DBRS Morningstar Downgrades Three Classes and Confirms 12 Classes of Wells Fargo Commercial Mortgage Trust 2016-NXS5

DBRS Limited (DBRS Morningstar) downgraded its ratings on three classes of the Commercial Mortgage Pass-Through Certificates, Series 2016-NXS5 issued by Wells Fargo Commercial Mortgage Trust 2016-NXS5 as follows:

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

In addition, DBRS Morningstar confirmed its rating on the following 12 classes:

-- Class A-3 at AAA (sf)
-- Class A-4 at AAA (sf)
-- Class A-5 at AAA (sf)
-- Class A-6 at AAA (sf)
-- Class A-6FL at AAA (sf)
-- Class A-S at AAA (sf)
-- Class A-SB at AAA (sf)
-- Class X-A at AAA (sf)
-- Class X-B at AA (low) (sf)
-- Class B at A (high) (sf)
-- Class C at BBB (high) (sf)
-- Class D at BBB (low) (sf)

DBRS Morningstar also discontinued the rating on Class X-F, as the reference obligation is now rated CCC (sf). DBRS Morningstar changed the trends on Classes D and E to Negative from Stable, while Classes F and G have ratings that do not typically carry a trend in commercial mortgage-backed securities (CMBS) ratings. All other trends are Stable.

The rating downgrades on Classes E, F, and G reflect an increase in DBRS Morningstar’s loss expectations for loans in special servicing, primarily driven by the liquidation of the 10 South LaSalle Street (Prospectus ID#2; 11.2% of the pool) loan, as further described below. As part of the analysis for this review, DBRS Morningstar liquidated five loans in special servicing from the trust, resulting in an implied loss of approximately $46.0 million. At the last rating action in November 2022, DBRS Morningstar changed the trends on Classes D, E, and F to Stable from Negative, as only two loans were liquidated from the trust with an implied loss of $17.4 million, which was contained to the nonrated Class H. Based on the analysis for this review, projected losses entirely depleted the nonrated Class H along with the majority of Class G and significantly erode the credit support provided to Classes E and F, warranting the downgrade actions. For this review, the Negative trends assigned to Classes D and E reflect the overall increased credit risk to those certificates, as well as additional concerns surrounding select loans on the servicer’s watchlist and the pool’s concentration of office properties, which totals 21.4%. In general, office properties have faced a heightened level of concern and scrutiny in recent months. Vacancy rates in many submarkets remain elevated primarily because of low space utilization, resulting from a change in workers’ preferences. This dynamic has led to an increase in office space being offered for sublease and tenants downsizing or vacating. Loans secured by office properties (excluding 10 South LaSalle Street) had a weighted-average debt yield of 7.3% based on the most recent financials available.

The rating confirmations reflect the otherwise stable performance of the transaction, with the remaining loans in the pool having experienced minimal changes since DBRS Morningstar’s last review. As of the March 2023 remittance, 56 of the original 64 loans remained in the trust. with an aggregate principal balance of $669.8 million, reflecting collateral reduction of 23.6% since issuance. In addition, 10 loans, representing 15.5% of the pool, are secured by collateral that has fully defeased. To date, two loans have been liquidated from the pool with realized losses totaling $3.3 million, which have been contained to the nonrated Class H certificate. There are seven loans, representing 7.8% of the pool, on the servicer’s watchlist, and six loans, representing 19.7% of the pool, in special servicing.

The largest loan in special servicing and in the pool is 10 South Lasalle Street, which is collateralized by a 781,426-square-foot (sf), Class B office property in the Central Loop submarket of Chicago. The 37-story building was built in 1987. Despite undergoing $17.8 million worth of renovations over the past five years, aimed at making the property more competitive, occupancy at the property has remained depressed since 2020 and is currently below 75.0%. The loan transferred to special servicing in August 2022 for imminent default; however, as of the most recent remittance, the loan remains current. The special servicer remains in contact with the borrower to evaluate next steps, with a resolution targeted for June 2023.

The annualized net cash flow (NCF) for the trailing seven-month period ended July 31, 2022, was $4.5 million, a significant decline from the YE2020 and issuance NCF figures of $8.1 million and $10.7 million, respectively. Likewise, the debt service coverage ratio (DSCR) remains stressed, with the July 2022 figure below breakeven at 0.95 times (x). As of the July 2022 rent roll, the property was 74.4% occupied, compared with the YE2020 and issuance rates of 72.0% and 89.0%, respectively. Rollover risk is elevated during the next 12 months, with tenant leases representing 12.4% of net rentable area (NRA) set to roll. Only $0.9 million remains in reserves to aid the borrower’s leasing efforts. The largest three tenants at the property are Chicago Title Co. (13.6% of NRA; lease expiry in March 2025), Amwins Brokerage of Illinois (7.4% of NRA; lease expiry in August 2027), and Clausen Miller PC (5.4% of NRA; lease expiry in December 2025).

