DBRS Morningstar Downgrades One Class of Hamlet Securitization Trust 2020-CRE1

DBRS Limited (DBRS Morningstar) downgraded its credit rating on one class of the Commercial Mortgage Pass-Through Certificates, Series 2020-CRE1 issued by Hamlet Securitization Trust 2020-CRE1:

-- Class F-RR to CCC (sf) from B (low) (sf)

In addition, DBRS Morningstar confirmed its credit ratings on the following classes:

-- Class A at AAA (sf)
-- Class B at AA (low) (sf)
-- Class C at A (low) (sf)
-- Class D at BBB (low) (sf)
-- Class E at BB (high) (sf)

All trends are Stable, with the exception of Class F-RR, which has a rating that does not typically carry a trend in commercial mortgage-backed securities (CMBS) ratings.

The rating downgrade reflects a period of unpaid interest and realized losses, stemming from 545 & 555 North Michigan Avenue (Prospectus ID#12, 3.2% of the pool), which received a loan modification in March 2023. Terms of the modification included splitting the loan into A and B notes, with interest being deferred on the A note through month 36 of the modification. As a result, interest shortfalls have been accumulating, extending into Class F-RR starting with the May 2023 reporting. In an effort to repay the shortfalls, the servicer diverted distributable principal starting with the May 2023 remittance, resulting in a realized loss of $2.5 million being passed through to the trust as of the September 2023 remittance. Although unpaid interest to Class F-RR has been partially reimbursed, the certificate has been shorted for five consecutive months as of the September 2023 remittance, and is approaching DBRS Morningstar’s maximum shortfall tolerance for the respective rating category assigned prior to this rating action. Given the structure of the loan modification, DBRS Morningstar expects that interest shortfalls will continue to accumulate or additional realized loss will be passed through to the trust to repay interest due, further eroding credit support to the bonds.

545 & 555 North Michigan Avenue is secured by two adjacent low-rise retail buildings on Chicago’s Magnificent Mile, on the corner of North Michigan Avenue and East Ohio Street, totalling 61,909 square feet (sf). The 555 building includes 45,904 sf, with the remaining 16,005 sf contained within the 545 building. At closing, both buildings were leased to single tenants; however, vacancy fell to 74.3% following the departure of Gap in 2020, which fully occupied the 555 building. The loan was transferred to special servicing in February 2022 for imminent monetary default following the borrower’s missed debt payment and the indication it would no longer be able to make future payments under the original loan terms.

As noted above, an A/B note structure loan modification was executed in March 2023, and the loan was subsequently returned to the master servicer in May 2023. Terms of the loan modification include splitting the note into a $55.0 million A note and a $20.0 million B note, which is subordinate to the borrower’s equity contribution of approximately $9.8 million. Interest on the A note will accrue until month 36, when it will be payable at the contract rate, while interest on the B note will continue to accrue through the remainder of the loan term in November 2027. Upon the effective modification date, the borrower was required to fund approximately $9.8 million of new equity, including a $4.6 million deposit into a stabilization reserve and a $1.8 million deposit into an operating shortfall reserve. The borrower will also be required to fund up to $5.0 million of tenant improvements arising under the newly signed Aritzia lease, among other obligations.

In May 2023, the borrower was permitted to execute a 12-year lease agreement with Aritzia, which will fully occupy the 555 building (74.3% of the net rentable area (NRA)), through August 2035, bringing the property’s occupancy to 100%. Following the build out of its new space, Aritzia will receive one full year of free rent and will pay an initial base rent of $71.35 per square foot (psf), with annual rent escalation of 3.0%. Prior to departing, Gap paid a base rent of $72.54 psf. At issuance, the 545 building was leased to luxury watch boutique retailer, Tourbillon, through its parent company, Swatch. The space was sublet to UGG coterminously with Swatch’s original lease expiration in January 2023. Following the conclusion of the sublease, UGG’s parent company, Deckers Retail, LLC, signed a direct lease for the space, expiring in January 2024. DBRS Morningstar has requested a leasing update, but no updates have been provided.

While financial performance has recently yielded negative cash flow, the recent restructuring of the loan through its modification, along with the recent signing of Aritzia and a significant contribution of borrower equity (some of which is specifically tied to TI/LC costs) should better the borrower’s ability to stabilize operations. Despite recent developments, DBRS Morningstar applied a probability of default (POD) penalty for this review, given the near-term tenant rollover coupled with the extremely soft market conditions, exhibiting vacancy of 17.8%. This resulted in an expected loss that was approximately 2.0 times (x) the pool average.

