Morningstar DBRS Confirms All Credit Ratings on Canadian Commercial Mortgage Origination Trust 4, Changes Trends on Three Classes to Negative

DBRS Limited (Morningstar DBRS) confirmed its credit ratings on all classes of Commercial Mortgage Pass-Through Certificates, Series 2018-4 issued by Canadian Commercial Mortgage Origination Trust 4 as follows:

-- Class A-1 at AAA (sf)
-- Class A-2 at AAA (sf)
-- Class B at AA (sf)
-- Class X at A (high) (sf)
-- Class C at A (sf)
-- Class D at BBB (sf)
-- Class E at BBB (low) (sf)
-- Class F at BB (sf)
-- Class G at B (sf)

Morningstar DBRS also changed the trends on Classes E, F, and G to Negative. The trends on all remaining classes are Stable.

The Negative trends on Classes E, F, and G reflect increased concerns over a number of loans that have been identified by Morningstar DBRS to have an elevated credit risk due to occupancy declines and/or concentrated rollover. The primary drivers are two loans: Morneau Shepell Office Complex (Prospectus ID#2, 8.3% of the pool) and the Europro Office Portfolio (Prospectus ID#12, #13, and #14, collectively representing 12.1% of the pool), discussed in further detail below. The credit rating confirmations reflect the overall stable performance of the transaction outside of the loans of concern, which remains in line with Morningstar DBRS' expectations since its last review.

Since the last credit rating action, there has been a 7.4% collateral paydown. As of the June 2024 remittance, 29 of the original 53 loans remain in the pool, representing a collateral reduction of 39.1% since issuance with a current trust balance of $335.0 million. The remaining loans have a weighted-average (WA) loan-to-value (LTV) ratio of 49%. There are five loans on the servicer's watchlist, representing 18.3% of the current pool being monitored for performance related declines. No loans are delinquent or specially serviced. The pool is concentrated by property type with loans secured by office and retail properties representing 36.8% and 24.9% of the current trust balance, respectively. In general, the office sector has been challenged by low investor appetite and high vacancy rates in many submarkets as a result of the shift in workplace dynamics. In the analysis for this review, Morningstar DBRS analyzed loans exhibiting increased risk from issuance with stressed scenarios to increase expected losses (EL) as applicable. For loans of concern backed by office properties in particular, this resulted in a WA EL that was more than double the pool average.

The Morneau Shepell Office Complex is secured by two identical Class A office properties located in North York, approximately 15 kilometres north of the Toronto CBD, totalling 253,700 square feet (sf). The 10-year loan is non-recourse to the borrower and amortizes over a 25-year schedule with a current LTV of 44%. Based on the May 2024 rent roll, the subject was 92% occupied, which remains in line with recent historical figures. Despite the stable historical performance and low leverage point, there is a significant concentration of space rolling in the near term. The largest tenant at the subject, Morneau Shepell Ltd., represents 56% of the net rentable area (NRA) and has an upcoming lease expiration in August 2024. Morningstar DBRS has received confirmation from the servicer that the tenant will be vacating at the conclusion of its lease.

According to the YE2023 financial statements, the subject reported a net operating income (NOI) of $2.9 million, which remains in line with the YE2022 and YE2021 figures. Morningstar DBRS expects this figure will drop significantly when Morneau Shepell Ltd. vacates the subject property, though this may not be reflected in the reporting until 2025. According to a Q1 2024 Colliers Toronto Office report, the Don Mills Eglinton submarket reported an 8.6% vacancy rate. The loan is sponsored by Fana Park Centre Corp., which does not provide any recourse to the loan. In its review, Morningstar DBRS analyzed this loan with an elevated probability of default (POD) and stressed LTV, resulting in an EL that was more than triple the pool average.

The Europro Office Portfolio is composed of three cross-collateralized and cross-defaulted loans secured by one Class A and two Class B office properties in downtown Kitchener, Ontario. Two of the properties, Europro Frederick Office (Frederick) (Prospectus ID#12, 4.2% of the pool) and Europro Queen Street Office (Queen) (Prospectus ID#13, 4.2% of the pool) were added to the servicer's watchlist in September 2023 for occupancy declines. Although only the Frederick and Queen offices are on the servicer's watchlist, the Europro King Street Office (King) has experienced similar occupancy declines. The March 2024 rent roll reported a portoflio occupancy rate of 56.3%, down from the March 2023 and December 2017 figures of 64.6% and 83.2%, respectively.

The initial decline in occupancy was caused primarily by downsizing at the Frederick office, after Easy Education Inc. (8.1% of the portfolio NRA) gave back a portion of its space. As of March 2024, this property was 55.3% occupied. There has been minimal leasing traction from 2023 to 2024. The Queen and King offices reported March 2024 occupancy rates of 56.9% and 57.4%, respectively. According to the Colliers Q1 2024 Waterloo Office Market report, the average vacancy rate for the downtown Kitchener submarket was 26.9%, remaining in line with the Q2 2023 figure of 26.2%. Morningstar DBRS expects the borrower will continue to face challenges backfilling vacant space given the soft submarket.

An updated OSAR was not provided; however, according to the YE2023 operating statements, on a consolidated basis, the portfolio reported an NOI of $4.4 million, which is below the Morningstar DBRS NOI of $5.1 million. Despite the occupancy declines, the subject continues to break even and the loan has remained current on its debt service payments. These loans have recourse limited to 50.0% of the original loan balance, which is guaranteed by Cedar Pointe MF Holdings Inc. To reflect the declining occupancy and lack of leasing activity, Morningstar DBRS analyzed this loan with a stressed LTV and an elevated POD, resulting in an expected loss that was more than two times the pool EL.

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; https://dbrs.morningstar.com/research/427030).

Class X is an interest-only (IO) certificate that references 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 Canadian 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 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.

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 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)

Rating North American CMBS Interest-Only Certificates (June 28, 2024; https://dbrs.morningstar.com/research/435294)

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://dbrs.morningstar.com/research/419592)

Legal Criteria for Canadian Structured Finance (June 20, 2023; https://dbrs.morningstar.com/research/416101)

A description of how DBRS Morningstar analyses structured finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/410863 (July 17, 2023).

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