The building is within the City of Chicago’s planned LaSalle Street re-development project, which is seeking to create a more mixed-use neighborhood along the LaSalle corridor in the Central Loop. As part of the initiative, developers plan to convert existing office space to residential units; however, the collateral is not included in a preliminary pool of participating properties. The subject property was most recently appraised in December 2015 at a value of $166.5 million; however, given the declines in occupancy and cash flow, coupled with the diminished investor appetite for this property type, the asset’s value has likely declined significantly, elevating the loan’s leverage and credit risk to the trust. It is noteworthy that an appraisal dated January 2023 was obtained for 135 South LaSalle Street, a Class A office building 0.1 mile from the subject property, which indicated a value decline in excess of 70.0% from issuance following a precipitous decline in occupancy to below 20.0%. DBRS Morningstar’s liquidation scenario for this loan, which resulted in an implied loss severity in excess of 30.0%, was based on a haircut to the issuance appraised value with consideration given to the outdated appraisal and soft market conditions.

The third-largest loan in special servicing, with the second-largest projected loss amount, is 1006 Madison Avenue. The loan is secured by a 3,917-sf single-tenant retail property on the Upper East Side of Manhattan, New York. Sponsorship for the loan is provided by Joseph Sitt, President and Chief Executive Officer of Thor Equities LLC. Sitt owns multiple properties in New York that are in various stages of foreclosure, the most notable among them being 597-599 Fifth Avenue, 3 East 48th Street, and 446 West 14th Street. The loan transferred to the special servicer in October 2018 for imminent monetary default, following the departure of the property’s sole tenant in late 2018, with the property remaining vacant since. The collateral has been real estate owned since July 2022. A November 2022 appraisal valued the property at $6.6 million, a 72.5% decline from the issuance appraised value of $24.0 million, reflecting a loan-to-value (LTV) ratio of 317.0% based on the total exposure. In its analysis, DBRS Morningstar liquidated the loan from the pool, resulting in an implied loss severity of nearly 95.0%.

DBRS Morningstar also has concerns about the largest loan on the servicer’s watchlist, 4400 Jenifer Street (Prospectus ID#8; 3.9% of pool balance). The loan is secured by a three-story, 83,777-sf Class B office property in the Friendship Heights neighborhood of Washington, D.C. The loan was added to the servicer’s watchlist in March 2022 following a decline in occupancy, which fell to 65.0% at YE2021 from the pre-Coronavirus Disease (COVID-19) pandemic figure of 86.0% at YE2019. Financials have shown a similar decline, with a YE2021 DSCR of 0.74x compared with the YE2019 figure of 1.51x. According to the October 2022 rent roll, occupancy had improved to 73.4%; however, there is significant near-term rollover risk. Tenants occupying 36.6% of NRA have leases set to expire within the next 12 months, including a major tenant, DC Radio Assets (27.3% of NRA; lease expiry in June 2023). DBRS Morningstar has reached out to the servicer to inquire about new leasing prospects at the property and to request updates related to potential lease extensions for existing tenants. In its analysis for this review, DBRS Morningstar analyzed the loan with an elevated probability of default penalty and made an adjustment to the LTV assumption to reflect the probable value decline of the collateral since issuance. The resulting expected loss was approximately 60.0% higher than the pool average.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors 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 (May 17, 2022).

Classes X-A and X-B 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.

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

The principal methodology is North American CMBS Surveillance Methodology (March 16, 2023; https://www.dbrsmorningstar.com/research/410912).

Other methodologies referenced in this transaction are listed at the end of this press release.

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 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 rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process for this rating action.

DBRS Morningstar had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This is a solicited credit rating.

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.

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.

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

The rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

North American CMBS Multi-Borrower Rating Methodology (March 16, 2023)/North American CMBS Insight Model v 1.1.0.0 (https://www.dbrsmorningstar.com/research/410913)

Rating North American CMBS Interest-Only Certificates (December 19, 2022)
https://www.dbrsmorningstar.com/research/407577/rating-north-american-cmbs-interest-only-certificates

DBRS Morningstar North American Commercial Real Estate Property Analysis Criteria (September 12, 2022)
https://www.dbrsmorningstar.com/research/402646/dbrs-morningstar-north-american-commercial-real-estate-property-analysis-criteria

North American Commercial Mortgage Servicer Rankings (September 8, 2022)
https://www.dbrsmorningstar.com/research/402499/north-american-commercial-mortgage-servicer-rankings

Interest Rate Stresses for U.S. Structured Finance Transactions (August 30, 2022)
https://www.dbrsmorningstar.com/research/402153/interest-rate-stresses-for-us-structured-finance-transactions

Legal Criteria for U.S. Structured Finance (December 7, 2022)
https://www.dbrsmorningstar.com/research/407008/legal-criteria-for-us-structured-finance

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