DBRS Morningstar Downgrades Three Classes, Changes Trends on Three Classes of HMH Trust 2017-NSS to Negative

DBRS Limited (DBRS Morningstar) downgraded its ratings on the Commercial Mortgage Pass-Through Certificates, Series 2017-NSS issued by HMH Trust 2017-NSS as follows:

-- Class C to BBB (low) (sf) from BBB (sf)
-- Class D to BB (low) (sf) from BB (sf)
-- Class E to CCC (sf) from B (low) (sf)

The ratings on the following classes were confirmed:

-- Class A at AAA (sf)
-- Class B at AA (low) (sf)

The trend on Class A is Stable. DBRS Morningstar changed the trend on Classes B, C, and D to Negative from Stable. Class E has a commercial mortgage-backed security (CMBS) rating that does not typically carry a trend.

The downgrades and Negative trends primarily reflect the hotel portfolio’s most recent appraised value, which fell to $186.2 million ($64,620 per key) as of July 2022, implying an elevated loan-to-value (LTV) of 109.5%, or 121.9% when factoring in the $23.0 million of outstanding servicer advances. Given that the special servicer’s updated workout strategy is a deed in lieu of foreclosure, which will likely result in an extended workout time frame, DBRS Morningstar considered a stressed scenario in its analysis for this review, which supports these actions, as further described below.

The $204.0 million trust mortgage loan is secured by the fee-simple interest in one hotel and leasehold interests in 21 hotels across nine different states, with the largest concentrations in California, Florida, and North Carolina. The capital stack includes a $25.0 million mezzanine loan held outside of the trust, and the trust permits an additional $26.0 million mezzanine loan; however, additional mezzanine debt has not been obtained to date. The mezzanine loans are co-terminous with the trust mortgage loan, which matured in July 2022. The loan is now flagged as a nonperforming matured balloon and no loan modification or extension has been executed to date.

The properties have solid brand affiliation, with either Hilton Worldwide Holdings Inc.; Hyatt Hotels Corporation; Marriott International, Inc.; or Choice Hotels International, Inc. flags on each hotel. All franchise agreements expire subsequent to loan maturity. Nearly half the pool operates as extended-stay hotels, with the remaining operating as either limited-service or select-service hotels. The sponsor for the loan is Jay H. Shidler, founder of The Shidler Group, which was founded in 1972 and is headquartered in Honolulu.

The loan has been in special servicing since May 2020 as a result of imminent monetary default after the borrower stopped making debt service payments and subsequently requested Coronavirus Disease (COVID-19)-related relief. Initially, there were discussions with the mezzanine lender regarding that entity taking title through a loan assumption and modification; however, terms were not ultimately reached, and those discussions appear to have fallen through completely. Amid the workout negotiations, the controlling class representative exercised its right to replace the special servicer, appointing Midland Loan Services to take over for AEGON USA Realty Advisors, LLC (which has since been replaced by Mount Street US (Georgia) LLP). The borrower has since consented to a court-appointed receiver and according to the special servicer, the receiver entered into a listing agreement with Jones Lang LaSalle Incorporated and began marketing the portfolio for sale in May 2022. More recently, however, as of March 2023, the portfolio workout strategy was confirmed to be a deed in lieu of foreclosure.

Since issuance, when the collateral portfolio was valued at $400.4 million ($138,883 per key), the servicer has obtained three rounds of updated appraisals, valuing the collateral portfolio on an as-is basis at $173.2 million ($60,076 per key) in November 2020, $295.8 million ($102,601 per key) in February 2021, and most recently at $186.3 million in July 2022. The July 2022 appraisal also indicated value-add potential for the portfolio, projecting a stabilized value of $275.6 million ($95,594 per key); however, stabilization periods were generally in a two-year time frame, which is beyond loan maturity.

According to the YE2022 financials, the portfolio reported a net cash flow (NCF) figure of $12.4 million (reflecting a debt service coverage ratio (DSCR) of 1.27 times (x)), in comparison to the YE2021 figure of $0.4 million (reflecting a DSCR of 0.04x). Per the most recent STR report, the portfolio reported the trailing 12 months ended November 30, 2022, occupancy average daily rate; and revenue per available room figures of 67.6% (+19.8% year-over-year (YOY)), $134 (+15.5% YOY), and $93 (+38.7% YOY), respectively, reflecting penetration rates of 107.4%, 107.1%, and 115.9%, respectively.

Despite the YOY increases across all three metrics, the loan’s NCF remains well below the DBRS Morningstar NCF figure of $19.9 million and the most recent pre-pandemic NCF of $23.0 million at YE2019. DBRS Morningstar anticipates further improvements in the portfolio performance as hotel demand has increased steadily in the last few years and appears to be continuing to stabilize; however, there remains uncertainty given the interest rate and pricing volatility that has been introduced as a result of the Fed’s efforts to curb inflation.

DBRS Morningstar’s analysis for this review is based on the updated appraised values for the collateral hotels as those generally represent market-based values. To account for the aforementioned uncertainty and volatility, DBRS Morningstar applied a 10.0% haircut to the July 2022 as-is value of $186.3 million when updating the LTV sizing in its analysis, resulting in a DBRS Morningstar value of $167.7 million. The DBRS Morningstar value implies an LTV of 135.4%, as compared with the LTV on the issuance appraised value of 51.0%. The qualitative adjustments applied to the sizing were unchanged from DBRS Morningstar’s last sizing completed in September 2020.

ENVIRONMENTAL, SOCIAL, AND 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 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 rating assigned to Class B is higher than the results implied by the LTV sizing benchmarks. This variance is warranted given the value assumed in the analysis was based on a stressed approach that supported the downgrades and Negative trends, as outlined above. DBRS Morningstar also considered mitigating factors in the July 2022 stabilized value, which is in excess of the loan amount, equating to an LTV of 74.0%.

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

North American Single-Asset/Single-Borrower Ratings Methodology (February 23, 2023; https://www.dbrsmorningstar.com/research/410191)

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].