DBRS Morningstar Confirms Ratings on All Classes of Real Estate Asset Liquidity Trust, Series 2019-HBC

DBRS Limited (DBRS Morningstar) confirmed its ratings on the Commercial Mortgage Pass-Through Certificates, Series 2019-HBC issued by Real Estate Asset Liquidity Trust, Series 2019-HBC as follows:

-- Class A at AAA (sf)
-- Class X at AA (high) (sf)
-- Class B at AA (sf)
-- Class C at A (sf)

All trends are Stable.

The rating confirmations reflect the overall stable performance of the transaction. At issuance, the transaction was collateralized by two cross-collateralized and cross-defaulted loans secured by The Hudson’s Bay (The Bay) flagship stand-alone department stores in downtown Montréal and Ottawa. In October 2022, the loan secured by the Montréal property successfully repaid in full upon its respective maturity date with a scheduled principal payment of $160.3 million. The loan secured by the Ottawa property remains the sole collateral for the transaction with a scheduled maturity date in June 2024 and an aggregate principal balance of $74.1 million per the July 2023 reporting, representing a collateral reduction of 70.4% since issuance. Based on the YE2021 financials (the most recent reporting available), the Ottawa property reported a net cash flow (NCF) that was 36.7% above the DBRS Morningstar NCF figured derived for the property at issuance. Given the continued improvement in performance of the underlying collateral, DBRS Morningstar performed a stressed cash flow scenario to test the durability of the ratings, as further described below, which supported the rating confirmations for this review.

The sponsor initially acquired the properties in 2015 as part of a five-property portfolio sale-leaseback transaction with an allocated purchase price of approximately $535.0 million. The vendor, Hudson’s Bay Company (HBC), retained an 87.5% ownership interest in the properties through RioCan-HBC Limited Partnership, the purchaser of the properties, a joint venture (JV) between HBC and RioCan Real Estate Investment Trust (RioCan; rated BBB with a Stable trend by DBRS Morningstar). Although HBC signed 20-year absolute-net leases that included five six-year renewal options, DBRS Morningstar considered the NCF from these properties to be more volatile given the revenue stream aligned with HBC’s retail operating business, with declines in foot traffic for some The Bay stores in recent years, even prior to the Coronavirus Disease (COVID-19) pandemic.

The Ottawa property is fully leased to The Bay, which subleases portions of its space to other tenants. According to an article published by CBC News in January 2023, the subject property is one of two dozen stores across Canada that announced plans to host the Zellers pop-up shops. Founded in 1931, Zellers department store was acquired by HBC in 1978 and operated as the discount division of its flagship department stores. Although Zellers stores were shut down in 2020 because of intense competition and an inability to adapt to the evolving retail environment, HBC announced the brand will be making a reappearance across the country in an effort to tap into consumers’ sense of nostalgia. While the opening of a Zellers at the subject property is generally viewed as a positive development, it is considered a temporary solution while HBC evaluates other profitable conquests.

As noted above, the Ottawa property’s NCF, largely derived from contractual rent payments made by HBC to the RioCan-HBC JV, has shown continued improvement since issuance. Per the YE2021 reporting, NCF improved to $10.8 million (a debt service coverage ratio (DSCR) of 2.21 times (x)), compared with the YE2020 NCF of $10.8 million (a DSCR of 2.21x) and the YE2019 NCF of $9.5 million (a DSCR of 1.96x). When analyzing the loan at issuance, DBRS Morningstar derived a NCF of $7.9 million, reflecting a variance of -14.7% from the Issuer’s NCF of $9.3 million, primarily driven by base-rent mark-to-market adjustments, as DBRS Morningstar marked The Bay’s rent to 110.0% of an estimated market rent of $22.10 per square foot (psf). As of December 2021, the property reported an average rental rate of $31.18 psf, compared with $29.68 psf at issuance.

The property is well located in the highest-trafficked retail district of downtown Ottawa near the newly renovated CF Rideau Centre, one of Ottawa’s top retail destinations, adjacent to Byward Market and the Rideau Canal. Furthermore, the loan benefits from a full-recourse guarantee from a strong sponsor that is required to maintain minimum equity of $750.0 million throughout the loan terms. Considering the aforementioned factors as well as strong financials year over year, DBRS Morningstar believes the loan will continue to operate as expected and successfully secure refinancing prior to its June 2024 maturity.

In determining the ratings, DBRS Morningstar analyzed the cash flow under both a base case and a stressed scenario. The base case scenario, which is based on a standard surveillance haircut to the YE2021 NCF, results in a base case DBRS Morningstar value of $145.4 million, compared with the DBRS Morningstar value of $108.9 million previously derived. Under the stressed scenario, which was based on a 20% stress to the YE2021 NCF, DBRS Morningstar derived a stressed value of $118.7 million, a -34.9% variance from the issuance appraised value of $182.3 million. The conservative haircut was used to evaluate the potential for upgrades given the recent improvement in collateral performance based on the most recent reporting. In both scenarios, DBRS Morningstar applied a capitalization rate of 7.3%, which is at the middle of the range of DBRS Morningstar capitalization rate ranges for retail properties. The implied DBRS Morningstar loan-to-value (LTV) for the stressed scenario is 62.5%.

DBRS Morningstar also maintained positive qualitative adjustments to the final LTV sizing benchmarks used for this rating analysis, totalling 2.5% to account for cash flow volatility, property quality, and market fundamentals.

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 (July 4, 2023) https://www.dbrsmorningstar.com/research/416784.

Class X is an interest-only (IO) certificate that references 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 credit ratings are subject to surveillance, which could result in credit ratings being upgraded, downgraded, placed under review, confirmed, or discontinued by DBRS Morningstar.

Notes:
All figures are in Canadian 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 credit rating was initiated at the request of the rated entity.

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

This is a solicited credit rating.

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

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

The credit 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)

Rating North American CMBS Interest-Only Certificates (December 19, 2022; https://www.dbrsmorningstar.com/research/407577)

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 (June 9, 2023; https://www.dbrsmorningstar.com/research/415687)

Legal Criteria for Canadian Structured Finance (June 20, 2023; https://www.dbrsmorningstar.com/research/416101)

A description of how DBRS Morningstar analyses structured finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/410863.

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