Morningstar DBRS Confirms Credit Ratings on All Classes of AREIT 2019-CRE3 Trust, Changes Trend to Negative on One Class

DBRS, Inc. (Morningstar DBRS) confirmed its ratings on all classes of Commercial Mortgage Pass-Through Certificates, Series 2019-CRE3 issued by AREIT 2019-CRE3 Trust as follows:

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

All trends are Stable except for Class F, which has a Negative trend. Morningstar DBRS changed the trend on Class F to Negative from Stable to reflect increased loss expectations for the loans in the pool exhibiting increased credit risks since issuance, including one loan that is in special servicing and others that are backed by office collateral that has underperformed expectations. There is a high concentration of office loans that are scheduled to mature in 2024 and given the hesitancy exhibited by lenders for that property type in 2023, Morningstar DBRS expects there to continue to be refinance difficulty for those borrowers over the near to moderate term.

In conjunction with this press release, Morningstar DBRS has published a Surveillance Performance Update report with in-depth analysis and credit metrics for the transaction as well as business plan updates on select loans. For access to this report, please click on the link under Related Documents below or contact us at [email protected].

The credit rating confirmations reflect the increased credit support to the bonds as a result of successful loan repayments, with collateral reduction of 57.4% since issuance. Although the paydown is a positive for the deal, it has increased the concentration risk for the remaining pool, which is heavily weighted toward loans backed by office collateral. The pool’s collateral initially consisted of 30 floating-rate loans secured by 31 properties, many of which were in a period of transition with plans to stabilize and improve asset values. As of the January 2024 reporting, there were four loans secured by office properties in the transaction, representing 63.6% of the current trust balance.

At issuance, the cut-off balance was $717.9 million, with an additional $93.9 million of available future funding commitments held outside of the trust. The transaction was structured with a 36-month Permitted Funded Companion Participation Acquisition Period that ended in August 2022. As of the January 2024 remittance, there were eight loans in the transaction with a current trust balance of $307.1 million. Since Morningstar DBRS’ previous credit rating action in April 2023, two loans, with a former cumulative trust loan balance of $35.9 million, have been repaid from the transaction. Beyond the office concentration noted above, there are three hotel properties, representing 31.5% of the current pool balance, and one retail property, representing 4.9% of the current pool balance. In terms of property location, the transaction is split between properties in urban and suburban markets. Morningstar DBRS defines urban markets as markets with a Morningstar DBRS Market Rank of 6, 7, or 8, while suburban markets have a Morningstar DBRS Market Rank of 3, 4, or 5. As of January 2024, six loans, representing 83.8% of the cumulative loan balance, were secured by properties in urban markets while two loans, representing 16.2% of the cumulative loan balance, were secured by properties in suburban markets. Historically, urban markets have shown greater liquidity and demand.

The collateral pool exhibits elevated leverage from issuance with a current weighted-average (WA) appraised loan-to-value ratio (LTV) of 70.7% and a WA stabilized LTV of 68.0%. In comparison, these figures were 69.3% and 63.0%, respectively, at closing. As the majority of individual property appraisals were conducted between 2019 and 2022, it is possible values may have decreased since that time, particularly for the office property types, given the current interest rate and capitalization rate environment. In the analysis for this review, Morningstar DBRS considered the likelihood of refinance for each of the remaining loans, based on a stressed value estimate where merited. The results of that analysis showed the pool’s cumulative potential exposure to loans with LTV ratios of more than 100.0% would be contained to the unrated Class G bond, which has a current balance of $55.6 million. However, the bond would be significantly eroded according to that analysis, supporting the Negative trend for Class F.

In total, the lender has advanced $20.6 million in loan future funding to five of the remaining individual borrowers to aid in property stabilization efforts, with the largest advances made to the borrowers 600 Chestnut Street ($6.4 million) and Gulf Tower ($6.3 million) loans. The 600 Chestnut Street loan is secured by an office property in Philadelphia, with the advanced funds used to pay for capital improvement and leasing costs. The Gulf Tower borrower used the advanced funds to cover leasing costs. As of this review, there are no other loans outstanding with available future funding dollars.

