DBRS Morningstar Changes Trends to Negative from Stable on Eight Classes of BBCMS Mortgage Trust 2017-C1

DBRS Limited (DBRS Morningstar) confirmed its ratings on the following classes of Commercial Mortgage Pass-Through Certificates, Series 2017-C1 issued by BBCMS Mortgage Trust 2017-C1:

-- Class A-3 at AAA (sf)
-- Class A-4 at AAA (sf)
-- Class A-SB at AAA (sf)
-- Class A-S at AAA (sf)
-- Class X-A at AAA (sf)
-- Class X-B at AA (high) (sf)
-- Class B at AA (sf)
-- Class C at A (low) (sf)
-- Class X-D at BBB (sf)
-- Class D at BBB (low) (sf)
-- Class X-E at BB (high) (sf)
-- Class E at BB (sf)
-- Class X-F at BB (low) (sf)
-- Class F at B (high) (sf)
-- Class X-G at B (sf)
-- Class G at B (low) (sf)

The trends on Classes X-D, D, X-E, E, X-F, F, X-G, and G have been changed to Negative from Stable. All other trends are Stable.

The rating confirmations and Stable trends reflect DBRS Morningstar’s current outlook and loss expectations for the transaction, which remain relatively unchanged from the November 2022 rating action. However, there are some challenges for the pool, primarily stemming from two loans in special servicing and the high concentration of loans secured by office properties, some of which are exhibiting performance declines given the general challenges faced in that sector. Because of these loan-specific challenges, and the downward ratings pressure implied by the CMBS Insight Model results on the six lowest-rated classes that are most exposed to loss, the Negative trends are warranted. Mitigating factors include the execution of a reinstatement agreement for the largest loan in special servicing and structural features for the three largest loans in the pool, which are secured by office properties, including low to moderate going-in loan-to-value (LTV) ratios and established leasing reserves or cash management provisions. The transaction also benefits from five years of amortization since issuance, as well loan repayments and defeasance, as further described below.

As of the July 2023 reporting, 52 of the original 58 loans remain in the pool with an aggregate principal balance of $751.7 million, representing collateral reduction of 12.2% since issuance, as a result of loan amortization, loan repayments, and the liquidation of one loan from the trust. Five loans, representing 3.0% of the pool, have been fully defeased. There are 14 loans, representing 37.9% of the pool, on the servicer’s watchlist, and two loans, representing 6.1% of the pool in special servicing.

The pool is concentrated by property type with loans secured by office, retail, and hotel properties representing 41.5%, 22.9%, and 15.9% of the pool balance, respectively. In general, the office sector continues to face challenges as uncertainty surrounding end-user demand places upward pressure on vacancy rates, challenging landlords’ efforts to backfill vacant space, and, in certain instances, contributing to value declines, particularly for assets in noncore markets and/or with disadvantages in location, building quality, or amenities offered. While the majority of office loans in the transaction continue to perform as expected, several of these loans are exhibiting increased risk, having seen deteriorations in operating performance as evidenced by the historical occupancy rate and/or cash flow trends demonstrated over the last few reporting periods. Where applicable, DBRS Morningstar increased the probability of default (POD) penalties, and, in certain cases, applied stressed LTV ratios for these loans, with the resulting weighted-average (WA) expected loss (EL) approximately 30.0% greater than pool average.

The largest loan, Alhambra Towers (Prospectus ID#1; 8.1% of the pool), is secured by a Class A office property in Coral Gables, Florida. The loan was added to the servicer’s watchlist in January 2023 for a low debt service coverage ratio (DSCR), which fell to 1.1 times (x) as of YE2022. The decline in the loan’s DSCR was driven by increased vacancy after two large tenant departures, including AerSale, Inc. (formerly 15.7% of net rentable area (NRA)) and Becker & Poliakoff (formerly 12.9% of NRA) in November 2021 and December 2022, respectively. As a result, occupancy fell to 78.0% at YE2022 from 94.4% at YE2020, causing a reduction in net cash flow (NCF). An additional four tenants, representing 14.4% of NRA, have scheduled lease expirations during the next 12 months; however, there has been positive leasing momentum at the property, with Quest Workspaces signing a 22,522-square-foot (sf) lease to occupy the entire tenth floor. The flexible workspace provider has a targeted opening date in Q3 2023. Per the July 2023 reporting, there was approximately $0.6 million held across three reserves.

Although occupancy and cash flow at the property have declined, the loan’s sponsor, The Allen Morris Company (Allen Morris), is an experienced real estate owner, operator, and developer, with more than 60 years of experience in the U.S. real estate market across various asset classes. Furthermore, Allen Morris remains committed to the asset as evidenced by the recent renovation program, which began in the third quarter of 2022 and focused on refinishing the common areas, introducing a new 8,000-sf fine-dining restaurant concept and creating the Alhambra Towers Collector Car Storage, a hurricane-safe private parking garage. According to Reis, the Coral Gables submarket reported a Q2 2023 vacancy rate of 14.1% with an average asking rental rate of $44.7 per sf (psf), compared with the subject’s in-place rate of $50.23 psf. Given the submarket’s soft fundamentals and the elevated vacancy rate at the property, DBRS Morningstar applied an elevated POD penalty in its analysis to reflect the current risk profile and increase the EL for this loan. The resulting EL was approximately 30.0% greater than the pool average.

