DBRS Morningstar Confirms All Classes of A10 Permanent Asset Financing 2017-II, LLC

DBRS Limited (DBRS Morningstar) confirmed its ratings on the following classes of A10 Permanent Asset Financing 2017-II, LLC:

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

All trends are Stable.

The rating confirmations reflect the overall stable performance of the transaction since the last rating action. Although the overall performance has remained stable in the last year, DBRS Morningstar does note performance challenges for several loans secured by office collateral. In total, nine loans, representing 28.9% of the current pool, are secured by office properties. Although these loans have performed in line with issuance expectations thus far, most recently reporting a weighted-average (WA) debt service coverage ratio (DSCR) of 1.69 times (x), the three largest office loans have all reported dark tenants or tenants that have been confirmed to be vacating in 2023, suggesting cash flow declines could be observed in the near to moderate term. Given the shift in demand for office space following the Coronavirus Disease (COVID-19) pandemic, DBRS Morningstar anticipates upward pressure on vacancy rates in the broader office market, presenting an additional challenge in re-tenanting these properties and increasing the potential for value declines.

In the analysis for this review, DBRS Morningstar increased the probability of default (POD) for loans with confirmed tenant departures to reflect their current risk profile and, in certain cases, applied stressed loan-to-value (LTV) ratios. Following these adjustments, the modeled expected losses (ELs) for loans secured by office properties were among the highest in the pool, with a WA EL 85.0% greater than the WA pool EL. Three of the loans receiving these adjustments are detailed, below. Although the concentration of office loans is concerning, this is partially mitigated by the presence of eight loans, representing more than 26.0% of the current pool and secured by self-storage, industrial, or multifamily properties, which have historically performed well and report modeled ELs well below the pool average. In addition, there has been meaningful paydown since issuance, with the credit enhancement for the lowest-rated Class C Notes increasing to 9.3% from 7.6% at issuance. The unrated Class D Notes still have the full issuance balance of $22.5 million, a significant cushion against liquidated losses for the rated Notes.

The third-largest loan in the pool, PacCorp Center (Prospectus ID#38; 7.3% of the current pool), is secured by an office property in Bellevue, Washington. The property was 87.5% occupied as of December 2022, however, tenants representing 22.0% of the property’s net rentable area (NRA) are scheduled to roll in 2023. Among these tenants are Isola Homes (Isola; 10.5% of NRA, lease expires July 2023) and Ford Motor Credit Company (Ford; 8.6% of NRA, lease expires November 2023). Per recent correspondence with the servicer, Isola has given notice that it will vacate its space and a reduced performance period has been triggered, initiating a cash flow sweep of $33,000 per month. Ford is reportedly in the preliminary stages of negotiating a lease extension. No replacement tenants have been signed to backfill Isola’s space, which currently contributes more than 11.0% of the base rent at the property. In addition, the property’s largest tenant, ProKarma (16.6% of NRA, lease expires June 2025), went dark in 2021. The servicer has confirmed that the entirety of ProKarma’s space has been subleased to The Topline Corporation through May 2025 for a starting base rent of $23.00 per square foot (psf), in comparison with ProKarma’s base rent of $37.00 psf. ProKarma has remained current on its lease payments and is expected to continue paying rent through its lease expiry in June 2025. According to the annualized financials for the trailing nine months (T-9) ended September 30, 2022, the loan reported a DSCR of 1.41x, in comparison with the YE2021 DSCR of 1.65x. DBRS Morningstar analyzed this loan with an elevated POD and a stressed LTV of 100.0%, resulting in an EL more than150.0% higher than the pool’s WA EL.

The largest loan on the servicer’s watchlist, 500 S Sepulveda Blvd (Prospectus ID#35; 4.0% of the current pool), is secured by an office property in Los Angeles. The loan was added to the servicer’s watchlist in July 2021 after the property’s largest tenant, Media Services (72.0% of NRA), went dark. The tenant is current on its rent, paying a rental rate of $22.80 psf on a lease through December 2027. Media Services is reportedly marketing one of its leased suites for sublease at a rental rate of $36.00 psf. In the absence of Media Services’ rent, the DSCR would fall well below 1.0x. With Media Services remaining current on its rent payments, however, the DSCR was reported at 1.55x as of September 2022, in line with the DSCR of 1.54x at YE2021. Given the reliance on a currently dark tenant, DBRS Morningstar increased the POD and applied a stressed LTV of 100.0% in its analysis of this loan, resulting in an EL more than150.0% higher than the pool’s WA EL.

The Clover Building loan (Prospectus ID#17; 3.8% of the current pool), also secured by an office property in Bellevue, was added to the servicer’s watchlist in December 2022 because of the upcoming lease expiry of the property’s largest tenant, AIM Consulting (29.8% of NRA, lease expires August 2023). A cash sweep has been initiated and, according to the servicer, there is $145,000 in the excess cash reserve as of April 2023. The tenant has reportedly given notice of its intention to vacate the property shortly after its lease expiry in August 2023. The suite is actively being marketed, however, there are no prospective tenants as of April 2023. AIM Consulting currently contributes 32.2% of the base rent at the property and, in the absence of any other leasing activity, the property’s occupancy rate would fall to approximately 63.0% and its DSCR could fall below the breakeven level. According to the financials for the T-9 ended September 30, 2022, the loan reported a DSCR of 1.75x, in line with the YE2021 DSCR of 1.76x. DBRS Morningstar analyzed this loan with an elevated POD and a stressed LTV of 100.0%, resulting in an EL more100.0% higher than the pool’s WA EL.

The transaction originally had a potential maximum funded balance of $400.0 million with a funding period that expired in December 2020. At that time, the transaction consisted of 38 loans with an aggregate balance of $292.4 million. The transaction reached its maximum funded balance of $297.2 million in December 2019 and began amortizing with the November 2020 Payment Date. As of the April 2023 remittance, the transaction consisted of 33 loans with an aggregate principal balance of approximately $243.0 million, representing an 18.2% collateral reduction as a result of scheduled amortization and the repayment of six loans. No loans are in special servicing and two loans, representing 7.8% of the current pool balance, are on the servicer’s watchlist.

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 (May 17, 2022) at https://www.dbrsmorningstar.com/research/396929.

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 the 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.

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

DBRS Limited
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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

DBRS Morningstar North American Commercial Real Estate Property Analysis Criteria (September 12, 2022) https://www.dbrsmorningstar.com/research/402646

North American Commercial Mortgage Servicer Rankings (September 8, 2022) https://www.dbrsmorningstar.com/research/402499

Interest Rate Stresses for U.S. Structured Finance Transactions (August 30, 2022) https://www.dbrsmorningstar.com/research/402153

Legal Criteria for U.S. Structured Finance (December 7, 2022)
https://www.dbrsmorningstar.com/research/407008

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