Morningstar DBRS Downgrades Credit Ratings on Four Classes of BXMT 2020-FL2, Ltd.; Confirms All Other Classes

DBRS, Inc. (Morningstar DBRS) downgraded its credit ratings on four classes of notes issued by BXMT 2020-FL2, Ltd. as follows:

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

Morningstar DBRS also confirmed its credit ratings on the remaining classes of notes as follows:

-- Class A at AAA (sf)
-- Class A-S at AAA (sf)
-- Class B at AA (low) (sf)
-- Class C at A (low) (sf)

Morningstar DBRS also changed the trends on Classes C, D, E, and F to Negative from Stable. Class G now has a credit rating that does not typically carry a trend in commercial mortgage backed securities ratings. The trends on Classes A, A-S, and B remain Stable.

The credit rating downgrades and trend changes reflect the increased credit risk to the transaction as a result of Morningstar DBRS’ increased loan-level expected losses for the majority of the loans in the transaction, particularly for the seven loans secured by office properties, which represent 47.8% of the current trust balance. An additional four loans, representing 38.0% of the current trust balance, are secured by mixed-use properties with a material office collateral component. The majority of these 11 loans have borrowers who have been unable to successfully execute the stated business plans to date. The stunted efforts to stabilize the collateral properties have also been compounded by increased debt service payments as all 15 loans in the transaction have floating interest rates. According to the financial statements for the collateral properties as of the trailing 12 months (T-12) ended September 30, 2023, the servicer reported the pool had a weighted-average (WA) net operating income (NOI) debt service coverage ratio (DSCR) of 0.89 times (x). The seven loans secured by office collateral reported a WA NOI DSCR of 0.80x, with a range of 0.48x to 1.52x.

Nine loans, representing 53.4% of the current trust balance, mature throughout 2024; of those, seven loans, representing 47.5% of the current trust balance, are secured by office and mixed-use properties. Based on the NOI in the T-12 ended September 30, 2023, for those seven properties and the most recent as-is appraised values (most of which date from issuance), the implied cap rates ranged between 2.5% and 6.3%, suggesting the as-is values have likely declined since those appraisals and borrowers will likely need to either contribute significant cash equity to secure refinance capital or exercise the remaining maturity extension options. As such, those loans were stressed in Morningstar DBRS’ analysis for this review to increase the expected losses, supporting the rating actions with this review.

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].

As of the February 2024 remittance, the trust reported an outstanding balance of $1.13 billion with 15 loans remaining in the trust, representing collateral reduction of 24.6% since issuance. Since the previous Morningstar DBRS rating action in April 2023, there has been a collateral reduction of $184.7 million, including the full repayment of two loans and the partial repayment of two loans as part of executed loan extensions. The two loans that repaid in full were secured by hotel properties. There are four remaining loans, representing 14.2% of the current trust balance, are secured by hotel properties.

There are currently no specially serviced loans; however, nine loans, representing 55.6% of the current trust balance, are on the servicer’s watchlist and all loans in the pool have been modified. Loan modifications have generally allowed borrowers to extend loans without meeting performance-based extension tests. In some cases, modifications allowed for changes to the interest rate terms. In exchange, borrowers have been required to contribute fresh capital, either in the form of deposits into operating reserves or paying down loan balances. In select cases, loan modifications have allowed for increases to future funding dollars, though the increase in potential additional debt is often junior to the senior loan held within the trust. In instances where senior debt was increased, the issuer requested a Rating Agency Condition letter from Morningstar DBRS.

Loans on the servicer’s watchlist have been flagged for upcoming loan maturities and/or below breakeven DSCRs. The largest loan on the servicer’s watchlist and the largest loan in the transaction is One South Wacker (Prospectus ID#19; 14.1% of the trust balance). The loan is secured by a 1.2 million-square foot (sf) Class A office tower in downtown Chicago. The $289.4 million A-note ($159.0 million trust note) matured in December 2023 and the loan was modified to allow the borrower to extend the maturity to December 2025 with four additional three-month extension options, pushing the final maturity date to December 2026. The modification also converted the previously outstanding $20.6 million of available loan future funding into junior debt and added an additional $46.0 million of future funding in the form of junior debt for leasing costs. The potential fully funded whole loan is now $356.0 million.

