Morningstar DBRS Downgrades Credit Ratings on Three Classes of Wells Fargo Commercial Mortgage Trust 2016-NXS5

DBRS Limited (Morningstar DBRS) downgraded its credit ratings on three classes of Commercial Mortgage Pass-Through Certificates, Series 2016-NXS5 issued by Wells Fargo Commercial Mortgage Trust 2016-NXS5 as follows:

-- Class D to BB (low) (sf) from BBB (low) (sf)
-- Class E to CCC (sf) from B (sf)
-- Class F to C (sf) from CCC (sf)

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

-- Class A-4 at AAA (sf)
-- Class A-5 at AAA (sf)
-- Class A-6 at AAA (sf)
-- Class A-6FL at AAA (sf)
-- Class A-S at AAA (sf)
-- Class A-SB at AAA (sf)
-- Class X-A at AAA (sf)
-- Class X-B at AA (low) (sf)
-- Class B at A (high) (sf)
-- Class C at BBB (high) (sf)
-- Class G at C (sf)

The trend on Class D remains Negative. In addition, Morningstar DBRS changed the trends on Classes X-B, B, and C to Negative from Stable. All other trends are Stable, with the exception of Classes E, F, and G, which have credit ratings that do not typically carry a trend in commercial mortgage-backed securities (CMBS) credit ratings.

Morningstar DBRS downgraded Classes E, F, and G during its prior review to reflect the projected loss expectations tied to loans in special servicing, primarily driven by the largest loan in the pool, 10 South LaSalle Street (Prospectus ID# 2; 11.8% of the pool), which is secured by a Class B office property in Chicago. The liquidation analysis assumed a haircut to the collateral’s appraised value at issuance but, considering operating performance at the property remains depressed; coupled with soft office submarket fundamentals, limited investor appetite for the asset class, and the current high interest rate environment, the property’s value has likely declined further since that time. Additional details of the loan are highlighted below. For this review, Morningstar DBRS assumed a liquidation scenario for four of the five loans in special servicing, resulting in a cumulative projected loss amount of $54.1 million, approximately $32.0 million of which is tied to the 10 South LaSalle Street loan. Those losses would erode the entirety of the Class H (nonrated) and Class G balance, in addition to approximately 25.0% of the Class F balance; supporting the credit rating downgrades with this review. The trend changes on Classes X-B, B, and C to Negative from Stable reflect the erosion in credit support to the transaction, based on Morningstar DBRS’ loss projections. Additionally, there is a moderate concentration of loans backed by office properties representing 18.5% of the pool balance. As the pool begins to wind down in 2025, Morningstar DBRS notes increased refinance risk for a few office-backed loans that could face difficulty securing replacement financing in the near to moderate term as performance declines from issuance and decreased tenant demand have likely eroded property values, which further supports the Negative trends assigned with this review.

As of the February 2024 remittance, 55 of the original 64 loans remain in the pool, with a trust balance of $635.7 million, representing collateral reduction of 27.4% since issuance. To date, the trust has incurred a total loss of $2.6 million, which has been contained to the nonrated Class H certificate. Ten loans, representing 18.5% of the pool balance, are on the servicer’s watchlist and five loans, representing 17.2% of the pool balance are in special servicing. In addition, 12 loans, representing 16.9% of the pool balance, are fully defeased.

The 10 South Lasalle Street loan is collateralized by a 781,426-square-foot (sf), Class B office property in the Central Loop submarket of Chicago. The 10-year fixed-rate loan pays interest only (IO) and is pari passu with Wells Fargo Commercial Mortgage Trust 2016-C32, which Morningstar DBRS also rates. The loan transferred to the special servicer in August 2022 for imminent default, though it has remained current since the transfer with active cash management provisions in place. The building is within the City of Chicago’s planned LaSalle Street redevelopment project, and as part of the initiative, developers hope to convert existing office space to residential units. The subject was not included in a March 2023 shortlist of properties selected for redevelopment that, according to recent reports, is expected to begin moving forward in the Spring of 2024.

No updated financials have been provided for this asset since the prior review. Occupancy has been in decline since issuance and according to the YE2022 operating statement analysis report (OSAR), the property was 75.5% occupied, with leases comprising11.4% of the net rentable area (NRA) scheduled to expire through 2024. The largest tenant is Chicago Title Insurance, occupying 13.6% of the NRA on a lease expiring in March 2025. The remaining tenancy is granular, which no other tenant representing more than 8.0% of the NRA. According to LoopNet, space is currently being marketed at an average rate of $19.0 per square foot (psf), which is below the Reis reported market average of $29.22 psf in Q4 2023. There has been no updated appraisal ordered since issuance, as the loan remains current. Given the continued concerns with performance trends, lack of leasing activity, and the soft submarket, Morningstar DBRS expects a considerable decline in value for this property. In the analysis for this review, Morningstar DBRS took a conservative approach and applied a haircut to the issuance value, resulting in a loss severity in excess of 40.0%.

The second-largest loan in special servicing, 1006 Madison Avenue (Prospectus ID#16; 2.7% of the pool), is secured by a 3,917-sf single-tenant retail property in Manhattan, New York. The loan transferred to the special servicer in October 2018 for imminent monetary default, following the departure of the property’s sole tenant in late 2018 (ahead of its lease expiration in 2025), with the property remaining vacant since. The collateral has been real estate owned since July 2022. A July 2023 appraisal valued the property at $6.6 million, unchanged from the November 2022 value but a steep decline from the issuance appraised value of $24.0 million. In its analysis, Morningstar DBRS assumed a full loss to the loan.

The second largest loan on the servicer’s watchlist, 4400 Jenifer Street (Prospectus ID#8; 4.0% of pool balance) is secured by a three-story, 83,777-sf Class B office property in the Friendship Heights neighborhood of Washington, D.C. The property was built in 1972 and underwent extensive renovations between 1998 and 1999. The loan was added to the servicer’s watchlist in March 2022 for low occupancy after the second-largest tenant, Long & Foster Real Estate (11.7% of NRA), vacated prior to its September 2021 lease expiration. Occupancy remains stressed, most recently reported at 68.2% (YE2023) with the debt service coverage ratio significantly below break-even since YE2021. According to the December 2023 rent roll, tenant leases representing 11.2% of the NRA are either operating on a month-to-month basis or are expected to roll within the next 12 months. In its analysis for this review, Morningstar DBRS analyzed the loan with an elevated probability of default penalty and stressed loan-to-value ratio, resulting in an expected loss that was more than double 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 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 (January 23, 2024) https://dbrs.morningstar.com/research/427030.

Classes X-A and X-B are IO certificates that reference 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 Morningstar DBRS.

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

The principal methodology is the North American CMBS Surveillance Methodology, (March 1, 2024; https://dbrs.morningstar.com/research/428798).

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

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 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.

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 Morningstar DBRS Long-Term Obligation Rating Scale definition indicates that 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.

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, (March 01, 2024)/ North American CMBS Insight Model v 1.2.0.0 https://dbrs.morningstar.com/research/428797

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)

Rating North American CMBS Interest-Only Certificates (December 13, 2023; https://dbrs.morningstar.com/research/425261)

Legal Criteria for U.S. Structured Finance (December 7, 2023; https://dbrs.morningstar.com/research/425081)

A description of how Morningstar DBRS analyzes structured finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/417279.

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