Morningstar DBRS Downgrades Credit Ratings on Six Classes of BBCMS Mortgage Trust 2017-C1

DBRS Limited (Morningstar DBRS) downgraded its credit ratings on six classes of Commercial Mortgage Pass-Through Certificates, Series 2017-C1 issued by BBCMS Mortgage Trust 2017-C1 as follows:

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

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

-- Class A-3 at AAA (sf)
-- Class A-4 at AAA (sf)
-- Class A-SB at AAA (sf)
-- Class A-S at AAA (sf)
-- Class X-A at AAA (sf)
-- Class X-B at AA (high) (sf)
-- Class B at AA (sf)
-- Class C at A (low) (sf)
-- Class X-D at BBB (sf)
-- Class D at BBB (low) (sf)

The trends on Classes C, X-D, D, X-E, E, X-F and F are Negative. All other trends are Stable with the exception of Classes X-G and G, which are assigned credit ratings that do not typically carry a trend in commercial mortgage-backed securities (CMBS) credit ratings.

During the prior credit rating action in August 2023, Morningstar DBRS assigned Negative trends to Classes D through G because of concerns related to the loans in special servicing, as well as the high concentration of loans secured by office properties, which, as of the most recent remittance, represents 40.6% of the pool balance. Since that time, the performance of the underlying collateral securing several of those loans has deteriorated further and, as such, Morningstar DBRS is projecting an increase in the expected loss to the trust, supporting the credit rating downgrades and Negative trends with this review. One specially serviced loan, the Gateway Plaza at Meridian (Prospectus ID#16; 2.1% of the pool balance), was analyzed with a liquidation scenario that resulted in an implied loss of approximately $10.0 million, which would erode the nonrated Class H balance by 40.0%, significantly reducing credit support to the lower-rated bonds in the transaction. Outside of the specially serviced loans, the pool's second- and third-largest loans, 1166 Avenue of the Americas (Prospectus ID#2; 7.6% of the pool balance) and 1000 Denny Way (Prospectus ID#3; 7.6% of the pool balance), respectively, which are secured by office properties, continue to exhibit increased credit risk with exposure to near-term lease roll-over and softening submarket fundamentals, details of which are outlined below. Morningstar DBRS analyzed those loans, in addition to select others exhibiting increased credit risk with elevated probability of default (POD) penalties and/or loan-to-value ratios (LTV), resulting in expected losses that were between 1.2 times (x) and 1.8x greater than the pool average.

As of the July 2024 remittance, 51 of the original 58 loans remain in the pool, with a trust balance of $738.1 million, representing a collateral reduction of 13.8% since issuance. To date, the trust has incurred a total loss of approximately $400,000, which has been contained to the nonrated Class H certificate. Thirteen loans, representing 42.7% of the pool balance, are on the servicer's watchlist and two loans, representing 2.8% of the pool balance, are in special servicing. In addition, 11 loans, representing 9.6% of the pool balance, are fully defeased.

The largest loan in special servicing, Gateway Plaza at Meridian, is secured by a 138,598 square foot (sf) four-story suburban office building located in Englewood, Colorado, approximately 18 miles southeast of the Denver central business district. Operating performance began trending downward in 2021 when Sierra Nevada Corporation (29.5% of net rentable area (NRA)) vacated the property upon lease expiration. According to a June 2024 asset status report, the property is currently 100.0% vacant after Camp Bowie Service Center (58.4% of NRA; lease expiration in July 2026), exercised an early lease termination option in June 2023. Conditions of the termination option included a 12-month written notice and an early termination fee of $2.5 million. The loan is currently cash managed and the borrower has been utilizing reserves to fund debt service payments. Per the July 2024 reporting, reserve balances total $350,000. The loan transferred to the special servicer for monetary default in June 2023, and a receiver is currently marketing the property for sale.

According to Reis, office properties in the Southeast Suburban submarket reported a Q2 2024 vacancy rate of 22.8% compared with the Q2 2023 vacancy rate of 20.9%. No updated appraisal has been provided since issuance when the property was valued at $23.6 million; however, given the sponsor's inability to backfill vacant space, combined with soft submarket fundamentals and general challenges for office properties in today's environment, Morningstar DBRS expects that the collateral's as-is value has likely declined significantly, elevating the credit risk to the trust. Morningstar DBRS' liquidation scenario considered a conservative haircut to the property's appraised value at issuance resulting in a loss severity in excess of 60.0%.

The largest loan on the servicer's watchlist, Alhambra Towers (Prospectus ID#1; 8.3% of the pool), is secured by a Class A office property in Coral Gables, Florida. The loan is currently being monitored for a low debt service coverage ratio (DSCR), which fell to 0.81x as of March 2024. The decline was driven by increased vacancy after two large tenant departures, including AerSale, Inc. (formerly 15.7% of NRA) and Becker & Poliakoff (formerly 12.9% of NRA) in November 2021 and December 2022, respectively. As a result, occupancy fell to a low of 78.0% at YE2022 from 96.3% at issuance, before rebounding slightly to 81.0% as of March 2024. There has been positive leasing momentum at the property, with Quest Workspaces signing a 22,522 sf lease to occupy the entire 10th floor. The flexible workspace provider opened during Q3 2023. In addition, the borrower has successfully signed four new leases, totaling 21,650 sf (12.4% of NRA) with start dates in May and June 2024, suggesting the occupancy rate at the property may be as high as 93.0%. Morningstar DBRS expects operating performance to trend upward over the subsequent few reporting periods as rent abatements tied to the new leases burn off. According to Reis, the Coral Gables submarket reported a Q2 2024 vacancy rate of 14.3% with an average asking rental rate of $46.60 per sf (psf), compared with the subject's in-place rate of $50.40 psf. Although the loan benefits from a strong sponsor, The Allen Morris Company, an experienced real estate owner, operator, and developer, with more than 60 years of experience, sustained declines in cash flow since issuance and the loan's below break-even DSCR are of concern. Morningstar DBRS' analyzed the loan with an elevated POD penalty, resulting in an expected loss that was approximately 25.0% greater than the pool average.

