Morningstar DBRS Changes Trends on Two Classes of VMC Finance 2022-FL5 LLC to Negative from Stable

DBRS Limited (Morningstar DBRS) confirmed its credit ratings on all classes of commercial mortgage-backed notes issued by VMC Finance 2022-FL5 LLC as follows:

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

Morningstar DBRS changed the trends on Classes F and G to Negative from Stable. The trends on the remaining classes remain Stable.

The trend changes reflect the increased credit risk to the transaction as a result of Morningstar DBRS' increased loan-level expected losses for six loans secured by office and mixed-use collateral with office components, which represent 32.7% of the current trust balance. Two of these six loans have been modified to allow borrowers to extend maturity dates by waiving performance tests as additional time to execute their respective business plans was needed. An additional three loans secured by office properties will likely require modifications or principal paydowns in order for borrowers to exercise upcoming maturity extension options. Business plan progression across these assets has been slow to date, with occupancy rates and/or cash flows below projected stabilized levels. Morningstar DBRS analyzed these loans with increased loan-to-value ratios (LTVs) and, in some cases, applied probability of default penalties to reflect the current risk profiles, resulting in a weighted-average (WA) expected loss approximately 15.0% greater than the pool's WA expected loss.

Over the next 12 months, 13 loans, representing 73.5% of the current trust balance, are scheduled to mature. Four of these loans, representing 20.6% of the current trust balance, are secured by office properties or mixed-use properties with office components. Given the ongoing headwinds in the office sector, lending activity on office properties slowed significantly in 2023 and continues to struggle through Q3 2024. As such, Morningstar DBRS expects borrowers to face difficulties in executing exit strategies over the near to medium term. While the majority of these loans include extension options, the borrowers will likely need loan modifications as the majority of these loans will be unable to achieve the performance-based extension requirements. The credit rating confirmations reflect the increased credit support to the bonds as a result of successful loan repayment, with collateral reduction of 16.6% since issuance, and the otherwise stable performance of majority of the loans in the pool, as these borrowers have generally been able to progress toward the completion of the stated business plans.

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 info-DBRS@morningstar.com.

The transaction closed in March 2022 with an initial collateral pool of 20 floating-rate mortgage loans secured by 20 mostly transitional real estate properties, with a cut-off pool balance totaling $650.0 million. The transaction was a managed vehicle with a 24-month Reinvestment Period, which ended with the March 2024 Payment Date. The transaction now has a sequential-pay structure following the expiration of the Reinvestment Period. As of August 2024, the pool comprises 19 loans secured by 19 properties with an outstanding balance of $542.4 million. Since the previous Morningstar DBRS credit rating action in September 2023, three loans with a former trust balance of $101.6 million were repaid in full and one loan, with a trust balance of $13.2 million, was added to the trust.

Beyond the office concentration noted above, the transaction comprises 10 loans, representing 55.9% of the pool, secured by multifamily properties; two loans, representing 8.1% of the pool, secured by hotel properties; and one loan, representing 3.3% of the pool, secured by an industrial property. In comparison with the August 2023 reporting, office and mixed-use represented 36.3% of the collateral while multifamily, hotel, and industrial properties represented 52.2%, 8.7%, and 2.8% of the collateral, respectively.

The loans are primarily secured by properties in suburban markets as 13 loans, representing 72.8% of the pool, are secured by properties in suburban markets, as defined by Morningstar DBRS, with a Morningstar DBRS Market Rank of 3, 4, or 5. The remaining six loans, representing 27.2% of the pool, are secured by properties with a Morningstar DBRS Market Rank of 6, 7, or 8, denoting urban markets. Both the suburban and urban market concentrations in the pool remain relatively unchanged with the August 2023 reporting.

Based on the as-is appraised values, leverage across the pool has decreased from issuance, with a current WA LTV of 71.5%, in comparison with the WA issuance LTV of 77.1%. Similarly, the WA stabilized LTV decreased over that same period, dropping to 67.1% from 70.0% at issuance. Morningstar DBRS recognizes that select property values may be inflated as the majority of the individual property appraisals were completed in 2021 and 2022 and may not reflect the current rising interest rate or widening capitalization rate environments. In the analysis for this review, Morningstar DBRS applied upward LTV adjustments across eight loans, representing 51.5% of the current trust balance.