In exchange, the borrower was required to make an initial cash equity deposit of $6.9 million with required additional contributions of $2.5 million each in April 2024, January 2025, and July 2025. The borrower must also make the following deposits into the newly created Reallocated Equity Contribution Reserve: $750,000 in April 2024 and $1.0 million in each of July 2024, October 2024, April 2025, October 2025, May 2026, and August 2026 (if the loan is extended). Regarding the loan extension options, which include up to four three-month extensions, the borrower will be required to contribute an additional $2.5 million each time if it extends the maturity dates to September 2026 and December 2026. Lastly, the borrower has agreed to an excess cash trap throughout the full term of the loan and to purchase a rolling three-month interest rate cap agreement with a 6.00% strike rate for the outstanding debt amount, inclusive of any future loan advances. The loan has a current floating-rate spread of 1.75% with a floating-rate benchmark floor of 3.50%.

As of December 2023, the property was 66.7% occupied, but according to the collateral manager, the property is 70.0% leased as the largest tenant, Invenergy (currently 14.2% of the net rentable area (NRA)), has agreed to an expansion. Morningstar DBRS is awaiting further information regarding the tenant’s lease renewal terms; however, multiple news articles noted the tenant is expected to occupy approximately 180,000 sf (15.1% of the NRA). To execute the lease, the borrower will fund costs totaling $26.0 million across tenant improvements, leasing costs, and amenity upgrades. According to the YE2023 financials provided by the collateral manager, the property generated NOI of $9.7 million, equating to an NOI DSCR of 0.60x and a 3.3% debt yield.

While operations are expected to improve given the Invenergy lease renewal and expansion, based on the original as-is appraised value from October 2019 and the YE2023 NOI, the implied cap rate is 3.1%, suggesting the current market value of the property has significantly declined and the current loan-to-value (LTV) ratio is above 100.0%. According to the CBRE “United States Cap Rate Survey H1 2023,” Class A stabilized office properties in the downtown Chicago market were valued at cap rates ranging from 7.75% to 8.50%. While the availability of additional loan funding may help secure new leases, market demand has been low over the life of the loan and is expected to remain muted for the near to medium term. As such, Morningstar DBRS believes it is unlikely the borrower will achieve the Morningstar DBRS’ stabilized net cash flow (NCF) of $19.6 million, or for that matter, the issuer’s originally projected stabilized NCF of $22.7 million. Given these increased risks, Morningstar DBRS analyzed the loan with elevated as-is and as-stabilized LTV ratios as well as an elevated probability of default. The resulting loan expected loss was three times greater than the expected loss for the pool.

Fourteen of the remaining 15 loans have been modified, with modifications generally allowing borrowers to exercise extension options without meeting required performance tests and/or amendments to interest rate terms. The Park Central loan (Prospectus ID#28; 4.0% of the current trust balance) was granted a short-term maturity extension to March 2024 with three additional three-month extension options to December 2024. The $261.1 million A-note ($47.0 million trust note) loan is secured by a full-service hotel in downtown San Francisco, which was reflagged as a Park Hyatt, opening in Q1 2022. According to the financials for the T-12 ended September 30, 2023, property NCF was $4.8 million, significantly below the issuer’s stabilized NCF projection of $21.8 million and the Morningstar DBRS stabilized NCF projection of $14.0 million. While the collateral manager noted operations may improve from increased food and beverage revenue, demand drivers for the downtown San Francisco market have materially changed from loan closing. The provided 2024 operating budget shows NCF is not projected to materially increase, further limiting the borrower’s exit options. At loan closing in October 2019, the property had an as-is appraised value of $336.0 million, indicative of a 1.4% cap rate based on the NCF for the T-12 ended September 30, 2023. As the property’s as-is value has likely drastically declined since issuance, Morningstar DBRS analyzed this loan with a liquidation scenario, suggesting a loan loss severity in excess of 40.0%.

ENVIRONMENTAL, SOCIAL, AND 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 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 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 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.

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.

DBRS, Inc.
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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 1, 2024)/North American CMBS Insight Model Version 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

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

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/410863.

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