DBRS Morningstar Confirms All Ratings of HFX Funding 2017-1

DBRS Limited (DBRS Morningstar) confirmed the ratings on all of the notes issued by HFX Funding 2017-1, as listed below:

-- Class A-2 Notes at AAA (sf)
-- Class A-3 Notes at AAA (sf)
-- Class B Notes at AA (low) (sf)
-- Class C Notes at A (low) (sf)
-- Class D Notes at BBB (low) (sf)

All trends are Stable.

The rating confirmations reflect the overall stable performance of the transaction, which benefits from a sizable unrated bond that insulates the rated classes from losses expected for the loan in special servicing, as further discussed below. The pool consists of 18 loans, secured by traditional commercial real estate properties. This transaction was initially structured with a post-closing funding period whereby loans could be contributed to the pool, with the final pool balance capped at a maximum balance of $300.0 million. Through the funding period, DBRS Morningstar analyzed newly funded loans when the pool reached funding targets of 25.0%, 50.0%, and 85.0% to ensure the collateral met the Target Enhancements set forth by the loan documents. Although the initial funding period was expected to expire within six months of closing, several extensions were granted and the deal was deemed fully funded as of June 2020, with 18 loans and a trust balance of $246.2 million.

According to the June 2021 remittance, the trust balance was $245.3 million, representing a collateral reduction of 3.4% from the fully funded trust balance at June 2020. There is one loan in special servicing, representing 3.6% of the pool, and one defeased loan, representing 2.8% of the pool. The pool is concentrated in multifamily, mixed-use, retail, and industrial properties, representing 25.8%, 25.0%, 22.4%, and 15.9% of the pool, respectively. The pool is somewhat concentrated by location, with loans backed by properties in California, Colorado, Texas, and Wisconsin, representing 24.0%, 16.2%, 11.8%, and 9.1% of the pool, respectively.

The specially serviced loan, Storrs Center Phase II (Prospectus ID#1, 3.6% of the pool), is secured by an unanchored retail property located in Storrs, Connecticut, home of the University of Connecticut (UConn). The loan transferred to special servicing in May 2020 for payment default and, as of February 2021, the loan became real estate owned. The collateral property caters to UConn students and the disruptions to campus populations amid the Coronavirus Disease (COVID-19) pandemic contributed to a compounding of performance declines that began in 2019. Occupancy has declined significantly, with the YE2020 leased rate reported at 64.3%, compared with the YE2019 occupancy rate of 76% and YE2018 occupancy rate of 97%. The former largest tenant, Storrs 86 LLC (doing business as Grille 86), represented 20.3% of the net rentable area (NRA) and vacated the subject in 2019, ahead of its November 2026 lease expiration. Amazon Pickup Points (Amazon; 11.3% of NRA) also vacated the subject, but its lease is backed by a corporate guarantee through the lease expiration of February 2026, which is two years beyond the loan term. Removing Amazon from the YE2020 leased rate reported by the servicer suggests a physical occupancy rate of 55.0%, well below the 100% occupancy rate at issuance.

As a result of Amazon’s departure, the borrower deposited $300,000 into a leasing reserve to backfill the space, in return for the servicer’s approval of a nine-month delay in the cash management requirement the tenant’s departure triggered. The May 2021 loan level reserve report showed $290,931 held across all reserves. Although the property is well located, the occupancy declines that began prior to the coronavirus pandemic suggest its prospects for stabilization are generally challenged and would require a significant investment to achieve leasing traction. Given these factors, DBRS Morningstar expects a significant loss will be realized at disposition and analyzed this loan with a liquidation scenario, which resulted in a loss severity in excess of 55.0%.

The 365 West Passaic loan (Prospectus ID#11, 8.2% of pool), is secured by a 218,493-square-foot (sf) Class B office building in Rochelle Park, New Jersey, located approximately 20 miles northwest of Lower Manhattan. Occupancy at the subject declined to 57.7% as of YE2020, compared with 85.0% at loan closing. This was due to the departure of the former largest tenant, Avenue Stores (26.2% of NRA), which vacated its space after filing for bankruptcy. As a result, the loan is cash managed and, based on the Q4 2020 reporting, the sweep has yielded approximately $486,000 in reserves. According to the May 2021 loan level reserve report, $2.0 million was held across all reserve including $959,577 in the leasing reserve, of which $344,470 was allocated for the former Avenue Stores space. There has been recent leasing activity at the subject with two new leases signed at rental rates of approximately $23.50 per sf (psf) on eight- and 10-year terms. The sponsor is expecting the occupancy to approach 65.0% with these new leases.

According to Reis, office properties located in the Hackensack/Teaneck submarket reported a Q1 2021 vacancy rate of 17.8% and asking rent of $27.41 psf, compared with the Q1 2020 vacancy rate of 16.3% and asking rent of $27.40 psf. The DBRS Morningstar net cash flow (NCF) derived at loan contribution represented a sizable 71.9% haircut to the issuer’s NCF, a factor of a significantly higher vacancy factor assumed by DBRS Morningstar. The significant haircut and resulting low DBRS Morningstar DSCR significantly increased the probability of default (POD) and expected loss for the loan in the DBRS Morningstar analysis.

The Kenmore Apartments loan (Prospectus ID#9, 6.7% of the pool) is secured by a 57-unit, multifamily property with 1,200 sf of ground floor retail located in Los Angeles. DBRS Morningstar is monitoring the loan closely as the loan remains outstanding for the April 2021 debt service payment and all payments due thereafter as of the May 2021 remittance, but had not transferred to special servicing as of the date of the remittance. DBRS Morningstar has requested an update on the status of the loan’s delinquency from the servicer and, as of the date of this press release, the servicer’s response is pending. The subject’s occupancy declined to 63.0% as of February 2021, compared with the YE2019 occupancy rate of 91.0%, but is still above the loan closing occupancy rate of 33.3%. The recent occupancy decline was a product of the coronavirus pandemic, with several tenants vacating at lease expiration. In addition, the City of Los Angeles recently extended its eviction moratorium, which has made it difficult to collect rents and evict delinquent tenants. The management team is working with its tenants to modify leases with rent deferrals while continuing to market the property for lease. Between September 2020 and December 2020, eight leases were signed at an average rental rate of $2,062 per unit.

According to Reis, multifamily properties located in the Wilshire/Westlake submarket reported a Q1 2021 vacancy rate of 5.8% and asking rent of $1,632.18 per unit, compared with the Q1 2020 vacancy rate of 5.2% and asking rent of $1,761.07 per unit. Based on the YE2020 financials, the loan reported a NCF of $522,207, compared with the trailing 12 months ended September 2019 NCF of $1.2 million and DBRS Morningstar NCF of $1.2 million. Although the submarket metrics are strong and there was some leasing traction reported in late 2020, the steep decline in NCF and continued challenges amid the eviction moratorium suggest significantly increased risks for this loan from issuance. As a result, DBRS Morningstar analyzed this loan with an elevated POD to increase the expected loss in the analysis for this review.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

The DBRS Viewpoint platform provides additional information on this transaction and underlying loans including DBRS Morningstar metrics, commentary, servicer-reported cash flows, and other performance-related data.

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 North American CMBS Surveillance Methodology (March 26, 2021), 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.

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

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