class B at AA (sf)
-- Class X-A at AAA (sf)
-- Class X-B at A (sf)
-- Class C at A (low) (sf)
-- Class X-D at BBB (high) (sf)
-- Class D at BBB (sf)

All trends are Stable, with the exception of Classes E, F, and G, which have Negative trends. DBRS Morningstar also removed classes X-D, D, E, F, and G from Under Review with Negative Implications, where they were placed on August 6, 2020.

The rating downgrades and Negative trends reflect ongoing performance issues with the three loans in special servicing, particularly the two largest, which are both top 10 loans that combine for 5.9% of the pool balance and are both backed by retail properties, which the ongoing Coronavirus Disease (COVID-19) pandemic has immediately affected. In total, 39 loans in the transaction are secured by hotel and retail properties, representing 46.7% of the pool balance. There are also 21 loans on the servicer’s watchlist, representing 25.5% of the pool balance. The largest of these loans are generally being monitored for a low debt service coverage ratio (DSCR) and/or occupancy issues that have generally been driven by disruptions related to the coronavirus pandemic. Six of the smaller loans on the watchlist that combine for 2.2% of the pool are secured by cooperative housing properties that are generally being monitored for low DSCRs or missing insurance documentation.

As of the January 2021 remittance, the transaction is composed of 79 loans, totalling $905.0 million. One of the original 72 loans has been repaid, with total collateral reduction since issuance of 5.2%. The transaction benefits from a concentration of office collateral as 12 loans, representing 25.0% of the current pool balance, are secured by office properties, which have shown greater initial resilience to cash flow declines during the pandemic. This includes the largest loan in the transaction, 9 West 57th Street (Prospectus ID#3, 7.2% of the current pool balance), which is secured by an office tower in Manhattan. At issuance, the 9 West 57th Street loan was shadow-rated investment grade. With this review, DBRS Morningstar confirms that the performance of this loan remains consistent with investment-grade loan characteristics.

The largest loan in special servicing, The Shops at Somerset (Prospectus ID#7, 3.3% of pool), is secured by an unanchored retail property in Glastonbury, Connecticut. The sponsors for this loan are Rouse Properties and Brookfield Property Partners. The loan transferred to special servicing in August 2020 as a result of payment delinquency and has remained over 90 days delinquent since September 2020. As of January 2021, the special servicer is in discussions with the borrower and exploring potential workout strategies, including a loan modification, and also a potential deed in lieu, according to the servicer’s most recent commentary from January 2021.

The largest three tenants represent only 17.7% of the net rentable area (NRA) and include Talbots (7.4% of the NRA) and Jos. A. Bank (4.4% of the NRA), both of which have tenant lease expirations in January 2021. A leasing update has been requested; both tenants were in operation at the property as of January 2021, according to the property website. Although updated quarterly financials are not reporting, the pre-pandemic financials were strong with a Q1 2020 DSCR of 2.59 times (x) and an occupancy rate of 77% compared with 1.80x and occupancy of 83% at YE2019. Given the outstanding payment default, the servicer’s suggestion that a deed in lieu is even on the table, and general challenges for the retail industry, DBRS Morningstar increased the probability of default (POD) to account for the increased credit risk of the loan for this review.

The second largest loan in special servicing, Gurnee Mills (Prospectus ID#10, 2.6% of pool), is secured by a single-level enclosed regional mall totalling 1.9 million square feet (sf), of which 1.7 million sf is part of the collateral. Simon Property Group (Simon) owns and operates the collateral portion of the property. At issuance, the largest tenants were Sears Grand, Bass Pro Shops, and Macy’s. Sears Grand was closed in 2018 and the sponsor has yet to backfill the space. The loan transferred to the special servicer in June 2020 as a result of monetary default related to the effects of the coronavirus pandemic. The loan was last paid in April 2020, according to the January 2021 remittance. Simon has submitted a coronavirus-related relief request and entered into a forbearance agreement in December 31, 2020, although the terms of the agreement have not been disclosed. According to the servicer, the loan will be returned to the master servicer in the near future.

Performance for the subject property was on the decline prior to the coronavirus pandemic, with cash flow trending downward for the past three consecutive years. The YE2019 net cash flow (NCF) decreased 11.1% compared with YE2018 and declined 17.5% compared with the issuer’s NCF. DBRS Morningstar notes the increased risks for the loan from issuance given the extended delinquency, the difficulty in backfilling the former Sears Grand space, and the property’s exposure to struggling retailers, including Macy’s. Given these factors, as well as the decline in performance prior to the pandemic, DBRS Morningstar applied a stressed POD for this loan in the analysis for this review, increasing the expected loss.

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.

Classes X-A, X-B, and X-D are interest-only (IO) certificates that reference 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 the following loans in the transaction:
-- Prospectus ID#7 – The Shops at Somerset (3.3% of the pool)
-- Prospectus ID#10 – Gurnee Mills (2.6% of the pool)

For complimentary access to this content, please register for the DBRS Viewpoint platform at www.viewpoint.dbrsmorningstar.com. The platform includes issuer and servicer 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 methodology is the North American CMBS Surveillance Methodology (March 6, 2020), which can be found on 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 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.

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