DBRS Morningstar Changes Trends to Negative on Six Classes of Morgan Stanley Capital I Trust 2018-L1, Confirms All Ratings

DBRS Limited (DBRS Morningstar) confirmed its credit ratings on all classes of the Commercial Mortgage Pass-Through Certificates, Series 2018-L1 issued by Morgan Stanley Capital I Trust 2018-L1 as follows:

-- Class A-2 at AAA (sf)
-- Class A-3 at AAA (sf)
-- Class A-4 at AAA (sf)
-- Class X-A at AAA (sf)
-- Class A-S at AAA (sf)
-- Class A-SB at AAA (sf)
-- Class X-B at AA (high) (sf)
-- Class B at AA (sf)
-- Class C at A (sf)
-- Class D at BBB (high) (sf)
-- Class X-D at BBB (sf)
-- Class E at BBB (low) (sf)
-- Class F-RR at BB (high) (sf)
-- Class G-RR at BB (sf)
-- Class H-RR at B (sf)

In addition, DBRS Morningstar changed the trends on Classes D, X-D, E, F-RR, G-RR, and H-RR to Negative from Stable. All other trends are Stable.

The credit rating confirmations and Stable trends reflect the overall stable performance of the transaction, which remains in line with DBRS Morningstar’s expectations since the last credit rating action. However, there are some challenges for the pool, including the high concentrations of loans secured by office properties with exposure to more challenged secondary markets including Bloomington, Indianapolis, and Rochester, New York. DBRS Morningstar notes mitigating factors including an unrated first loss piece totaling $28.6 million with no losses incurred to the trust to date and no imminent loss projections. In addition, several of the loans backed by office properties continue to perform as expected. DBRS Morningstar also maintained its investment-grade shadow rating on three loans with this review. However, given the loan-specific challenges for select office loans and the downward ratings pressure implied by DBRS Morningstar’s Commercial Mortgage-Backed Securities (CMBS) Insight Model’s results, the Negative trends on the five lowest-rated classes most exposed to loss are warranted.

Per the September 2023 reporting, 46 of the 47 original loans remained in the pool, with an aggregate principal balance of $873.3 million, reflecting a collateral reduction of just 3.0% since issuance as a result of scheduled loan amortization and one loan repayment. No loans have been defeased. There are 13 loans, representing 40.3% of the pool balance, on the servicer’s watchlist; however, over half of these loans on the servicer’s watchlist are being monitored for non-credit-related reasons, namely deferred maintenance. There is one loan, representing 2.9% of the pool, in special servicing. Since DBRS Morningstar’s last review, the Navika Six Portfolio loan (Prospectus ID#4, 4.8% of the pool) was returned to the master servicer as a corrected loan, following a significant improvement in performance. A loan modification was executed in April 2023, which included a full repayment of the $3.4 million in deferred payments and reserve deposits.

The pool is most concentrated by loans that are secured by retail and office properties, which represent 31.6% and 25.5% of the pool, respectively. In general, the office sector has been challenged, given the low investor appetite for the property type and high vacancy rates in many submarkets as a result of the shift in workplace dynamics. While most of the loans continue to perform in line with issuance expectations, the concentration is noteworthy given the overall stress for the office market in recent years. To account for this risk, DBRS Morningstar conducted an analysis to determine office loans that could be exposed to value declines for the collateral properties based on the current performance or future challenges that could arise given rollover concentrations through the loan term. In its analysis for this review, DBRS Morningstar applied stressed loan-to-value ratios (LTVs) or increased probability of default (POD) assumptions for four loans backed by office properties exhibiting increased risks, resulting in a weighted-average (WA) expected loss (EL) nearly double the pool average.

One of the office loans that DBRS Morningstar is monitoring is the Regions Tower (Prospectus ID#11, 3.4% of the pool), which is secured by a 687,237-square-foot (sf) Class A office tower in Indianapolis. The loan was added to the servicer’s watchlist in June 2023 for its upcoming maturity in October 2023. Per the September 2023 reporting, the loan is late on its payment, but less than 30 days delinquent. A pari passu note held in the DBRS Morningstar-rated BANK 2019-BNK16 deal, however, was recently transferred to special servicing for imminent default.

Since issuance, loan performance has declined, with occupancy falling from 84.5% to 76.9% as of Q2 2023, and net cash flow falling from the Issuer's underwritten net cash flow (NCF) figure of $6.7 million (a debt service coverage ratio (DSCR) of 1.85 times (x)) to $5.7 million (a DSCR of 1.59x) as of Q1 2023. While performance has declined, tenant rollover is limited during the next 12 months, with only 2.1% of the net rentable area (NRA), having scheduled lease expirations, and the largest five tenants, representing 39.0% of the NRA, signed to long-term leases with no rollover until November 2025. Nonethless, market conditions have softened, with vacancy reported at 18.2% according to CBRE’s Q2 2023 data, while interest rates have continued to rise, making it more challenging to secure take-out financing, an obstacle the borrower is likely facing. Given the depressed occupancy and NCF figures coupled with the soft market conditions, DBRS Morningstar notes that the collateral’s as-is value has likely declined since issuance, elevating the credit risk to the trust. With consideration for the elevated refinance risk, DBRS Morningstar increased its 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 office properties, with the resulting LTV well above 100.0% and an adjusted EL that was approximately 2.5x the pool average.

The sole specially serviced loan, Shelbourne Global Portfolio I (Prospectus ID#16, 2.9% of the pool), is secured by a portfolio of diverse assets, including three industrial, two office, and one office/flex buildings, totaling 641,000 sf, all of which are located in suburbs of New Jersey. The loan transferred to special servicing in December 2022 because of the borrower’s failure to cure a defined event of default of a lease termination fee and failure to deposit the required TI/LC reserves. While there is no clear workout strategy, the borrower and lender are discussing next steps. Despite the event of default, the loan remains current and has performed with strong occupancy and stable cash flow since issuance. Most recently, the portfolio was reappraised in September 2021 for $166.8 million, reflecting a 17.0% increase over the issuance appraised value and an LTV of 55.7%.

At issuance, DBRS Morningstar assigned investment-grade shadow ratings to three loans: Aventura Mall - Trust (Prospectus ID#1, 6.9% of the pool), Millenium Partners Portfolio – Trust (Prospectus ID#2, 6.9% of the pool), and The Gateway (Prospectus ID#6, 4.6% of the pool). As part of this review, DBRS Morningstar confirmed that the performance of these loans remains consistent with the investment-grade loan characteristics.

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 (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 implied by the predictive model to be a significant factor in evaluating the credit rating. The rationale for the material deviation is uncertain loan-level event risk. The analysis for this review included stressed scenarios for several office loans given the general challenges facing the office sector. The results of the analysis suggest downward pressure through the middle and bottom of the bond stack, most pronounced for Class B. DBRS Morningstar believes the increased risks are most concentrated in the lowest-rated classes, supporting the Negative trend assigned with this review.

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 (August 23, 2023; https://www.dbrsmorningstar.com/research/419593)

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].