The rating confirmations and Stable trends reflect the otherwise overall consistent performance of the transaction since last review. Per the September 2023 reporting, 21 of the original 23 loans remain in the pool, with an aggregate principal balance of $1.67 billion, representing a collateral reduction of 11.9% since issuance. There are no delinquent or special serviced loans, following the reinstatement of 545 & 555 North Michigan Avenue, but there are nine loans, representing 38.9% of the pool balance, on the servicer’s watchlist. Four of these loans (16.8% of the pool) are being monitored for failing to submit updated financials, while the remaining five loans (22.1% of the pool) are being monitored for either low debt service coverage ratios (DSCRs) or other servicing trigger events.

At issuance, there were four transitional loans (27.9% of the pool) secured in the pool. Three of the four loans have completed their original business plans; however, 20 Broad Street (Prospectus ID#1, 13.2% of the pool) is still working toward its original plan of leasing up its retail space and remains on the servicer’s watchlist for a low DSCR. The loan is secured by the leasehold interest in a 533-unit luxury residential property, with 39,029 sf of retail space located in Manhattan’s Financial District. The sponsor, MetroLoft, acquired the property in 2015 and completed a gut renovation to reposition the property.

While leasing of the retail space has been slower than expected, the borrower does have a master lease signed for the unleased space, which will be released as the space is signed. Per the Q4 2022 reporting, the retail space was 46% occupied, up from 38% in Q3 2022 following the signing of Los Tacos (7.7% of the NRA). The borrower is also in discussions with two prospective tenants that are interested in leasing the remaining ground floor space. At issuance, 235 of the 355 residential units were subject to a 10-year lease with Sonder through August 2029; however, the tenant stopped making rent payments in July 2020. Following the tenant’s default, the lease was ultimately terminated, with litigation ongoing. While the sponsor has leased the residential space back to 95% occupied as of Q4 2022, following an aggressive marketing campaign which included the use of concessions, financials have not yet captured the upside. Per the trailing 12-month financials ending September 30, 2022, the loan reported a net cash flow of $10.9 million (a DSCR of 0.78x), which is well below the budgeted figure for 2023 and the DBRS Morningstar Stabilized figure of $15.1 million (a DSCR of 1.70x). Given the recent leasing updates, DBRS Morningstar remains optimistic about the borrower’s ability to stabilize property operations during the near term.

The pool is considerably concentrated, with loans secured by office and multifamily properties, representing 40.1% and 32.4% of the pool balance, respectively. In general, the office sector has been challenged, given the low investor appetite for that property type and high vacancy rates in many submarkets as a result of the shift in workplace dynamics. While select office loans in the transaction continue to perform as expected, several others are exhibiting increased risk. In its analysis for this review, DBRS Morningstar applied stressed loan-to-value (LTV) ratios or increased POD assumptions for two loans backed by office properties that are exhibiting declines in performance, resulting in a weighted-average (WA) expected loss (EL) approximately 3.0x greater than the pool average.

One of these loans, Merritt on the River Portfolio (Prospectus ID #3, 12.0% of the pool), is secured by three Class A office buildings and two Class B office buildings, totalling 974,575 sf, located in Norwalk, Connecticut. According to the most recent rent roll dated September 2022, the subject was 85.9% occupied compared to the issuance occupancy rate of 73.2%; however, there is a considerable amount of tenant rollover during the next 24 months, as tenants representing 55.5% of NRA have leases scheduled to expire. This includes two of the three largest tenants at the property, GE Capital (39.7% of the NRA, lease expiry February 2025) and Bridgewater (9.4% of the NRA, lease expiry April 2024). According to LoopNet, approximately 27.0% of the total NRA is currently being marketed for lease, including a portion of the GE Capital space. As of Q2 2023, Reis data indicated that the submarket of Central in Fairfield County reported a vacancy rate of 25.5%, an increased over the Q2 2023 rate of 22.4%. Per the Q3 2022 annualized financials, the loan reported a net operating income of $19.6 million, lower than the year-end (YE) 2021 NOI of $24.5 million and the DBRS Morningstar figure of $22.3 million. The decreased NOI in 2022, despite a rise in the occupancy rate, was primarily due to a $2.8 million termination fee from Bridgewater that was included in revenue during the 2021 reporting period. Furthermore, the subject has seen an increase in operating expenses since issuance also contributing to the decline in 2022 and as compared to the DBRS Morningstar figures. Given the near-term concentration of tenant rollover paired with the soft submarket conditions, DBRS Morningstar analysed this loan with a stressed LTV assumption and a POD penalty, resulting in an expected loss that was nearly 3.5x 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).

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.

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/North American CMBS Insight Model Version 1.1.0.0 (March 16, 2023; 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 22, 2023; https://www.dbrsmorningstar.com/research/420982)

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 analyzes 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].