DBRS Morningstar Downgrades Ratings on Nine Classes of Wells Fargo Commercial Mortgage Trust 2016-C36, Changes Trends on Three Classes to Negative from Stable

DBRS Limited (DBRS Morningstar) downgraded its ratings on nine of the Commercial Mortgage Pass-Through Certificates, Series 2016-C36 issued by Wells Fargo Commercial Mortgage Trust 2016-C36 as follows:

-- Class X-D to BBB (sf) from BBB (high) (sf)
-- Class D to BBB (low) (sf) from BBB (sf)
-- Class E-1 to BB (high) (sf) from BBB (low) (sf)
-- Class E-2 to B (sf) from B (high) (sf)
-- Class E to B (sf) from B (high) (sf)
-- Class F-1 to B (low) (sf) from B (sf)
-- Class F-2 to CCC (sf) from B (low) (sf)
-- Class EF to CCC (sf) from B (low) (sf)
-- Class F to CCC (sf) from B (low) (sf)

DBRS Morningstar also confirmed its ratings on the remaining classes as follows:

-- 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 (sf)
-- Class G1 at CCC (sf)
-- Class G2 at C (sf)
-- Class EFG at C (sf)
-- Class G at C (sf)

DBRS Morningstar also changed the trends on Classes C, X-D and D to Negative from Stable. The trends on classes E-1, E-2, E and F-1 remain Negative. Classes F-2, F, EF, G-1, G2, G and EFG have ratings that do not typically carry a trend for commercial mortgage-backed securities (CMBS) ratings. All other trends are Stable.

The rating actions primarily reflect DBRS Morningstar’s increased concerns over the transactions’ implied credit deterioration, driven by the implied losses for two specially serviced loans that were liquidated from the trust and a high concentration of loans backed by office and retail properties exhibiting declines in performance and/or projected values since issuance, including the three largest loans, which represent 28.9% of the pool.

While the concentration of loans in special servicing has been reduced since last review to three loans, representing 2.8% of the pool, following the reinstatement of Conrad Indianapolis (Prospectus ID#6, 3.9% of the pool) to the master servicer and a principal curtailment for Mall at Turtle Creek (Prospectus ID#7, 1.7% of the pool) funded through insurance proceeds, DBRS Morningstar liquidated the two REO loans from the trust, resulting in an implied loss of more than $16.0 million. Based on these results, the balance of second loss-piece, Class H-1, would be written down by more than 60%, significantly eroding the transaction’s credit support, particularly toward the bottom of the capital stack. While many office and retail loans in the transaction continue to perform as expected, several others are exhibiting increased risk, and as such, DBRS Morningstar applied stressed loan-to-value ratios (LTV) or increased probability of default (POD) assumptions, resulting in a weighted-average (WA) expected loss (EL) for the pool that was nearly 1.4 times (x) greater than the previous review. When compounded with DBRS Morningstar’s liquidation analysis, the CMBS Insight Model results indicate significant downward pressure, supporting the rating actions.

Aside from the changes noted above, the transactions’ collateral composition remains relatively unchanged since last review. Per the August 2023 reporting, 66 of the original 73 loans in the pool, with a trust balance of $717.8 million, represented a collateral reduction of 16.4% since issuance as a result of scheduled loan amortization and loan repayment. There are 14 loans, representing 9.0% of the pool, that are secured by collateral that has been fully defeased. Nine loans, representing 20.1% of the pool are on the servicer’s watchlist, and three loans, representing 2.8% of the pool, are in special servicing.

The largest specially serviced loan, Mall at Turtle Creek, is a pari passu loan secured by a portion of a regional mall in Jonesboro, Arkansas. Following a period of gradual decline in performance since issuance, exacerbated by business interruptions from the pandemic and significant damage from a tornado, which destroyed the majority of the mall, the loan was transferred to special servicing in August 2020 for monetary default. The trust took title of the property in December 2022 through an agreement that provided nearly $14.0 million of principal curtailment, which reduced the loan’s total exposure, reported to be $12.5 million per the August 2023 reporting. While an August 2023 news article indicates that the Spinoso Real Estate Group (SREG) has plans to revive the property, which is currently being demolished, a major redevelopment would need to be undertaken, requiring a significant amount of capital. According to the servicer, a sale of the site is expected to occur no earlier than Q4 2023. DBRS Morningstar has requested an update from the servicer to indicate if SREG is the receiver or has acquired interest in the mall collateral, in addition to an updated appraisal in light of the ongoing demolition. Given the current condition of the property without any clarity surrounding potential redevelopment plans, DBRS Morningstar liquidated the loan from the trust with an implied loss matching the loan’s total exposure, or a loss severity of 100%.

