DBRS Morningstar Upgrades Credit Ratings on Three Classes of Real Estate Asset Liquidity Trust, Series 2017; Changes Two Trends to Positive From Stable

DBRS, Inc. (DBRS Morningstar) upgraded its credit ratings on three classes of the Commercial Mortgage Pass-Through Certificates, Series 2017 issued by Real Estate Asset Liquidity Trust, Series 2017 as follows:

-- Class B to AA (high) (sf) from AA (sf)
-- Class X to AA (high) (sf) from AA (low) (sf)
-- Class C at to AA (sf) from A (high) (sf)

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

-- Class A-2 at AAA (sf)
-- Class D-1 at BBB (high) (sf)
-- Class D-2 at BBB (high) (sf)
-- Class E at BBB (low) (sf)
-- Class F at BB (sf)
-- Class G at B (sf)

DBRS Morningstar also changed the trends on Classes D-1 and D-2 to Positive from Stable. The trends on all remaining classes are Stable.

The credit rating upgrades and Positive trends reflect the paydown of approximately $70.3 million since DBRS Morningstar’s last credit rating action in November 2022 and the overall stable-to-improving performance of the remaining collateral. While there are increased risks for a few loans, to which DBRS Morningstar applied elevated probability of default (POD) factors in its analysis, reported performance metrics for most of the pool have been strong, as illustrated by the weighted-average (WA) debt service coverage ratio (DSCR) of 1.74 times (x) based on the most recent year-end financials, compared with the YE2021 DSCR of 1.56x.

As of the October 2023 remittance, 43 of the original 71 loans remain in the pool with a current trust balance of $185.6 million, reflecting collateral reduction of 54.4% since issuance. Since the last credit rating action, the pool size has been reduced by 27.5%. One loan is defeased, representing 4.2% of the pool. To date, there have been no losses to the trust. There are no delinquent or specially serviced loans, although one loan representing 14.2% of the pool balance is on the servicer’s watchlist because of occupancy challenges, as further described below. It is also noteworthy that the majority of the loans in the pool benefit from some level of material recourse to the loan sponsor.

Ten loans, representing 22.4% of the current pool balance, have maturity dates within the next 12 months and are expected to repay at the scheduled maturity date or execute short-term forbearances, based on their healthy credit metrics. This expected paydown will lead to further improvement in credit enhancement, especially for the senior and mid-capital stack bonds. The highest property type concentration is retail, representing 42.1% of the pool, followed by self storage and industrial making up 26.2% and 12.0%, respectively. Although the Coronavirus Disease (COVID-19) pandemic exacerbated existing concerns within the retail sector and changing consumer trends, there have not been any loan defaults or other indicators to date suggesting significantly increased risks from issuance. Only three loans, representing 8.3% of the pool balance, are backed by office properties, further highlighting the favorable makeup of the pool’s underlying collateral.

The largest loan in the pool is Skyline Thunder Centre (Prospectus ID#1; 14.2% of the current pool balance), which is secured by the borrower’s fee interest in a 168,087-square-foot (sf) anchored retail property in Thunder Bay, Ontario. The loan was added to the servicer’s watchlist in September 2020 following the departure of previous tenants Home Outfitters, Marks Work Warehouse, and Pier 1 Imports, which drove occupancy to a low of 65% at YE2019. Occupancy has rebounded slightly, most recently reported at 83.3% as of February 2023, but below the issuance occupancy rate of 99%. According to servicer reported financials, the YE2022 DSCR was 0.88x, up from 0.40x at YE2020, but well below the DBRS Morningstar DSCR of 1.31x at issuance. Over the next year, six tenants composing approximately 20% of net rentable area (NRA) have scheduled lease expirations, including the largest tenant Old Navy which accounts for 8.9% of NRA and has a lease scheduled to expire in November 2024. Mitigating factors include no prior events of default or relief requests, as well as the loan’s full recourse nature to the sponsor, Skyline Commercial REIT. To account for the increased risks associated with the occupancy challenges, DBRS Morningstar analyzed this loan with a POD penalty resulting in an expected loss that was more than three times the pool WA expected loss.

The Worthington Office North Bay loan (Prospectus ID#22, 3.0% of the current pool balance) is secured by a 71,491-sf office property in North Bay, Ontario, and is considered a loan of concern because of its declining performance metrics since issuance. According to the servicer reported financials, occupancy and DSCR were 69.9% and 0.86x, respectively, as of YE2022, compared with 71.8% and 0.88x at YE2021, well below the issuance occupancy of 91% and the DBRS Morningstar DSCR of 1.38x at issuance. Most recently, the former third-largest tenant Strickland Larmer vacated 8.0% of NRA upon lease expiration in 2022 while the two largest tenants, Canada Post Corporation, 27.3% of NRA, and Redpath Mining 12.8% of NRA, extended their leases to 2027 and 2032, respectively. In its analysis, DBRS Morningstar applied a POD penalty to this loan, reflecting the increased risk associated with the performance challenges, resulting in an expected loss that was more than double the pool WA expected loss.

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 is an interest-only (IO) certificate that references a single rated tranche or multiple rated tranches. The IO credit 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 Canadian 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 ratings assigned to Classes D-1, D-2, E, F, and G materially deviate from the credit ratings 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 ratings would consider a three-notch or more deviation from the credit ratings stress implied by the predictive model to be a significator factor in evaluating the credit ratings. The rationale for the material deviation is uncertain loan-level event risk. In particular, the Skyline Thunder Centre, Worthington Office North Bay, and Macyro Group Building loans continue to report below breakeven DSCRs and sustained cash flow declines well below issuance figures. As the loans in question are currently underperforming and the junior classes do not provide significant cushion for losses should these loans or any other loans experience further performance declines, these deviations were deemed warranted, but the Positive trends placed on Classes D-1 and D-2 signal the overall optimistic outlook and suggest upgrades could be made as part of future review cycles.

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 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, Inc.
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Chicago, IL 60602 USA
Tel. +1 312 332-3429

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 version 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 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 Canadian Structured Finance (June 20, 2023; https://www.dbrsmorningstar.com/research/416101)

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