Morningstar DBRS Downgrades Credit Ratings on All Classes of COMM 2016-667M Mortgage Trust

DBRS, Inc. (Morningstar DBRS) downgraded its credit ratings on all classes of Commercial Mortgage Pass-Through Certificates, Series 2016-667M issued by COMM 2016-667M Mortgage Trust as follows:

-- Class XA to A (sf) from AAA (sf)
-- Class A to A (low) (sf) from AAA (sf)
-- Class B at BB (sf) from AA (high) (sf)
-- Class C to B (sf) from A (high) (sf)
-- Class D CCC (sf) from BBB (high) (sf)
-- Class E CCC (sf) from BBB (sf)

The trends on Class XA, Class A, Class B, and Class C are Stable. There are no trends on Class D and Class E as those classes have credit ratings that do not typically carry a trend in commercial mortgage-backed securities (CMBS) credit ratings.

All credit ratings have been removed from Under Review with Negative Implications where they had been placed on April 15, 2024, as part of Morningstar DBRS' review of transactions secured by office properties within its North American Commercial Mortgage Backed Securities Single-Asset/Single-Borrower (NA CMBS SASB) portfolio. The review was prompted by Morningstar DBRS' view that a shift in the use and demand for office space has been observed in the past few years. Amid the increase in remote work and hybrid schedules, tenant demand in urban markets, such as those most frequently represented in the NA CMBS SASB space, has been the most resilient for those higher-quality buildings that offer extensive amenity packages and are located close to transportation hubs with other nearby draws for commuters and city dwellers alike. These trends are expected to be sustained in the long term and their ripple effects of increased tenant improvement costs, capital improvement expectations, and decreased demand for some markets and neighborhoods will continue to influence investment activity for the office sector as a whole. For more information regarding the approach and analysis conducted, please refer to the press release titled, "Morningstar DBRS Takes Rating Actions on North American Single-Asset/Single-Borrower Transactions Backed by Office Properties," published on April 15, 2024.

At the conclusion of the April 2024 review, several transactions, including the subject transaction, remained Under Review with Negative Implications. This generally reflected the existence of evolving factors for those credits for which Morningstar DBRS identified a need for more information to be gathered to inform the analysis. With this review of the subject transaction, Morningstar DBRS has resolved the Under Review with Negative Implications status. The full details of the credit rating action and ratings rationale are outlined below.
The credit rating downgrades reflect the increased credit risks to the transaction with the updates to the Morningstar DBRS net cash flow (NCF) and Morningstar DBRS Value for the collateral office property securing the underlying loan. The updated Morningstar DBRS value results in significant downward pressure in the loan-to-value (LTV) sizing benchmarks, supporting the credit rating downgrades. The Stable trends are generally reflective of Morningstar DBRS' expectation that, even when accounting for an interest rate stress to levels currently observed in recent financings for this property type and market, the implied debt service coverage ratio (DSCR) on the updated Morningstar DBRS NCF remains above breakeven for the combined balance of Class A, Class B, and Class C.

The updates to the Morningstar DBRS inputs were made to capture the secular shift noted above, as well as the subject property's reported occupancy and cash flow declines, which are expected to remain depressed as compared with issuance expectations through the longer term. The YE2023 net cash flow (NCF) of $8.2 million represented a steep decline from the YE2022 NCF of $22.9 million as the occupancy rate decreased to 78.6% from 96.7%. Additionally, operating expenses increased by $3.5 million, primarily related to leasing costs funded by the borrower, which were reported in the repairs and maintenance (R&M) line item, according to the servicer. The loan is currently on the servicer's watchlist and in cash management as a result of the decline in performance, with a YE2023 DSCR of 1.0x times.

The collateral property is a 25-story, Class A office building in Midtown Manhattan at the corner of Madison Avenue and 61st Street, one block east of Central Park. The property was constructed by a sponsor-affiliate in 1985 and consists of 254,316 square feet (sf) of office space and 14,832 sf of retail space. The $254.0 million whole loan is interest only (IO) for the entire 10-year term. This transaction consists of a $214.0 million trust loan, with an additional senior $40.0 million A-2 pari passu note securitized in the CD 2016-CD2 transaction, not rated by Morningstar DBRS. The loan is sponsored by Hartz Financial, a subsidiary of Hartz Group, Inc.

An updated Morningstar DBRS NCF of $14.9 million was derived with this review, based on the June 2024 rent roll provided by the servicer with new leases taken into account. The concluded in-place weighted-average rental rate was $147.48 psf with an economic vacancy rate of 16.0%. Operating expenses were largely based on the year-end 2023 figures with the exception of R&M, which was based on the more moderate year-end 2022 figure. Leasing costs were based on recently executed new and renewal leases, which are discussed in greater detail below. The Morningstar DBRS below-the-line expenses were 2.5x greater than the servicer-reported figure in the year-end 2023 OSAR. According to the rent roll, the property was 77.6% occupied; however, according to the property's website, the leased rate is 84.2% with five suites listed as available. Three suites totaling 24,605 sf (9.1% of the NRA) are currently leased to Redbird Capital (Redbird) through November 2024. According to the June 2024 rent roll, Redbird will be vacating these suites as it signed a new, 10-year lease for 42,223 sf (15.7% of the NRA) of space across the sixth, seventh, and eighth floors. The space was formerly leased to Loews Corporation, which vacated the property in 2023. Redbird will become the property's largest tenant when its new lease commences in November 2024. The tenant received a buildout package of $10.4 million (approximately $250.00 psf) and will pay a starting base rental rate of $130.00 psf, below its former rental rates, which ranged from $150.00 psf to $175.00 psf. The lease has one contractual rental rate increase, scheduled to occur in November 2029.

