DBRS Morningstar Upgrades Credit Ratings on Three Classes of Real Estate Asset Liquidity Trust, Series 2016-2, Confirms Ratings on All Remaining Classes

DBRS Limited (DBRS Morningstar) upgraded its credit ratings on three classes of the Commercial Mortgage Pass-Through Certificates, Series 2016-2 issued by Real Estate Asset Liquidity Trust, Series 2016-2 as follows:

-- Class C to AAA (sf) from AA (high) (sf)
-- Class X to AA (high) (sf) from AA (sf)
-- Class D to AA (sf) from AA (low) (sf)

In addition, DBRS Morningstar confirmed its credit ratings on the remaining five classes as follows:

-- Class A-2 at AAA (sf)
-- Class B at AAA (sf)
-- Class E at A (sf)
-- Class F at BB (high) (sf)
-- Class G at B (high) (sf)

All trends are Stable.

The credit rating upgrades reflect the significant paydown since issuance for the transaction and the overall stable performance of the remaining collateral. Since DBRS Morningstar’s last credit rating action, two loans (5.0% of the original pool balance) were repaid in full at their scheduled maturity dates. In total, loan repayments and amortization have reduced the pool balance to $163.6 million as of the October 2023 reporting, representing a collateral reduction of 61.2% since issuance. Two loans, representing 13.2% of the current balance, are scheduled to mature in the second half of 2024. Both of the remaining 2024 maturities benefit from some level of meaningful recourse to the loan’s sponsor, as do the majority of the remaining loans in the pool. One loan is fully defeased, representing 5.5% of the current pool balance. Three loans, representing 20.4% of the pool balance, are on the servicer’s watchlist and there are no specially serviced or delinquent loans.

The largest loan on the servicer’s watchlist, 480 Heslper Road (Prospectus ID#7, 8.1% of the pool), is being monitored for deferred maintenance and the upcoming maturity. The loan is performing as expected, with a debt service coverage ratio (DSCR) of nearly 2.0 times (x) as of YE2022. The collateral anchored retail property in Cambridge is nearly fully occupied and benefits from long-term tenancy that generally has lease expiration dates beyond the loans scheduled maturity date in October 2024. The loan is also full recourse to the sponsor. Given the strong credit metrics, a refinance is expected at maturity. The remaining two loans on the servicer’s watchlist, The Opus (Prospetus ID#8, 7.2% of the pool) and The Duke of Devonshire (Prospectus ID#17, 5.2% of the pool), are being monitored for low DSCRs that were below breakeven based on the YE2022 financials. The Opus loan is secured by a boutique hotel in Vancouver, and cash flows were affected by the decline in travel amid the Coronavirus Disease (COVID-19) pandemic. However, revenue per available room has rebounded significantly with the 2023 reporting, which showed performance above pre-pandemic levels, suggesting the 2023 cash flows should show significant improvement over the prior year.

The Duke of Devonshire loan is secured by a 105-unit independent living facility in Ottawa. The loan has been on the servicer’s watchlist intermittently since October 2017 for a low DSCR, driven by depressed occupancy rates since issuance. Performance declines have been attributed to an oversupply in the local market. The property is owned and operated by Chartwell Retirement Residences (Chartwell; rated BBB (low) with a Negative trend by DBRS Morningstar). As noted in the press release for that credit in April 2023, DBRS Morningstar noted the Negative trend reflected the company’s debt load coupled with the slower-than-expected occupancy recovery and elevated operating expense environment attributed to the effects of the pandemic.

As of March 2023, the property was 56.0% occupied, an improvement from 44.0% in December 2021. Litigation against the vendor has been ongoing since January 2018 relating to breach of contract/fraudulent misrepresentation claims, with the most recent update from the servicer indicating litigation was still in the discovery stage. The loan is full recourse to Chartwell and, although the company has recently dealt with some challenges within their portfolio, it is noteworthy that the subject loan has never been delinquent. However, the sustained performance declines and ongoing litigation could affect the scheduled maturity in September 2024. As such, in the analysis for this review, DBRS Morningstar modeled the loan with an elevated probability of default, resulting in an expected loss (EL) that was nearly double the pool average EL.

The transaction is concentrated by property type with loans backed by office, retail, and industrial properties representing 34.8%, 19.0%, and 14.9% 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. Despite the high concentration of office loans, the majority of the collateral properties benefit from historically stable operations, with a significant concentration of government tenants and leases signed to tenants on a long-term basis. According to the YE2022 reporting, the pool’s office loans reported weighted-average occupancy and DSCR figures of more than 95% and 1.50x. It is noteworthy that there is a concentration of leases expiring during 2024, but all affected loans (excluding one representing 3.3% of the pool) benefit from some level of meaningful recourse to the loan’s sponsor.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factor(s) 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 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 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 rating stress(es) implied by the predictive model to be a significant factor in evaluating the credit ratings. The rationale for the material deviations is uncertain loan-level event risk, primarily tied to select loans that are being monitored on the servicer’s watchlist, as noted above. In addition, as the pool continues to season, there could be risk factors associated with cash flow volatility and/or adverse selection.

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.

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 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)

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/410863.

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