The second largest loan, 1166 Avenue of the Americas (Prospectus ID#2; 7.5% of the pool), is secured by the first five floors of a Class A office property in Midtown Manhattan. The loan was added to the servicer’s watchlist in July 2023 because the largest tenant, The D.E. Shaw Group (D.E. Shaw; 43.6% of NRA) confirmed they will be vacating their space upon lease expiration in June 2024 (although they may extend the lease an additional three to six months beyond their scheduled expiration date). The second largest tenant, Arcesium (20.0% of NRA), has a lease guaranteed by D.E. Shaw and also has a lease expiration in June 2024. Arcesium is reportedly looking for space elsewhere; although, final decisions have not been confirmed. While the servicer has reported that a 10-year lease is currently being negotiated with a prospective tenant that could occupy most of the third floor (between 15.0% and 20.0% of NRA), occupancy will likely experience volatility over the near to moderate term.

The property generated NCF of $9.8 million in 2022 resulting in a DSCR of 2.2x, which compares favourably with the issuance figures of $8.2 million and 1.8x, respectively. The loan is also structured with a cash sweep that was triggered when D.E. Shaw and Arcesium failed to provide notice of renewal 18 months prior to their June 2024 lease expirations. The cash sweep, which will aid the borrower in its releasing efforts, is structured to trap all excess cash until an amount equal to $75.0 psf is collected. According to the July 2023 reporting, a disbursement of $2.1 million was made from an “other” reserve account, leaving $0.9 million in a tenant reserve.

While the upcoming roll-over is noteworthy, the loan benefits from structural mitigants, namely, the low going-in LTV ratio of 48.9% (based on the whole-loan balance of $110.0 million and the issuance appraised value of $225.0 million) and the cash sweep provisions, which are designed to help mitigate rollover risk by offsetting leasing costs. Moreover, the loan’s maturity date in 2027, will provide the sponsor time to backfill vacant space and work toward stabilization once tenants begin rolling in 2024. Furthermore, the property benefits from its excellent location in Manhattan and a strong loan sponsor, Edward J. Minskoff Equities, Inc. (EJME), a privately held real estate investment and development firm based out of Manhattan, which has ownership interests, leases, and/or manages more than 4.0 million sf of commercial real estate space, which includes other prominent New York properties such as 51 Astor Place and 590 Madison Avenue. In its analysis, DBRS Morningstar increased the POD penalty and LTV ratio for this loan, resulting in an EL approximately 30.0% greater than the pool average.

The third largest loan, 1000 Denny Way (Prospectus ID#3; 7.4% of the pool), is secured by a Class B office building totaling 262,565 sf in Seattle. The loan was added to the servicer’s watchlist in August 2021 after the property’s former largest tenant, The Seattle Times (59.7% of NRA), downsized its space by 108,561 sf as part of a January 2021 lease renewal, driving occupancy down to 63.0%. However, as part of The Seattle Times five-year renewal, the tenant significantly increased its base rental rate from approximately $20.88 psf to $45.00 psf, helping to offset a reduction in rental revenue. A portion of the space formerly occupied by The Seattle Times, was backfilled by Best Buy, which previously subleased 32,500 sf (12.4% of NRA) of space. Best Buy executed a direct lease through 2026 at a rate of $47.90 psf. According to Reis, office properties in the Central Seattle submarket reported a Q2 2023 vacancy rate of 19.0% with an average asking rental rate of $45.81 psf. Despite the significant reduction in occupancy, coverage remains healthy at 1.83x. No updated appraisal has been provided since issuance, when the property was valued at $108.0 million; however, given the low occupancy rate and general challenges for office properties in today’s environment, DBRS Morningstar notes that the collateral’s as-is value has likely declined significantly, elevating the credit risk to the trust. As such, DBRS Morningstar increased the POD for this loan and derived a stressed value based on the property’s in-place cash flow, using the high end of DBRS Morningstar’s capitalization rate range for office properties, resulting in an LTV ratio assumption of more than 100.0%. The resulting EL was approximately 30% greater than the pool average.

As noted above, the borrower for the largest specially serviced loan, Marriott Anaheim Suites (Prospectus ID#9; 3.9% of the pool), has entered into a reinstatement agreement and brought the loan current as of the July 2023 reporting. Despite the workout resolution, the loan is still underperforming expectations. In its analysis for this review, DBRS Morningstar elevated the loan’s POD penalty, resulting in an EL loss that was more than double the pools WA EL.

At issuance, DBRS Morningstar shadow-rated the State Farm Data Center (Prospectus ID#11; 3.3% of the pool) loan as investment grade. This assessment was supported by the loans’ strong credit metrics, strong sponsorship strength, and historically stable collateral performance. With this review, DBRS Morningstar confirms that the characteristics of these loans remain consistent with the investment-grade shadow rating.

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

Classes X-A, X-B, X-D, X-E, X-F, and X-G 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 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 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 credit rating assigned to Class B materially deviates from the credit rating implied by the predictive model. DBRS Morningstar typically expects there to be a substantial likelihood that a reasonable investor or other user of the credit rating would consider a three-notch or more deviation from the credit rating stress(es) implied by the predictive model to be a significant factor in evaluating the credit rating. The rationale for the material deviations is the uncertain loan-level event risk primarily associated with the pool’s high concentration of loans secured by office and retail collateral.

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.

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 credit ratings are monitored.

DBRS Limited
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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 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)

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

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/417279.

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