DBRS Morningstar Changes Trends on Two Classes to Negative From Stable of DC Office Trust 2019-MTC, Confirms All Credit Ratings

DBRS Limited (DBRS Morningstar) confirmed the following credit ratings of the Commercial Mortgage Pass-Through Certificates, Series 2019-MTC issued by DC Office Trust 2019-MTC (the Issuer):

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

DBRS Morningstar changed the trends on Classes D and E to Negative from Stable. All remaining trends are Stable.

The Negative trends reflect DBRS Morningstar’s concerns with the potential for cash flow decline following WeWork’s (12.7% of the net rentable area (NRA); lease expiration in November 2026) bankruptcy announcement and ongoing lease negotiations. DBRS Morningstar conducted a stressed value scenario assuming WeWork’s space to be vacant and determined that the implied property value, which considered updated financials, was in line with DBRS Morningstar’s value derived when assigning ratings in 2020, supporting the rating confirmations. Despite the collateral’s exposure to WeWork, the property remains fully occupied with more than 80.0% of base rent contributed by investment-grade tenant Fannie Mae (82.2% of the NRA, lease expiration in September 2033).

The loan is secured by the Midtown Center, an 867,654-square-foot (sf), 14-story Class A office campus built in 2018, located in Washington, D.C., with ground-floor retail and a three-level below-grade parking garage with 562 spaces. The sponsor, Carr Properties, is an experienced owner, developer, and manager of commercial properties primarily in Washington, D.C., and Boston.

Whole-loan proceeds of $525.0 million were primarily used to refinance existing debt of $472.3 million, fund upfront reserves of $32.3 million, and return $17.1 million of equity to the sponsor. The trust loan balance of $404.0 million has a split-loan structure composed of three senior pari passu A notes totaling $261.0 million and three subordinate B notes totaling $143.0 million. The remaining $121.0 million of the whole loan is composed of pari passu A notes (companion notes); of those companion notes, 23.0% are held in BANK 2019-BNK22 (DBRS Morningstar rated) and the remaining 12.7% are in COMM 2018-GC44 (not rated by DBRS Morningstar). The underlying fixed-rate loan for the subject transaction is interest only (IO) until its stated maturity in September 2033; however, the loan has an anticipated repayment date (ARD) in October 2029. If the borrower is unable to refinance or pay off the loan as of the ARD, the loan shall begin to hyperamortize through use of all excess property cash flow.

Fannie Mae’s lease is structured with contraction rights that allow for 160,200 sf (22.4% of NRA) of space to be contracted annually between the loan’s sixth year and ninth year. Additionally, the lease also features a termination option, where upon at least 32 months’ notice is given, the tenant may terminate its lease in May 2029 or cease operations for at least 50% of its leased space at the subject property. However, the termination risk is mitigated by a termination fee equating to the unamortized transaction costs should the tenant not contract any space prior to exercising the termination option, which was estimated to be $66.2 million as of the termination date. In addition, if Fannie Mae exercised its termination option, the maturity date would revert to the ARD.

As noted at issuance, WeWork’s lease does not have a termination option. If the space goes dark, the tenant would be subject to a penalty in the form of a $8.5 million surety bond that was posted at lease execution, in addition to one year’s rent and carry expenses estimated at $8.3 million. In addition, WeWork signed a corporate guarantee for its space at issuance of which 39,785 sf (4.5% of NRA) is also guaranteed by Fannie Mae. In May 2023, WeWork was granted a 25.0% rent forbearance through December 2024. Other terms included adding another year to WeWork’s lease and increasing its corporate guaranty to 24 months of rent, with the borrower holding the right to void the forbearance at any time. While WeWork remains current on its rent obligations under the current terms of forbearance, the servicer has indicated that the tenant has requested significant rent reduction and contraction at the subject property; however, discussions are still ongoing, and any further modifications have yet to be confirmed.

Based on updated financial reporting, the loan had an annualized trailing six-month ended June 30, 2023, net cash flow (NCF) of $48.6 million (reflecting a debt service ratio (DSCR) of 2.97 times (x)), above the YE2022 figure of $45.0 million (a DSCR of 2.74x), reflecting healthy year-over-year revenue growth despite WeWork’s forbearance, primarily a result of Fannie Mae’s rental rate escalation, as well as increased expense reimbursements and other income. When assigning ratings in 2020, DBRS Morningstar derived an NCF of $42.8 million (a DSCR of 2.65x). While considering a straight-line rent credit for Fannie Mae given the tenant’s long-term credit tenant status, DBRS Morningstar also assumed a blended vacancy rate of 6.2%, and as a result, its NCF was well below the Issuer’s NCF of $47.6 million (a DSCR of 2.86x). According to the June 2023 rent roll, the property had an average rental rate of $51.64 per sf (psf), slightly lower than the September 2022 rate of $51.98 psf and below the East End submarket average rental rate of $64.97 psf for Class A office properties as of September 2023, according to Reis.

When the credit ratings were assigned in 2020, DBRS Morningstar derived the $659.1 million value using a capitalization rate of 6.5%. This resulted in a DBRS Morningstar trust loan-to-value (LTV) ratio of 58.0% and a whole-loan LTV of 79.7%. The DBRS Morningstar value represents a -31.3% variance to the appraiser’s value of $960.0 million. In April 2021, the sponsor sold a 49.0% stake in the subject property to a South Korean syndicate for approximately $490.0 million, valuing the property at $980.0 million, which is above the issuance appraisal and the DBRS Morningstar value. Overall, the property benefits from high occupancy, investment-grade tenancy, and minimal rollover given Fannie Mae’s lease, as well as the property’s above-average quality and location within Washington, D.C.’s East End and Central Business District submarkets. As such, DBRS Morningstar maintained positive qualitative adjustments to the final LTV sizing benchmarks used for this credit rating analysis, totaling 7.0%, to reflect the property’s Class A trophy asset status; close proximity to the White House, Dupont Circle, and Lafayette square; and stable rental income from Fannie Mae’s long-term lease.

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 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.

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
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 Single-Asset/Single-Borrower Ratings Methodology (October 19, 2023; https://www.dbrsmorningstar.com/research/422174)

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].