Morningstar DBRS Downgrades Credit Ratings on All Classes of TMSQ 2014-1500 Mortgage Trust, Removes from Under Review with Negative Implications

DBRS Limited (Morningstar DBRS) downgraded its credit ratings on the Commercial Mortgage Pass-Through Certificates, Series 2014-1500 issued by TMSQ 2014-1500 Mortgage Trust as follows:

-- Class X-A to BBB (high) (sf) from AA (low) (sf)
-- Class A to BBB (sf) from A (high) (sf)
-- Class B to B (sf) from BBB (high) (sf)
-- Class C to CCC (sf) from BB (high) (sf)
-- Class D to CCC (sf) from B (high) (sf)

Morningstar DBRS assigned Negative trends to Classes X-A, A, and B. Classes C and D are assigned a credit rating that does not typically carry a trend in commercial mortgage-backed securities (CMBS) transactions.

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 last 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 neighbourhoods 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 actions and ratings rationale are outlined below.

The credit rating downgrades and Negative trends reflect Morningstar DBRS' loss expectations for the underlying loan, which is collateralized by the borrower's fee-simple interest in a 33-story Class A mixed-use building located within the Times Square Bowtie in New York City. Although the loan remains current and is not in special servicing at this time, given the significantly increased risks that suggest the in-place occupancy rate will fall well below issuance levels and the expected re-leasing difficulty, Morningstar DBRS considered a liquidation scenario based on a dark value analysis for the subject property. The result of that analysis indicates that the property's value has deteriorated considerably from issuance, suggesting losses could fully erode the Class D and C certificates, and partially erode the Class B certificate upon the eventual disposition of the loan. Morningstar DBRS' analytical approach considered the anticipated departure of the property's two largest tenants, Times Square Studio (TSS) and Nasdaq, in May 2025 and August 2024, respectively. In addition, refinance risk remains elevated as the loan is scheduled to mature in October 2024, and based on the collateral's prolonged low occupancy rate, cash flows that have continued to decline, and weak office submarket fundamentals, it is unlikely that the subject's operating performance will rebound in the near term. Mitigating factors include the loan's strong sponsorship, a well-performing retail segment, and the significant signage component to the property, which is regarded as one of the most prominently positioned advertising assets in the world, a factor of its prime location in Times Square.

The whole loan of $505.0 million consists of $335.0 million of senior debt held within the trust and $170.0 million of mezzanine debt held outside of the trust. The loan was structured with a 10-year interest-only (IO) term. The sponsor, TREHI, a subsidiary of Tamares Group, a private investment company headquartered in London, has reportedly been exploring refinance options since early 2023; however, no formal agreement has been reported to date. Based on the March 2024 rent roll, the majority of the building is designated as office space while approximately 106,000 square feet (sf) is designated as retail and storage space.

According to the March 2024 rent roll, occupancy at the property has declined from 95.0% at issuance to 74.6%. The office portion of the property was 76.1% occupied whereas the retail segment reported an occupancy rate of 100.0%. The largest tenants at the property, TSS and Nasdaq, occupy approximately 15.0% and10.0% of the net rentable area (NRA) at rental rates of $189.24 per square foot (psf) and $74.68 psf, respectively. The remainder of the tenant roster is relatively granular, with no other tenant accounting for more than 4.0% of NRA.

The bulk of the TSS space is configured for studio use and it is currently the filming location for Walt Disney Co. (Disney)-owned ABC's Good Morning America (GMA) program. The TSS lease runs through May 2025, at which time, GMA is slated to vacate the property as part of a larger move by Disney, aimed at consolidating the company's physical footprint at its new headquarters in Hudson Square. The borrower has hired a retail leasing team from CBRE to market the space ahead of GMA's departure; however, given the unique build out and distinctive requirements of studio/production space, Morningstar DBRS expects releasing efforts to progress at a slow pace. Nasdaq currently subleases its space to several tenants and the subleases are coterminous with Nasdaq's lease, which expires in August 2024. The servicer has confirmed that Nasdaq intends to relinquish its space at the property upon lease expiration. In addition, two tenants, Novocure (formerly 3.8% of the NRA) and Supervest (formerly 0.6% of the NRA) departed the property in April and May of this year, suggesting the physical occupancy rate is slightly lower than reported in the March 2024 rent roll.

