Morningstar DBRS Upgrades Credit Ratings on Two Classes of BDS 2021-FL8 Ltd.

DBRS Limited (Morningstar DBRS) upgraded its credit ratings on two classes of notes issued by BDS 2021-FL8 Ltd. as follows:

-- Class C to A (high) (sf) from A (sf)
-- Class D to BBB (high) (sf) from BBB (sf)

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

-- Class A at AAA (sf)
-- Class B at AA (sf)
-- Class E at BBB (low) (sf)
-- Class F at BB (low) (sf)
-- Class G at B (low) (sf)

All trends are Stable.

The credit rating upgrades reflect the increased credit support provided to the bonds as a result of successful loan repayments, which has resulted in a collateral reduction of 17.6% since Morningstar DBRS' last review in June 2023 and 35.9% since issuance.

The transaction primarily consists of multifamily collateral, which represents 78.8% of the current trust balance across 12 loans. Morningstar DBRS expects the majority of those loans will successfully secure replacement financing, given the underlying collateral has demonstrated stable to improving operating performance over the last few reporting periods, as the respective borrowers have generally progressed toward completion of their stated business plans. The remaining two loans in the pool, which represent 21.2% of the current trust balance, are secured by office properties, both of which are exhibiting increased credit risk from issuance as performance declines and softening market conditions have delayed the successful execution of the borrowers' respective business plans. As such, Morningstar DBRS expects those borrowers to face difficulties in executing exit strategies over the near to medium term. However, the larger of the two office loans has a one-year maturity extension option and unadvanced loan future funding available, providing the sponsor additional time to work toward stabilization.

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 transaction closed in July 2021 with a cut-off pool balance totaling approximately $576.4 million, excluding approximately $47.2 million of future funding commitments. At issuance, the pool consisted of 23 floating-rate mortgage loans secured by 23 properties, most of which were in a period of transition with plans to stabilize and improve asset values. The collateral pool for the transaction was static; however, the issuer had the right to use principal proceeds to acquire fully funded future funding participations subject to stated criteria. The replenishment period ended with the August 2023 payment date.

As of the April 2024 reporting, the pool comprises 14 loans secured by 14 properties with a cumulative trust balance of $369.3 million. Since issuance, nine loans with a former cumulative trust balance of $228.8 million have successfully repaid from the pool. Of these nine loans, five loans with a former trust balance of $99.7 million have repaid since Morningstar DBRS' prior credit rating action in June 2023.

The loans are concentrated by properties in suburban locations, which Morningstar DBRS defines as markets with a Morningstar DBRS Market Rank of 3, 4, or 5. As of April 2024, 11 loans, representing 78.6% of the cumulative loan balance, were secured by properties in suburban markets. Two loans, representing 13.3% of the cumulative loan balance, were secured by properties in urban markets, defined as markets with a Morningstar DBRS Market Rank of 6, 7, or 8, while only one loan, representing 8.1% of the cumulative loan balance, was secured by a property located in a tertiary market, defined as markets with a Morningstar DBRS Market Rank of 2.

Based on the as-is appraised value, leverage across the pool has remained relatively static, with a current weighted-average (WA) as-is appraised loan-to-value ratio (LTV) of 70.8% (unchanged from closing) and a WA stabilized LTV of 68.4% (compared to 67.5% at closing). Morningstar DBRS recognizes, however, that select property values may be inflated as the majority of the individual property appraisals were completed in 2020 and 2021 and may not reflect the current rising interest rate or widening capitalization rate (cap rate) environments. In the analysis for this review, Morningstar DBRS applied upward LTV adjustments across three loans representing 32.3% of the current trust balance.

Through April 2024, the collateral manager had advanced $19.0 million in loan future funding to nine of the 14 remaining individual borrowers, to aid in property stabilization efforts. The two loans with the largest future funding advances to date are the Stone Arbor Apartment Village loan (Prospectus ID#13; 6.3% of the pool balance) ($3.7 million) and the Eleven One Eleven loan (Prospectus ID#3; 12.0% of the pool balance) ($2.8 million). An additional $8.5 million of unadvanced loan future funding allocated to the borrower of the Eleven One Eleven loan remains outstanding.

The Stone Arbor Apartment Village loan is secured by a multifamily property totaling 88 units in Oceanside, California. The borrower used loan future funding of $3.7 million to complete an extensive capital expenditure (capex) project across the property, including fully renovating all 88 unit interiors, in addition to exterior renovations involving a roof replacement, pool upgrades, and an overhaul of the clubhouse. The capex project is completed and the loan is fully funded. As of the December 2023 rent roll, the property was 96.6% occupied with an average rental rate of $2,807 per unit, surpassing the Morningstar DBRS stabilized rental rate projection of $2,295 per unit. The loan matures in August 2024 and, however, according to the collateral manager, the borrower has requested a one-year extension. Although the loan will meet the debt yield requirement, the collateral manager noted that the debt service coverage ratio (DSCR) threshold will not be met and as such, the borrower will be required to maintain an interest rate cap agreement and will likely be required to deposit funds into a debt service reserve to meet anticipated shortfalls.