As of the January 2024 remittance, there were no loans in special servicing; however, the 318-334 Lincoln Road loan (Prospectus ID# 22; 4.9% of the pool balance), was reported delinquent and is expected to transfer to special servicing with the February 2024 remittance. The loan, which has been delinquent since November 2023, is secured by a retail center totaling 27,391 sf in Miami Beach, Florida. As of Q3 2023, the property was 49% occupied with a reported debt service coverage ratio (DSCR) of 0.44 times (x). The loan was previously modified extending the loan maturity to May 2024. The property was last valued at $22.0 million in February 2022; however, Morningstar DBRS believes the as-is value has likely since declined significantly. In the analysis for this review, Morningstar DBRS considered a stressed value that implied an LTV of over 150%.

There are six loans are the servicer’s watchlist, representing 50.8% of the pool balance, including the aforementioned 318-334 Lincoln Road loan. All loans have been flagged for upcoming loan maturity, though select loans have also been flagged for below-breakeven DSCRs. The largest loan on the servicer’s watchlist is Rialto I & II (Prospectus ID# 4; 12.2% of the pool balance), which is secured by two adjacent, Class A office buildings in Austin, Texas. The property was 91.6% occupied as of the October 2023, up slightly from 88.8% as of January 2023. The loan, which reported a year-end 2023 DSCR of 1.44x, has an upcoming final loan maturity in May 2024. In its analysis, Morningstar DBRS applied a market cap rate to the in-place net cash flow (NCF), which resulted in an elevated LTV ratio near 100%, suggesting a replacement loan will require a significant equity contribution.

The second-largest loan on the servicer’s watchlist, Gulf Tower (Prospectus ID# 7; 11.4% of the pool balance), is secured by an office property in downtown Pittsburgh. The loan has been modified several times with the most recent occurring in June 2023, which extended the loan’s final maturity to February 2024. According to the servicer, the loan may be extended again as the timing for the borrower’s efforts to complete a sale of the property will likely extend beyond the February 2024 maturity date. The property is 45.2% occupied as of October 2023 rent roll, while the loan reported a DSCR of 0.59x. Despite its recent depressed performance, the loan does benefit from outstanding cash reserves of $29.7 million, which include a portion of insurance proceeds to eventually be paid out following an explosion that occurred in May 2021. According to the collateral manager’s Q4 2023 collateral report, the borrower has reached a settlement with the insurance provider that would nearly repay the subject loan in full (when including reserves in place). Morningstar DBRS will continue to monitor closely as the terms of the settlement are finalized and the plans for the loan maturity are solidified.

Morningstar DBRS also notes ongoing concerns surrounding the pool’s largest loan,110 Tower (Prospectus ID#1; 29.4% of the pool balance). The loan, which is secured by an office property in downtown Fort Lauderdale, Florida, has an upcoming final loan maturity of August 2024. The property was 80.7% occupied as of the October 2023 rent roll, which remains in line with the January 2023 figure of 79.5%. According to the T-12 ended September 30, 2023, financials provided by the servicer, the property generated NCF of $5.1 million, equating to a DSCR of 0.76x. In the analysis for this review, Morningstar DBRS applied a market cap rate to the in-place NCF, which resulted in an elevated LTV in excess of 100%, a scenario that weakens refinance prospects later this year.

ENVIRONMENTAL, SOCIAL, AND 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 Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://dbrs.morningstar.com/research/427030 (January 23, 2024).

All credit ratings are subject to surveillance, which could result in credit ratings being upgraded, downgraded, placed under review, confirmed, or discontinued by Morningstar DBRS.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal methodology is North American CMBS Surveillance Methodology (March 16, 2023), https://dbrs.morningstar.com/research/410912.

Other methodologies referenced in this transaction are listed at the end of this press release.

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.

Morningstar DBRS 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.

Morningstar DBRS notes that a sensitivity analysis was not performed for this review as the transaction is in wind-down, with only eight remaining loans. In these cases, Morningstar DBRS credit ratings are typically based on a recoverability analysis for the remaining loans.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS’ outlooks and credit ratings are monitored.

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The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

-- North American CMBS Multi-Borrower Rating Methodology (November 3, 2023)/North American CMBS Insight Model Version 1.2.0.0, https://dbrs.morningstar.com/research/422859
-- DBRS Morningstar North American Commercial Real Estate Property Analysis Criteria (September 22, 2023), https://dbrs.morningstar.com/research/420982
-- North American Commercial Mortgage Servicer Rankings (August 23, 2023), https://dbrs.morningstar.com/research/419592
-- Interest Rate Stresses for U.S. Structured Finance Transactions (June 9, 2023), https://dbrs.morningstar.com/research/415687
-- Legal Criteria for U.S. Structured Finance (December 7, 2023), https://dbrs.morningstar.com/research/425081

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