Nasdaq's upcoming departure will leave approximately 53,000 sf of additional office space vacant prior to loan maturity and push the collateral's occupancy rate down to 60.0%. Should the borrower fail to backfill the TSS space prior to May 2025, occupancy at the property will decline further to approximately 45.0%. Moreover, leases representing approximately 10.0% of the NRA are scheduled to roll within the next 12 months, potentially placing further upward pressure on the property's vacancy rate prior to loan maturity. According to Reis, the Q1 2024 office vacancy rate for the Midtown West submarket was 13.4%, compared with the Q1 2023 vacancy rate of 13.6%. The vacancy rate is forecasted to remain elevated, above 13.0%, through 2025 and 2026. The servicer reported a trailing nine months ended September 2023 annualized net cash flow (NCF) of $28.9 million, compared with the year-end (YE) 2022 NCF of $26.9 million and the Morningstar DBRS NCF at issuance of $34.1 million. Despite the declines in occupancy and cashflow, the loan continues to cover debt service obligations, with a debt service coverage ratio of 2.21 times (x) as of September 2023. However, these figures do not reflect the recent tenant departures, as noted above, nor the upcoming TSS and Nasdaq rollover. Given TSS and Nasdaq account for approximately 33.0% and 11.0% of in-place base rent at the property, respectively, Morningstar DBRS estimates that future cash flows may no longer be sufficient to cover debt service obligations once those tenants vacate the property.

Morningstar DBRS' analysis for this review considered the property's three distinct segments, including the office and ground-floor retail components, as well as the TSS space. Given the sizeable concentration of tenant rollover within the next 12 months, Morningstar DBRS derived individual dark values for the office component and the TSS space, with each estimating a stabilized cash flow and utilizing a capitalization (cap) rate of 8.75% (including a 100 basis point dark value adjustment to account for the time and risk to re-tenant vacant space) with lease-up costs deducted in each case. In addition, credit was given to the income generated by the exterior signage. Based on this analysis, Morningstar DBRS derived a dark value of $114.3 million and $61.4 million for the office and TSS segments, respectively. Given the ground-floor retail space continues to perform well, with an occupancy rate of 100.0%, Morningstar DBRS reanalyzed the existing cash flow stream based on the in-place tenancy and recent market data to determine an as-is value. A cap rate of 7.0% was utilized for the ground-floor retail component, resulting in a value of $82.0 million. The aggregate Morningstar DBRS value of $257.8 million ($509 psf) for all three segments represents a 50.8% and 68.2% decline, respectively, from the Morningstar DBRS value derived in 2020 and the appraised value at issuance. The updated Morningstar DBRS value implies an LTV ratio of 130.0% on the senior debt, based on the current loan balance of $335.0 million.

Given the deterioration in performance, soft submarket demand, and near-term maturity amid declining cash flows, a liquidation scenario was derived based on the Morningstar DBRS value of $257.8 million and an estimated exposure of $351.4 million when accounting for projected servicer advances and liquidation fees, which resulted in an implied loss of nearly $94.0 million, representing a loss severity of 28.0%. As previously noted, should those losses be incurred, there would be principal loss for Classes D through B with approximately $5.3 million (18.0%) of cushion remaining in Class B, supporting the credit rating downgrades with this review.

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 press releases 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 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.

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 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 info-DBRS@morningstar.com.

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 credit ratings of this transaction are highly subject to the asset's liquidation value. As a result, a sensitivity whereby Morningstar DBRS stresses the Morningstar DBRS Cap Rate and Morningstar DBRS NCF to evaluate the impact of a Morningstar DBRS value decline based on the LTV sizing benchmarks was not completed. 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 credit 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.

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

-- 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 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 https://dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.