As of the April 2024 remittance, no loans were in special servicing; however, all 14 remaining loans, are on the servicer's watchlist, the vast majority of which are being monitored for upcoming maturity dates. The second largest loan on the servicer's watchlist, Eleven One Eleven is secured by a five-story, Class A office building in Reston, Virginia. The loan is currently being monitored for a low occupancy rate. According to the March 2024 rent roll the property was 74.9% occupied with the largest tenants at the property, General Dynamics Information Technology (GDIT; 58.4% of net rentable area (NRA) and Akami Technologies (7.4% of the NRA) on long-term leases through July 2027 and November 2029, respectively. The loan was structured with $11.3 million in future funding to cover leasing costs, carry out minor capital improvements associated with maintaining the 93.5% occupancy rate at closing, and backfilling existing vacant units; however, given leasing activity at the property has been slower than expected, only $2.8 million of future funding has been released to the borrower to date. The collateral manager confirmed that the borrower requested a loan modification to extend the expiration of the future-funding window by one year, from December 2023 to December 2024. The loan has an initial maturity date in January 2025, with one 12-month extension option. According to the YE2023 financial reporting, the property generated NCF of $3.79 million (a DSCR of 0.89 times (x)), relatively in line with the YE2022 NCF of $3.81 million (a DSCR of 1.44x) and the Morningstar DBRS NCF of $3.74 million. Given the floating rate nature of the loan, debt service obligations increased by almost 2.0x between issuance and YE2023, placing downward pressure on the DSCR.

Morningstar DBRS maintains a cautious outlook for the loan, given the sustained upward pressure on office vacancy rates within the submarket, and continued uncertainty surrounding end-user demand in the near to medium term, which will challenge the borrower's efforts to backfill vacant space at the property. Moreover, the collateral manager noted that the property is held within the sponsor's (Meridien Realty Partners) second fund, which is facing liquidity issues given its substantial exposure to office assets. In the analysis for this review, Morningstar DBRS applied LTV adjustments to both the in-place and stabilized property value assumptions made by the appraiser at closing, resulting in an expected loss (EL) that was approximately 35.0% greater than the pool average.

The third largest loan on the watchlist, 606-654 Venice Boulevard (Prospectus ID#4; 9.2% of the pool balance) is being monitored for a low occupancy rate, DSCR, and an upcoming final maturity date in September 2024. The interest-only loan was structured with an initial 16-month term and included two one-year extension options, both of which have been exercised by the borrower. The loan is secured by a five-building, 63,598 square foot (sf) creative office complex in the Los Angeles neighborhood of Venice. The property was previously 100.0% leased to Snap Inc. (Snap), which had been the sole tenant at the property since May 2015. Snap was not expected to renew its lease upon expiration as it had already begun to transition operations to its new office space at the Santa Monica Business Park. In Q4 2022, the borrower negotiated a termination agreement with Snap, with the tenant paying an $8.5 million termination fee. The loan was subsequently modified to allow for Snap's termination fee to be used to pay senior debt service obligations.

The borrower has engaged CB Richard Ellis to lease up the property and, according to the Q4 2023 collateral manager report, membership club operator Soho House Group is interested in leasing approximately 45,000 sf of space at the subject, however an agreement has yet to be signed and the property continues to be 100% vacant. Morningstar DBRS notes that re-leasing vacant space could prove difficult given the subject's Class B construction and the declining demand for office space. There are reserves in place to fund potential costs should leases be signed, with $4.8 million in a tenant reserve as of April 2024. Although the collateral manager noted that the loan is expected to be repaid at maturity and the appraiser's concluded as-is value of $60.0 million at issuance results in a low LTV of 61.5% with a projected go-dark value only slightly lower at $58.8 million (well above the current loan amount of $34.0 million), Morningstar DBRS estimates the collateral's as-is value has likely declined considerably from issuance given the continued performance trends, lack of leasing activity in a soft market, and reduced investor appetite for the property type. Morningstar DBRS analyzed the loan with an elevated probability of default penalty, resulting in an EL that was approximately 32.0% greater than the pool average.

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 (January 23, 2024) at https://dbrs.morningstar.com/research/427030.

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 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 ratings assigned to Classes C, D, E, F and G materially deviate from the credit ratings implied by the predictive model. Morningstar DBRS 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 stresses 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 given the near term maturity (within the next 12 months) of the remaining loans in the pool, in addition to the exposure to loans secured by underperforming office collateral.

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.

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.

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://dbrs.morningstar.com/about/methodologies.

North American CMBS Multi-Borrower Rating Methodology (March 1, 2024)/North American CMBS Insight Model v 1.2.0.0, https://dbrs.morningstar.com/research/428797

Interest Rate Stresses for U.S. Structured Finance Transactions (February 26, 2024), https://dbrs.morningstar.com/research/428623

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

Legal Criteria for U.S. Structured Finance (April 15, 2024), https://dbrs.morningstar.com/research/431205

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].