Excluding collateral that has been defeased, the pool is concentrated by loans secured by retail and office properties, which represent 32.6% and 24.7% of the pool, respectively. Given the uncertainty related to the end-user demand and investor appetite for office properties, DBRS Morningstar anticipates upward pressure on vacancy rates in the broader office market, challenging landlords’ efforts to backfill vacant space. In certain instances, this pressure can contribute to value declines, particularly for assets in noncore markets and/or with disadvantages in location, building quality, or amenities offered. While select office loans in the transaction continue to perform as expected, DBRS Morningstar applied stressed LTVs or increased POD assumptions to four loans backed by office properties exhibiting declines in performance, resulting in a WA EL that was approximately 80.0% greater than the pool average.

The second largest office loan, Plaza America I & II (Prospectus ID#3, 9.1% of the pool), is secured by a 514,615-square foot (sf), Class A, office complex in Northern Virginia, about 20 miles northwest of Washington, D.C. Occupancy at the subject property has declined from 88.0% at issuance to 80.1% as of June 2023 following the loss of a few smaller tenants and the downsizing of the property’s largest tenant, Software AG (currently 12.1% of net rentable area (NRA)), which relinquished 11,218 sf (2.1% of NRA) in February 2020. While Software AG retains two five-year renewal options, servicer commentary indicates that the tenant will be vacating upon its lease expiration in February 2024, further reducing occupancy to an implied rate below 70.0%, with an additional 19 tenants (34% of NRA) scheduled to roll prior to loan maturity in August 2026. According to LoopNet, the borrower is currently marketing 236,323 sf (45.9% of NRA) of the property’s space, with asking rates between $42.5 per square foot (sf) and $44 psf, compared with the subject properties’ average rental rate of $31.25. As of Q2 2023, Reis reported that office properties in the Reston submarket had an average vacancy rate of 18.2%, an average effective rental rate of $30.7, psf and an average asking rental rate of 36.5 psf, respectively, compared with the Q2 2022 figures of 16.4%, $30.6 psf, and $36.6 psf, respectively. While loan performance has historically been healthy, the trailing-six month financials ended June 30, 2023, reported a debt service coverage ratio of 1.77 times (x), exhibiting nearly a 10% decline in cash flow from the Issuer’s underwritten figure of 1.96x, with a property availability rate of nearly 50%. Given the potential volatility coupled by the soft market conditions, which could significantly elevate the loans’ refinance risk, DBRS Morningstar analyzed this loan with a stressed LTV and POD assumption that resulted in an EL nearly 2.5x the pool average.

The largest loan in the pool, Gurnee Mills (Prospectus ID#1, 10.4% of the pool), is secured by a portion of a regional mall in Gurnee, Illinois. Simon Property Group (Simon) owns and operates the collateral portion of the property. At issuance, the largest tenants were Sears, Bass Pro Shops, and Macy’s. The Sears closed in 2018, and the sponsor has yet to backfill the space. The loan was transferred to special servicing in June 2020 as a result of monetary default related to the effects of the coronavirus pandemic; however, following forbearance and loan modification, the loan was returned to the master servicer in May 2021. While there has been moderately improved performance since the lows of the Coronavirus Disease (COVID-19) pandemic, net cash flow was reported at $19.7 million, reflecting a decline of nearly 20% from the Issuer’s underwritten NCF of $25.1 million. Occupancy at the subject property has declined from 91.1% at issuance to 76.0% as of March 2023, following the loss of such tenants as Sears (formerly 12.0% of NRA) in 2018, Rink Side (formerly 3.3% of NRA) in 2021, and most recently, Bed Bath & Beyond (formerly 3.6% of NRA) in 2022. Given that occupancy and NCF at the property have remained stressed for an extended period of time, DBRS Morningstar notes that the collateral’s as-is value has likely declined significantly since issuance, elevating the credit risk to the trust. As such, DBRS Morningstar increased POD assumption 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 cap rate range for retail properties, with the resulting LTV well above 100.0% and the adjusted EL that was 2.3x 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/416784 (July 4, 2023).

Classes X-A, X-B, and X-D are interest only (I-O) 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 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
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 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 (August 23, 2023; https://www.dbrsmorningstar.com/research/419592)

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].