DBRS Morningstar Downgrades Six Classes of Hilton USA Trust 2016-SFP, Changes All Trends to Negative, Removes All Classes From Under Review With Negative Implications

DBRS Limited (DBRS Morningstar) downgraded its ratings on six classes of the Commercial Mortgage Pass-Through Certificates, Series 2016-SFP issued by Hilton USA Trust 2016-SFP as follows:

-- Class B to AA (low) (sf) from AA (sf)
-- Class C to A (low) (sf) from A (sf)
-- Class X-NCP to BBB (low) (sf) from A (low) (sf)
-- Class D to BB (high) (sf) from BBB (high) (sf)
-- Class E to B (high) (sf) from BBB (low) (sf)
-- Class F to CCC (sf) from B (high) (sf)

In addition, DBRS Morningstar confirmed its rating on the following class:

-- Class A at AAA (sf)

DBRS Morningstar also discontinued and withdrew its rating on Class X-E, as the lowest referenced obligation was downgraded to CCC (sf). DBRS Morningstar changed the trends on all classes to Negative from Stable, with the exception of Class F, which has a rating that does not typically carry a trend in commercial mortgage-backed securities (CMBS) ratings. As of this review, DBRS Morningstar removed the transaction from Under Review with Negative Implications where it had been placed on June 16, 2023.

The rating downgrades and trend changes reflect DBRS Morningstar’s deteriorated view of this transaction given the expectation that the as-is values have declined sharply for the underlying collateral, two full-service hotels in San Francisco’s Union Square. At the last review in June 2023, DBRS Morningstar placed all ratings Under Review with Negative Implications following the announcement from the loan’s sponsor, Park Hotels & Resorts Inc., that the collateral hotels would be dropped from the sponsor’s portfolio and loan payments would no longer be made. As anticipated, the loan was subsequently transferred to special servicing for imminent default. The loan has a scheduled maturity in November 2023.

Given the sustained performance declines since 2020 and the distressed San Francisco market, DBRS Morningstar believes that the collateral’s as-is value has likely declined significantly with a loan-to-value ratio (LTV) in excess of 100%. To analyze the impact of a liquidation scenario, which seems likely given the sponsor’s lack of commitment to the collateral portfolio, DBRS Morningstar conducted a recoverability analysis based on a newly derived DBRS Morningstar value, which suggests that Classes D, E, and F would be most exposed to the increased possibility of loss, supporting the downgrades to below investment grade on those classes. While the recoverability analysis suggests that Classes A through C are currently insulated from losses, the as-is value decline suggests significant deterioration in the credit quality of the transaction as a whole, driving the downgrade actions taken with this review. The Negative trends reflect the potential for further value deterioration given the significant market contraction and the potential for a prolonged workout, which could result in accruing advances (or decreased willingness to advance interest given the uncertainties) and increased credit risk to those bonds.

When ratings were assigned in September 2020, the DBRS Morningstar value considered a 45.0% decline to the issuance appraised value of $1.56 billion, to account for the impact of the Coronavirus Disease (COVID-19) pandemic. With loan performance still not at pre-pandemic levels and declining demand in the San Francisco lodging market for the foreseeable future, DBRS Morningstar derived an updated value based on a newly derived as-is net cash flow (NCF) of $47.2 million and a stressed cap rate of 10.0%, resulting in an updated DBRS Morningstar value of $472.6 million ($160,578 per key) for this review. DBRS Morningstar’s as-is NCF incorporates the portfolio’s trailing 12 months (T-12) ended March 30, 2023, revenue per available room (RevPAR) of $126 while maintaining a total expense ratio of 70.7%, in line with the DBRS Morningstar NCF derived when ratings were assigned in 2020. The DBRS Morningstar value implies an LTV of 153.4%, compared with the LTV of 84.4% when ratings were assigned in 2020. DBRS Morningstar made positive qualitative adjustments to the final LTV sizing benchmarks, totaling 0.5% to account for property quality. A previous 1.5% adjustment for market fundamentals was removed with this review because of the stress currently facing the San Francisco market. The results of the LTV sizing suggested significant downgrade pressure across the capital stack, further supporting the downgrades with this review.

The certificates are backed by a $725 million, seven-year, interest-only (IO), fixed-rate, first-mortgage loan secured by the borrower’s fee and leasehold interest and the operating lessees’ leasehold interest in two full-service hotels: Hilton San Francisco Union Square (Union Square) and Hilton Parc 55 San Francisco (Parc 55). The hotels are well located in San Francisco’s Tenderloin District, just off Market Street and less than 0.5 miles from the Moscone Center. The Hilton Union Square property is a 1,919-room, convention-oriented hotel that includes 130,000 square feet (sf) of meeting space. The hotel is the largest in San Francisco and derives about 40% of its demand from the meetings and group segment. The 32-story Parc 55 property is the fourth-largest full-service hotel in San Francisco, with 1,024 guest rooms and 28,000 sf of meeting space. After acquiring the property in 2015, the sponsor invested $5.5 million in upgrades to meet Hilton standards.

The coronavirus pandemic caused economic strain on both hotels for most of 2020, 2021, and 2022 as bookings declined substantially given the reliance on business and corporate as well as leisure travel, which have all been slower to recover relative to other markets. Conferences and large groups drive demand for these hotels as they are within walking distance of the Moscone Center, where most events were cancelled from 2020 to 2021. Demand has not recovered to pre-pandemic levels as only 33 events were booked in 2022. According to the San Francisco Travel Association, in 2023, hotel rooms associated with Moscone Center events are projected to total approximately 663,000 across 36 events, as compared with 968,000 room nights across 49 events in 2019. While bookings are up from 2022, the San Francisco Travel Association does not project bookings and visitor numbers to reach pre-pandemic levels until 2024 or 2025. Recently, however, it was announced that Alphabet would be moving its high-profile Google Cloud Next conference to Las Vegas next year, with other major conferences, such as Salesforce’s Dreamforce, potentially soon to follow.

Although both properties reported notable performance increases in 2022, the Parc 55 hotel did not reopen until May 2022 and the loan continued to produce negative cash flow as of the T-12 ended March 30, 2023. According to the STR report for the T-12 ended March 30, 2023, the properties reported a weighted-average occupancy rate of 52.9%, an average daily rate of $232, and RevPAR of $126, representing significant increases from March 2022 figures, but well below DBRS Morningstar figures assumed when assigning ratings in 2020 of 87.7%, $253, and $222, respectively.

The DBRS Morningstar ratings assigned to Classes A, B, C, D, and E are higher than the results implied by the LTV sizing benchmarks by three or more notches. The variances are warranted given the uncertain loan level event risk, which is compounded by the loan’s recent transfer to special servicing in June 2023 and uncertainty surrounding the collateral’s value. In addition, DBRS Morningstar notes that the hypothetical liquidation scenario considered as part of this review suggests liquidated losses would be contained to the Class D certificate, indicating cushion for Class C and above should a liquidation be realized in the near to medium term.

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).

Class X-NCP is an 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 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. Please note a sensitivity analysis is not performed for CMBS bonds rated CCC or lower. The DBRS Morningstar Long-Term Obligation Rating Scale definition indicates that credit 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 credit ratings are monitored.

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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 (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.