Morningstar DBRS Changes Trends on Four Classes of Wells Fargo Commercial Mortgage Trust 2016-LC25 to Negative from Stable, Confirms Credit Ratings on All Classes

DBRS, Inc. (Morningstar DBRS) confirmed its credit ratings on all classes of Commercial Mortgage Pass-Through Certificates issued by Wells Fargo Commercial Mortgage Trust 2016-LC25 as follows:

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

The trends on Classes D, E, F, and X-D were changed to Negative from Stable. The trends on the remaining classes are Stable with the exception of Class G, which has a rating that does not typically carry a trend in commercial mortgage-backed securities (CMBS) ratings.

The Negative trends reflect Morningstar DBRS' concern about the increased maturity default risk for several loans as the pool approaches its maturity year in 2026, including the exposure to office loans in secondary markets, which account for almost 20% of the pool balance. Morningstar DBRS notes the pool has a high concentration of loans collateralized by retail and office properties, which represent 29.5% and 27.0% of the pool balance, respectively. Those include a few larger loans that are facing elevated refinance risk, namely The Shops at Somerset Square (Prospectus ID#7; 3.8% of the pool), Causeway Plaza I, II, & III (Prospectus ID#8; 3.6% of the pool), and Gurnee Mills (Prospectus ID#10; 3.0% of the pool), each of which have experienced significant contractions in cash flow since issuance. While the majority of office loans in the pool have reported healthy performance metrics, in the analysis for this review, select office loans that were demonstrating increased risks from issuance were analyzed with stressed scenarios to increase the expected losses, resulting in a weighted-average (WA) expected loss (EL) that is in line with the pool EL. When considering the likelihood of repayment and value deficiency for the pool as a whole, the three lowest-rated classes were most exposed to loss, supporting the Negative trends.

The credit rating confirmations reflect the otherwise stable performance of the transaction, which remains in line with Morningstar DBRS' expectations. The majority of loans in the pool continue to exhibit healthy credit metrics, evidenced by the pool's WA debt service coverage ratio (DSCR) of 1.71 times (x) based on the most recent financial reporting available. In addition, the largest loan in the pool, 9 West 57th Street (Prospectus ID#1; 6.3% of the pool), is shadow rated as investment grade by Morningstar DBRS and the transaction benefits from increased credit support to the bonds as a result of scheduled amortization, loan repayments, and defeasance, further supporting the credit rating confirmations and Stable trends.

As of the September 2024 remittance, 75 of the original 80 loans remain in the pool with an aggregate principal balance of $788.2 million, representing a collateral reduction of 17.5% since issuance. Nine loans, representing 10.3% of the current pool balance, are fully defeased. There are currently no delinquent loans and only one loan, representing 1.4% of the pool balance, is in special servicing. An additional nine loans, representing 12.0% of the pool balance, are being monitored on the servicer's watchlist.

The sole loan in special servicing, Holiday Inn Milwaukee River (Prospectus ID#26; 1.4% of the pool) is secured by a 160-key full service hotel in Milwaukee, Wisconsin. The loan transferred to the special servicer in August 2024 for imminent default because of the borrower's unwillingness to fund shortfalls. The occupancy rate at the property has hovered around 50% for the past several years, most recently reported at 51.7% as of the trailing 12 months ended March 31, 2024. According to the borrower, the property continues to outperform its competitive set; however, the local market suffers from excess supply outpacing demand with nearly 30 new hotels having been delivered since 2019 with no correlating increase in demand. As a result of the depressed occupancy rate, the DSCR declined below breakeven as of the YE 2023 reporting and was reported at 0.55x as of March 2024. While no updated appraisal has been provided since issuance, the property value has likely experienced a significant decline. As such, in its analysis Morningstar DBRS liquidated the loan based on a conservative haircut to the issuance appraised value, resulting in a loss severity of approximately 35.0%.

The Shops at Somerset Square, the largest loan on the servicer's watchlist, is secured by an unanchored retail property in Glastonbury, Connecticut. As of June 2024, the occupancy rate and DSCR were 75.6% and 0.91x, respectively, up slightly from YE2023, but still well below pre-pandemic and issuance levels. The property was reappraised for $17.8 million in August 2022, reflecting a -57.6% variance from the issuance appraised value of $42 million and the current loan-to-value ratio (LTV) of 168%. Given the occupancy and value declines since issuance, Morningstar DBRS analyzed this loan with an elevated probability of default (POD) penalty and LTV, resulting in an EL that is nearly 2.5x greater than the pool average.

As previously mentioned, at issuance, Morningstar DBRS assigned an investment-grade shadow rating to the largest loan in the pool, 9 West 57th Street (Prospectus ID#1; 7.5% of the pool), which is secured by an office tower in Midtown Manhattan. With this review, Morningstar DBRS maintains that the performance of this loan remains consistent with investment-grade loan characteristics.

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

Classes X-A, X-B, and X-D 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 01, 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.

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.

DBRS, Inc.
22 West Washington Street
Chicago, IL 60602 USA
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.

-- 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 (September 19, 2024), https://dbrs.morningstar.com/research/439702

-- 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.