DBRS Morningstar Finalizes Provisional Ratings on AOA 2021-1177 Mortgage Trust Commercial Mortgage Pass-Through Certificates

DBRS, Inc. (DBRS Morningstar) finalized its provisional ratings on the following classes of Commercial Mortgage Pass-Through Certificates issued by AOA 2021-1177 Mortgage Trust (AOA 2021-1177):

Class A at AAA (sf)
Class X-CP at A (sf)
Class X-EXT at A (sf)
Class B at AA (sf)
Class C at A (high) (sf)
Class D at A (low) (sf)
Class E at BBB (low) (sf)
Class HRR at BB (high) (sf)

All trends are Stable. Class X-CP and Class X-EXT are interest-only (IO) classes whose balances are notional.

The AOA 2021-1177 transaction is secured by the fee simple interest in 1177 Avenue of the Americas, a 47-story, 1,036,549-square-foot (sf) office tower. The building is located between 45th Street and 46th Street on 6th Avenue (Avenue of the Americas) in the Grand Central submarket of Manhattan. Built in 1992, the building was acquired in 2007 by the California State Teachers’ Retirement System (CalSTRS), Silverstein Properties (Silverstein), and UBS. In June 2021, CalSTRS acquired UBS’s equity position in the property at a valuation of $865.0 million. The property was also previously securitized in the AOA 2015-1177 transaction and this financing retires the previous securitization. The property has undergone a recent lobby renovation including new turnstiles, limestone walls, lighting, artwork, and upgraded elevator mechanical systems. As of September 30, 2021, the property was 87.0% leased to 23 tenants with a weighted-average remaining lease term of approximately 9.1 years.

The loan’s appraised loan-to-value ratio (LTV) is 52.0% based on a $865 million valuation. The DBRS Morningstar LTV is 81.9% at an assumed cap rate of 6.50%. Another key credit metric of the loan is the high appraised land value of $430 million, or $651.93 sf on a floor area ratio basis. With its location along Sixth Avenue, land value carries a significant premium, which reduces the downside risk in the event of distress.

The property consists of 968,772 sf of office space and 4,992 sf of ground-floor retail space. Other space includes storage, management offices, and amenity spaces. There are two retail tenants (Charles Tyrwhitt, which is an apparel retailer, and a newsstand) inside the lobby. Charles Tyrwhitt was granted a partial rent abatement during the Coronavirus Disease (COVID-19) pandemic-related shutdowns and is required to pay back its rent in arrears.

The property is a high-quality asset in one of Manhattan’s high-rise office corridors with good access to transit. The rent roll counts law firms, banks, and other financial services firms among its 23 tenants. The largest tenant, Kramer Levin Naftalis & Frankel (Kramer Levin), occupies 27.0% of the net rentable area (NRA) under a lease that expires in 2035. The firm is based in New York and maintains its headquarters at the property. In 2017, Kramer Levin, which has been in occupancy since 2005, signed a lease extension for 265,000 sf that took effect in 2020.

Signature Bank (Signature), a private client bank, is the second-largest tenant with 8.4% of the NRA. The bank, which operates its Signature Securities Group arm out of the property, signed a lease in 2017 that expires in 2033. One concern is that the bank subsequently signed a lease at 1400 Broadway in 2018 and, according to media reports, intended to relocate staff from the subject to 1400 Broadway. Because Signature Bank has a 2028 termination option in its lease, DBRS Morningstar believes there is some risk that this tenant may vacate. According to the sponsor, however, Signature amended its lease in April 2020, adding 24,637 sf and extended the term on its fourth-floor space in 2021. This demonstrates a commitment to the property that DBRS Morningstar considered in its analysis of the tenant. Furthermore, none of Signature’s space has been subleased or is listed as available sublease. Given these facts, DBRS Morningstar did not assign any negative credit adjustments to this tenant.

As a result of the ongoing pandemic, two tenants were granted some type of deferral or abatement. One, Regus, an operator of shared office space, extended its lease term and posted a letter of credit in consideration of the abatement, while the retail tenant, Charles Tyrwhitt, agreed to repay any deferred rent. The occupancy rate in 2019 was 90.5% and with September occupancy of 87.0%, the decline to date has been relatively minimal. Historically, the property’s seven-year average occupancy is 91.7% and leases on only 25.6% of the space will expire during the full extended loan term.

However, there are concerns regarding the future of return to office across the Manhattan office market. Sublease space in Midtown Manhattan is currently at an all-time high with over 11 million sf of supply and Cushman and Wakefield anticipates this could put pressure on rents in the short term.

Some tenants have deferred decisions on renewals by signing short term extensions and others have sought out properties offering significant discounts to lock in lower rental rates for the long term. While the Manhattan office market remains in a transitional phase, DBRS Morningstar believes that the ultimate beneficiaries will be higher quality assets with well-capitalized sponsors who can weather short-term disruptions. In the case of the subject, there is a historically stable asset with good tenancy and strong sponsorship with expertise in the market and good relationships with tenants in the market.

