DBRS Morningstar Downgrades Ratings on Two Classes of Ready Capital Mortgage Financing 2020-FL4, LLC

DBRS, Inc. (DBRS Morningstar) downgraded its ratings on two Classes of Ready Capital Mortgage Financing 2020-FL4, LLC as follows:

-- Class F to CCC (sf) from BB (low) (sf)
-- Class G to CCC (sf) from B (low) (sf)

DBRS Morningstar also confirmed its ratings on the remaining classes as follows:

-- Class A at AAA (sf)
-- Class A-S at AAA (sf)
-- Class B at AA (sf)
-- Class C at A (sf)
-- Class D at BBB (sf)
-- Class E at BBB (low) (sf)

All classes have Stable trends with the exception of Classes of F and G as they have a rating that does not carry a trend. In conjunction with this press release, DBRS Morningstar published a Surveillance Performance Update report with in-depth analysis and credit metrics for the transaction and with business plan updates on select loans. For access to this report, please click on the link under Related Documents below or contact us at [email protected].

The rating downgrades on Classes and F and G are the result of accumulated interest shortfalls, which have persisted for more than six consecutive months. As per DBRS Morningstar’s Structured Finance and Covered Bonds Ratings Committee Global Procedure dated October 2022, the tolerance threshold for a DBRS Morningstar credit rating in the BB or B rating category is six months. The shortfalls stem from the difference in the floating interest rate benchmark between the bonds and some of the individual loans remaining in the transaction. While the bonds’ benchmark rate has now transitioned to the Secured Overnight Financing Rate (SOFR), the benchmark rate on many of the remaining loans has yet to transition from Libor and is not expected to in the immediate term. As a result, DBRS Morningstar expects interest shortfalls to continue to accrue on Classes F and G; however, the shortfalls may ultimately be repaid over time as the benchmark rates on the loans all transition to SOFR.

At issuance, the pool consisted of 56 floating-rate mortgages secured by 63 mostly transitional properties with an aggregate principal balance of $405.3 million, excluding $147.5 million of future funding commitments. The transaction was structured with a 24-month acquisition period that expired in July 2022.

As of the March 2023 reporting, 21 of the original 56 loans remain in the pool with an aggregate principal balance of $276.0 million, resulting in a collateral reduction of 33.3% since issuance. In general, the borrowers for the remaining loans have been unable to execute the stated business plans at issuance as nine loans, representing 46.9% of the current pool balance, are in special servicing, five of which are delinquent. In addition, there are eight loans, representing 2.9% of the current pool balance, being monitored on the servicer’s watchlist, which have been flagged for credit concerns including maturity risk, delinquency, and low debt service coverage ratio (DSCR).

Seven of the remaining loans, representing 38.5% of the current trust balance, are secured by office properties; five loans, representing 36.7% of the current trust balance, are secured by industrial properties; and five loans, representing 18.2% of the current trust balance, are secured by mixed-use properties. The remaining loans are secured by one retail property and three multifamily properties. In terms of location, 10 properties, representing 52.9% of the trust balance, are located in suburban markets and 11 properties, representing 47.1% of the trust balance, are in urban markets. This compares with 64.0% of the trust balance and 27.9% of the trust balance, respectively, at issuance.

Twenty of the 21 remaining loans were structured with future funding components totaling $115.0 million to assist individual borrowers in the respective business plans, which included funds for property renovations, accretive leasing costs, and performance-based earn-outs. As of February 2023, the lender had advanced a total of $69.0 million to all 20 individual borrowers. The largest advance, $11.7 million, was provided to the borrower of the Frogtown Gilroy loan (Prospectus ID#21, 5.8% of the current pool balance), which is secured by a portfolio of eight Class C industrial/flex mixed-use and retail properties totaling 59,279 square feet (sf) in suburban Los Angeles. This loan is currently on the servicer’s watchlist for its upcoming June 2023 maturity date and poor performance as the YE2022 DSCR was 0.17 times (x). According to servicer commentary, the borrower is actively pursuing take-out financing with a third-party lender.

An additional $46.0 million of loan future funding allocated across 16 individual borrowers remains available. The largest portion ($8.3 million) is allocated to the borrower of the Parkwood Plaza loan (Prospectus ID#7; 6.7% of current pool balance). The loan, the third-largest in special servicing, is secured by a Class A/B office building in suburban Atlanta. The loan transferred to special servicing in February 2023 for maturity default. The borrower’s business plan has stalled as the occupancy rate remains unchanged from issuance at 2.8%; however, the borrower has completed the capital improvement plan. An updated appraisal completed in December 2022 valued the property at $20.0 million, a minor decrease of 1.0% from the issuance appraisal of $20.2 million. The borrower and lender are currently negotiating a potential loan modification as the current performance of the collateral does not meet the required minimum thresholds to qualify for the first of two 12-month loan extension options. If an agreement is finalized and the loan is extended, the borrower may have to pay down the principal balance of the loan, deposit funds into an operating shortfall reserve, and purchase a new floating interest rate cap agreement.

The largest loan in the pool, 55 East Jackson (Prospectus ID#1; 16.1% of current pool balance), transferred to special servicing in February 2023 for ground lease default. According to the servicer, discussions with the borrower are ongoing with a resolution expected by August 2023. The loan is secured by a Class B office building totaling 451,258 sf in the East Loop Submarket of Chicago. Occupancy decreased to 47.0% after the property’s largest tenant, DePaul University (DePaul), vacated upon its lease expiration in December 2022. According to the collateral manager, the borrower is in discussions with a non-profit tenant that would back-fill the space; however, no further material information has been provided to date. As of YE2022, the loan reported a DSCR of 2.27x, which is expected to decrease significantly following the departure of DePaul. The loan matures in August 2023 and includes one,12-month extension option.

The second-largest loan in special servicing, 19 South Lasalle (Prospectus ID#5; 7.2% of pool balance), transferred to special servicing in May 2022 for imminent default risk and matured in July 2022. The sponsor’s business plan at issuance of increasing occupancy and rents to market levels never materialized because of a combination of factors caused by the Coronavirus Disease (COVID-19) pandemic. Since issuance, the property has experienced sharp declines in occupancy. As of July 2022, the property was 43.3% occupied; however, a February 2023 update from the collateral noted that additional unspecified tenants have vacated since that time, further lowering the occupancy rate.

An updated appraisal completed in June 2022 valued the property with an in-place value of $13.3 million, down from $25.4 million at issuance. Based on the current outstanding loan balance of $19.9 million and current outstanding advances of $0.9 million, the total loan exposure to value ratio is 156.6%. DBRS Morningstar liquidated the loan from the trust in its most recent analysis, resulting in a loss severity in excess of 50.0%.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factor(s) that had a significant or relevant effect on the credit analysis.

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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022).

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

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

The principal methodology is North American CMBS Surveillance Methodology (March 16, 2023), 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.

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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