Additional leasing activity since 2023 includes leases to two tenants, comprising the entirety of the retail space. Michael Kors, which originally occupied 5,162 sf at loan closing, renewed its lease in January 2023 through August 2034 and expanded its footprint as the tenant now occupies 10,613 sf. The tenant's rental rate of $425.00 sf is below the previous rate of $959.00 psf; however, the decline was expected given the increased footprint. In terms of tenant incentives, the tenant was provided a buildout package of $4.9 million and free rent credit of $3.4 million. A lease for the remaining 4,219-sf retail space was recently signed in June 2024 with a luxury retailer with terms including a ten-year lease through June 2034 at a starting rental rate of $400.00 psf. Morningstar DBRS was not provided with details of any potential tenant incentive package. A five-year lease renewal was also executed with Sciens Management (5.8% of the NRA). The tenant received a tenant improvement (TI) allowance of $1.2 million (approximately $75.00 psf) and pays a base rental rate of $110.00 psf, which is unchanged from its previous rental rate.

Beyond the loss of Loews Corporation noted above, other tenants such as Northmax, Willoughby Capital, and ServPro also vacated in 2023. ServCorp operated the entire fourth and fifth floors (11.9% of the NRA) as coworking and short-term office rental space. A new coworking space operator, BevMax, has taken over management of the space with its lease expiring in October 2028. BevMax pays a rental rate of $90.00 psf. The remaining tenant roster is granular, with the next largest tenant beyond Redbird and BexMax occupying 4.4% of the NRA. The majority of tenants are related to the finance industry. There is no further tenant rollover risk in 2024; however, four tenants occupying 10.9% of the NRA have scheduled lease expirations in 2025 and four tenants occupying 12.9% of the NRA have scheduled lease expirations in 2026 prior to loan maturity.

While Morningstar DBRS notes the positives regarding the sponsor's commitment to the property in terms of funding new and renewal tenant incentive packages, the large TI allowances are an indication of how expensive it is to execute leases in the submarket and the specific challenges the sponsor continues to face in signing new leases. According to the Cushman & Wakefield Marketbeat Manhattan Office Q1 2024 report, properties in the Madison/Fifth Avenue submarket reported a vacancy rate of 26.4% with an average asking rental rate of $102.12 psf. The average asking rental rate for Class A properties was reported at $108.13 psf. The subject is currently outperforming the submarket; however, the overall softness is concerning and highlights the negative change experienced throughout the sector. The loan does benefit from an existing leasing reserve of $1.9 million, a cash management reserve of $1.3 million, and an insurance reserve related to a 2019 water main break of $2.3 million. According to the servicer, the final remediation work was completed in Q4 2023 and the borrower is expected to request the outstanding funds once the final invoices are received from contractors. Morningstar DBRS also notes the outstanding leasing reserve has likely already been allocated to the recently signed leases noted above in addition to the funds the borrower will have to provide out of pocket.

The updated Morningstar DBRS property valuation of $212.6 million was derived by applying a 7.0% cap rate to the updated Morningstar DBRS NCF of $14.9 million. In its LTV sizing analysis, Morningstar DBRS also applied cumulative positive qualitative adjustments of 4.0% for cash flow volatility, property quality, and market fundamentals. The 7.0% cap rate is above the cap rate of 6.5% previously assumed by Morningstar DBRS when credit ratings were assigned in 2020 and the resulting value is a 29.1% decline from the previous Morningstar DBRS Value of $322.8 million. According to the CBRE United States Cap Rate Survey H2 2023, Value-Add Class A office properties in the Downtown New York City market were valued at cap rates ranging from 6.75% to 7.50% while Stabilized Class A office properties in the market were valued at cap rates ranging from 6.00% to 6.50%.

Morningstar DBRS expects the loan to remain current and for the YE2023 DSCR of 1.00 times to improve as rental revenue from new and renewal leases is realized. However, the sponsor is expected to encounter difficulty securing a replacement loan at maturity in October 2026 unless it is able to significantly increase property cash flow, which appears unlikely to occur in the near term given the leasing activity that has occurred to date and as further described above, or is willing to supplement the transaction with significant additional cash equity.

Morningstar DBRS' credit ratings on the applicable classes address the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents. Where applicable, a description of these financial obligations can be found in the transactions' respective private rating letters at issuance.

Morningstar DBRS' long-term credit ratings provide opinions on risk of default. Morningstar DBRS considers risk of default to be the risk that an issuer will fail to satisfy the financial obligations in accordance with the terms under which a long-term obligation has been issued. The Morningstar DBRS short-term debt rating scale provides an opinion on the risk that an issuer will not meet its short-term financial obligations in a timely manner.

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 DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024); https://dbrs.morningstar.com/research/427030.

Classes XA is interest-only (IO) certificates that reference 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 Morningstar DBRS.

Notes:
All figures are in US 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 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.

DBRS, Inc.
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Tel. +1 312 332-3429

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

Morningstar DBRS North American Commercial Real Estate Property Analysis Criteria (June 28, 2024), https://dbrs.morningstar.com/research/435293

North American Commercial Mortgage Servicer Rankings (August 23, 2023), https://www.dbrsmorningstar.com/research/419592

Interest Rate Stresses for U.S. Structured Finance Transactions (February 26, 2024), https://dbrs.morningstar.com/research/428623/interest-rate-stresses-for-us-structured-finance-transactions

Legal Criteria for U.S. Structured Finance (April 15, 2024), https://dbrs.morningstar.com/research/431205/legal-criteria-for-us-structured-finance

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

North American Single-Asset/Single-Borrower Ratings Methodology (March 1, 2024; https://dbrs.morningstar.com/research/428799)

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].