The second-largest loan on the servicer's watchlist, 1166 Avenue of the Americas, is secured by the first five floors of a Class A office property in Midtown Manhattan. The loan was added to the servicer's watchlist in July 2023 because the largest tenant, The D.E. Shaw Group (D.E. Shaw; 43.6% of NRA) confirmed it will be vacating its space upon lease expiration in September 2024. Bloomberg reports that the tenant is moving its headquarters to Two Manhattan West in 2024. The second-largest tenant, Arcesium (20.0% of NRA), has a lease guaranteed by D.E. Shaw and had a lease expiration in June 2024. The servicer noted that Arcesium is looking for space elsewhere; however, a final decision remains pending. Although it appears Arcesium remains active at the property, the tenant is likely operating on a month-to-month lease. While the borrower has suggested a number of prospective leases could be executed in the near future, occupancy will likely experience some degree of volatility over the short to moderate term.

According to the YE2023 financial reporting, the property generated $10.8 million of net cash flow (a DSCR of 2.4x), higher than the prior year and issuance figures of $9.8 million (a DSCR of 2.2x) and $8.2 million (a DSCR of 1.8x), respectively. The loan is also structured with a cash sweep that was triggered when D.E. Shaw and Arcesium failed to provide notice of renewal 18 months prior to their initial June 2024 lease expiration dates. The cash sweep is structured to trap all excess cash until an amount equal to $75.0 psf is collected. According to the July 2024 reporting, reserve balances total $4.2 million, the majority of which is held in a tenant reserve account. While the upcoming roll-over is noteworthy, the loan benefits from structural mitigants, namely, the low going-in LTV ratio of 48.9% (based on the whole-loan balance of $110.0 million and the issuance appraised value of $225.0 million) and the cash sweep provisions. Moreover, the loan's maturity date in 2027 will provide the sponsor time to backfill vacant space and work toward stabilization once tenants begin rolling in 2024. Furthermore, the property benefits from its excellent location in Manhattan and a strong loan sponsor, Edward J. Minskoff Equities, Inc. Morningstar DBRS analyzed the loan with an increased POD penalty and stressed LTV, resulting in an expected loss of approximately 1.8x greater than the pool average.

The third-largest loan on the servicer's watchlist, 1000 Denny Way, is secured by a Class B office building totaling 262,565 sf in Seattle. The loan was added to the servicer's watchlist in August 2021 after the property's former largest tenant, The Seattle Times Company (Seattle Times) downsized its space by 108,561 sf as part of a January 2021 lease renewal, driving occupancy down to 63.0%. However, as part of renewal, the tenant significantly increased its base rental rate from approximately $20.88 psf to $45.00 psf, helping to offset some of the reduction in rental revenue. Seattle Times now occupies 47,424 sf (18.1% of the NRA). A portion of the space formerly occupied by Seattle Times, was backfilled by Best Buy, which previously subleased 32,500 sf (12.4% of NRA) of space. Best Buy executed a direct lease through 2026 at a rate of $47.90 psf. However, both tenants have lease expirations in 2026 prior to loan maturity in 2027. Despite the significant reduction in occupancy, the loan continues to cover debt service obligations with a DSCR of 1.95x as of December 2023.

According to Reis, office properties in the Central Seattle submarket reported a Q2 2024 vacancy rate of 19.1% with an average asking rental rate of $46.19 psf, relatively unchanged from the prior year. Given the collateral's low in-place occupancy rate, elevated tenant roll-over risk prior to loan maturity, and weak submarket fundamentals, Morningstar DBRS analyzed this loan with an elevated LTV ratio and increased POD penalty, resulting in an expected loss that was approximately 50.0% greater than the pool average.

At issuance, Morningstar DBRS shadow-rated the State Farm Data Center (Prospectus ID#11; 3.4% of the pool) loan as investment grade. This assessment was supported by the loans' strong credit metrics, strong sponsorship strength, and historically stable collateral performance. With this review, Morningstar DBRS confirms that the characteristics of these loans remain consistent with the investment-grade shadow rating.

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, 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/437781 (August 13, 2024).

Classes X-A, X-B, X-D, X-E, X-F and X-G are 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 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 rating assigned to Class B materially deviates from the credit rating 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 rating would consider a three-notch or more deviation from the credit rating stress(es) implied by the predictive model to be a significant factor in evaluating the credit rating. The rationale for the material deviation is the uncertain loan-level event risk. Morningstar DBRS analyzed loans of concern with elevated POD penalties and stressed LTVs, as outlined above, increasing the pool's baseline expected loss. Given the majority of loans in question are currently performing with approximately 18 months to stabilize operating performance and/or cash flows prior to maturity, this material deviation was deemed to be warranted. The Negative trends assigned to the four lowest-rated classes most exposed to loss signal Morningstar DBRS' overall concerns and suggest additional credit rating downgrades could occur as part of future review cycles.

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. 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.

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

A description of how DBRS Morningstar 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].