Through July 2024, the lender had advanced cumulative loan future funding of $30.3 million to 10 individual borrowers to aid in property stabilization efforts. The largest future funding advances have been released to the borrowers of the Crabtree Terrace loan (Prospectus ID#8, 6.4% of the pool; $6.7 million) and the Citi on Camelback loan (Prospectus ID#6, 7.6% of the pool; $5.8 million). The Crabtree Terrace loan is secured by a 173,000 square-foot (sf) suburban, Class A office property in Raleigh, North Carolina, while the Citi on Camelback loan is secured by a 360-unit, Class A multifamily complex in Phoenix, Arizona. The borrower for the Crabtree Terrace loan has used loan future funding for tenant improvement and leasing commission costs in order to lease-up the property to a stabilized occupancy rate. According to the Q1 2024 collateral report, tenants representing 32.0% of net rentable area (NRA) have been signed since issuance, with the property reporting a physical occupancy rate of 87.1% as of March 2024. In April 2024, the sponsor signed a tenant comprising 7.0% of NRA, increasing the property's leased rate to 94.1%. The borrower for the Citi on Camelback loan has used loan future funding for capital improvements, budgeting $5.3 million ($23,000 per unit) for value-add unit renovations on 230 units with an additional $735,000 budgeted for exterior renovations. As of March 2024, the property was 94.4% occupied and renovations on 180 units had been completed. Rental premiums of $207 per unit are being achieved over the pre-renovated average rental rate.

An additional $31.2 million of loan future funding allocated to eight individual borrowers remains available. Available loan proceeds for each respective borrower are for planned capital expenditures or tenant improvements, with the largest portion of available funds, $10.0 million, allocated to the borrower of the Mountain View Corporate Center loan (Prospectus ID#7, 6.8% of the pool). The loan is secured by a four-building, Class A office park in Broomfield, Colorado. Loan future funding is available to the borrower to help fund leasing costs in order to manage tenant rollover and lease vacant space. According to the Q1 2024 collateral manager update, the property was 78.4% occupied; however, the largest tenant, Danone (39.5% of NRA, lease expires December 2024) gave notice it will downsize its space significantly, resulting in an implied occupancy rate of 50.0%. Following Danone's failure to renew the entirety of its space, a $5.0 million letter of credit was triggered and will be held as additional collateral. Discussions with a prospective tenant which would occupy 9.9% of NRA were ongoing as of March 2024. Given the upcoming vacancy, Morningstar DBRS analyzed this loan with an elevated LTV and probability of default penalty, resulting in an expected loss more than 50.0% greater than the WA pool expected loss.

As of the August 2024 remittance, there are no delinquent loans or loans in special servicing; however, 12 loans, representing 70.6% of the current trust balance, are on the servicer's watchlist for a variety of reasons, mainly for upcoming loan maturity as well as low debt service coverage ratios and occupancy rates. All affected borrowers, with the exception of the Timberhill Common Apartments loan (Prospectus ID#21, 3.4% of the pool), have available maturity date extension options.

Ten loans, representing 65.7% of the pool, have been modified. The modifications have generally allowed borrowers to exercise loan extension options by amending loan terms in return for fresh equity deposits in the form of a principal paydown or reserve deposits and the purchase of a new interest rate cap agreement. Two loans, Wilshire Palm (Prospectus ID#9, 5.3% of the pool) and Broadstone Market Station (Prospectus ID#12, 4.8% of the pool), received short-term forbearance agreements. Immediately following the conclusion of the forbearance period, the Wilshire Palm loan was modified to extend its maturity date to July 2026 and provide for one, 12-month extension option, conditional on a $4.5 million principal paydown, a $3.25 million deposit into a lease reserve, and the purchase of a new interest rate cap agreement. The forbearance period for the Broadstone Market Station loan will end in September 2024, at which point it is expected that a similar maturity extension will be granted subject to principal paydown and reserve deposits. Outside of the modifications to interest rate cap agreements and the aforementioned forbearances, the 1700 California loan (Prospectus ID#2, 8.0% of the pool), was modified twice to amend various collateral release provisions, extend the loan's maturity one year to June 2025, and convert the loan into an A/B note structure.

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 Factors in Credit Ratings (August 13, 2024) at https://dbrs.morningstar.com/research/437781.

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 ratings were initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for these credit rating actions.

Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with these credit rating actions.

These are solicited credit ratings.

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 version 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
-- 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, 2024), https://dbrs.morningstar.com/research/438283
-- 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 (July 17, 2023).

For more information on this credit or on this industry, visit https://dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.