1177 Avenue of the Americas is on Sixth Avenue between 45th and 46th Streets in Midtown Manhattan. It is a short distance from Times Square, Bryant Park, and Grand Central Terminal. It is near several subway stations, which provide access throughout the area. With the location in a highly desirable corridor in Midtown Manhattan, the property has an indicated land value of $430 million, or $652 per foot on a floor-area-ratio basis. The land value accounts for approximately 50% of the property value.

From 2014 to 2019, the property maintained average occupancy of greater than 90%. While occupancy dipped during the pandemic to 89%, the long-term leases have helped cushion it from further weakness. Going forward, lease rollover will total less than 45% of the total gross rent through 2030.

Kramer Levin is the largest tenant with more than 300 attorneys and maintains its headquarters at the property. It has been a tenant since 2005 and signed a lease extension in 2017 that extends through 2035. Beyond Kramer Levin, no other tenants account for more than 10% of the property’s total based rent.

The loan sponsors are Silverstein and CalSTRS. Silverstein has more than 60 years of experience in real estate, primarily in New York City, and has owned or managed more than 40 million sf of space since it was founded. CalSTRS is one of the largest public pension funds in the United States with more than $310 billion in assets under management and owns a significant portfolio of commercial real estate directly through investment funds.

The ongoing coronavirus pandemic continues to pose challenges and risks to virtually all major commercial real estate property types, creating an element of uncertainty around future demand for office space, even in gateway markets that have historically been highly liquid. The property negotiated coronavirus-related lease amendments with two tenants, Regus and Charles Tyrwhitt. Regus, which occupies 33,628 sf, has a 50% reduction in rent that was effective from January 2021 to September 2021, for which it extended its lease from March 2026 to February 2031. Charles Tyrwhitt had deferred rent from April 2020 through June 2020 and agreed to pay arrears of the amounts from April 2020 to February 2021.

The loan does not have a nonrecourse carve-out guarantor, effectively limiting the recourse back to the sponsor for bad act carveouts. “Bad boy” guarantees and consequent access to the guarantor help mitigate the risk and increased loss severity of bankruptcy, additional encumbrances, unapproved transfers, fraud, misappropriation of rents, physical waste, and other potential bad acts of the sponsor. In this case, the loan sponsors are experienced and well capitalized, including the California State Teachers’ Retirement System. The sponsors have owned the property through joint ventures since 2007 and maintained strong performance. A loan backed by the property was securitized in AOA 2015-1177 and paid as agreed.

The borrower did not obtain environmental insurance on the property and there is no environmental indemnitor, save for the borrower. Typically borrowers obtain environmental insurance to protect the trust against losses caused by environmental spoilage and nonrecourse carveout guarantors are required to backstop the risk of environmental damage.
The loan is structured with recycled special-purpose entities (SPEs). The borrowers have given backward-looking representation, from the date of the SPE’s formation, that it does not carry any prior liabilities. Additionally, if the borrower’s SPE representations are breached, a guarantee from the sponsor is triggered.

There are no performance triggers, financial covenants, or fees required for the borrower to exercise any of the three one-year extension options. The options are exercisable by the borrower subject only to compliance with the following conditions: (1) at least 30 days prior written notice to lender, (2) no event of default existing as of the commencement of the applicable extension term, (3) borrower’s purchase of a cap agreement for each extension term providing for a cap on Libor, and (4) reimbursement of lender and servicer’s reasonable third party out-of-pocket costs and expenses actually
incurred in connection with processing and documenting the extension option.

The underlying mortgage loan for the transaction will pay floating rate, which presents potential benchmark transition risk as the deadline approaches for the elimination of Libor. The transaction documents provide for the transition to an alternative benchmark rate, which is primarily contemplated to be either the Term Secured Overnight Financing Rate (SOFR) plus the Benchmark Replacement Adjustment, or Compounded SOFR plus the applicable Benchmark Replacement Adjustment.

ESG CONSIDERATIONS
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.

Classes X-CP and X-EXT are interest-only (IO) certificates that reference 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.

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Notes:
All figures are in U.S. dollars unless otherwise noted.

With regard to due diligence services, DBRS Morningstar was provided with the Form ABS Due Diligence-15E (Form-15E), which contains a description of the information that a third party reviewed in conducting the due diligence services and a summary of the findings and conclusions. While due diligence services outlined in Form-15E do not constitute part of DBRS Morningstar’s methodology, DBRS Morningstar used the data file outlined in the independent accountant’s report in its analysis to determine the ratings referenced herein.

The principal methodology is North American Single-Asset/Single-Borrower Ratings Methodology (March 2, 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.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. DBRS Morningstar analysis considered impacts consistent with the baseline scenarios as set forth in the following report: https://www.dbrsmorningstar.com/research/384482/baseline-macroeconomic-scenarios-application-to-credit-ratings.

Please see the related appendix for additional information regarding the sensitivity of assumptions used in the rating process.

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

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