Morningstar DBRS Confirms Credit Rating on First Mortgage Bonds Issued by SEC LP and ARCI Ltd. (Suncor Energy Centre)

DBRS Limited (Morningstar DBRS) confirms the credit rating on the first mortgage bonds (the Bonds) issued by SEC LP and ARCI Ltd. (Suncor Energy Centre) (the Issuer) as follows:

-- 5.188% Series 1 Senior Secured Bonds due August 29, 2033 at BBB (low) (sf)

The trend is Stable.

The credit rating confirmation reflects the overall stable performance of the transaction which remains relatively unchanged since the previous credit rating action in January 2024. The primary credit risk associated with the transaction is the term default risk, should Suncor Energy Inc. (Suncor; 79.4% of net rentable area (NRA)) not elect to renew its lease for a portion of their space expiring in November 2028, representing nearly 37.6% of NRA. The borrower, Brookfield Office Properties Inc., however, has successfully extended the largest two leases at the property, representing 46.0% of the NRA, well beyond loan maturity. In addition, the borrower's commitment to the property is further evidenced by the proposed redevelopment of a large portion of the property over the next three years, with a projected budget of approximately $90.0 million.

The Bonds are secured by the Issuer's ownership interest in Suncor Energy Centre and have a current outstanding balance of $389.8 million, with a maturity date of August 29, 2033. The property is a 1.7 million square foot (sf) office complex in Calgary's central business district. Built in 1984, the complex is a certified green building with LEED Gold certification. The subject serves as the headquarters for Suncor, the largest tenant at the property, occupying nearly 80.0% of the NRA on various leases and generating more than 85.0% of the in-place rents. Morningstar DBRS notes that, following a lease modification in September 2022, more than half of Suncor's space (41.8% of the NRA) is now leased well beyond the term of the mortgage through November 2048; however, the remainder of the Suncor space (37.6% of the NRA) is on a separate lease that is scheduled to expire in November 2028. The tenant has historically subleased small portions of its space and Suncor cut approximately 1,500 jobs in 2023. The risk of the relatively near-term lease expiry for nearly 40% of the NRA is somewhat mitigated given Suncor has to provide notice of its intent to renew the leases expiring in 2028 by December 2025, providing significant time for re-leasing efforts, if required.

According to the September 2024 rent roll, the property was 86.4% occupied with an average rental rate of $34.63 per square foot (psf), as compared to the June 2023 figures of 86.4% and $32.61 psf, respectively. Property occupancy has fallen from 98.0% in 2020, following the departure of Cenovus Energy Inc. (formerly 8.1% of the NRA), an investment-grade tenant that did not renew at its lease expiration in May 2020. The second-largest tenant, PricewaterhouseCoopers International Limited (PwC; 5.5% of the NRA)) occupies five floors at the property, and recently renewed its lease on four floors; however, is expected to vacate the fifth floor upon lease expiration in September 2025.

The property's occupancy rate is in line with other Class AA office properties in the Downtown Calgary Office submarket, which had a 14.0% vacancy rate as of Q3 2024, however, significantly outperforms by average rental rate reported at $25.52 psf, per CBRE's Q3 2024 Calgary Downtown Office Report. Suncor and PWC currently pay rental rates of $34.00 psf and $46.00 psf, respectively; however, those rates will fall to $32.00 and $29.00 psf, respectively, as the new leases begin. The borrower is actively touring prospective tenants, advertising available space for least at in line or above market rates, depending on the space, with tenant improvement packages, and has budgeted $2.5 million for planned capital improvements throughout the building during 2025. As noted above, the borrower is also contemplating a redevelopment of the ground floor and 15 floors of Suncor's space that would involve a new food hall, restaurant, ground floor finishes and tenant amenities.

The annualized net operating income (NOI), based on reporting for Q3 2024, was $64.8 million, an improvement over the YE2023 NOI figure of $60.8 million and the YE2022 NOI figure of $60.6 million, a result of both increased revenue and decreased operating expenses. During last review, Morningstar DBRS was in receipt of the Q2 2023 financials, which also reported an annualized NOI of $63.9 million that was well above the noted YE figures.

In its analysis for this review, Morningstar DBRS maintained its assumptions from the January 2024 review. As part of that analysis, Morningstar DBRS considered a conservative approach in its analysis and completed a sizing based on a stressed haircut to the YE2022 NOI that reflected market vacancy and significant below-the-line items, including re-leasing costs totalling $3.4 million, which yields a Morningstar DBRS net cash flow (NCF) of $44.1 million. Using a capitalization rate of 8.25%, Morningstar DBRS derived a value of $534.3 million, resulting in an LTV of 73.0% based on the current senior mortgage balance. While CBRE's Q3 2024 "Canadian Cap Rates & Investment Insights indicates that cap rates have risen by 100 basis points YoY to 9.0% to 9.5%, the property continues to outperform its competitive set as the borrower continues to invest in capital improvements despite the market conditions.

To further test the durability of the rating, Morningstar DBRS also conducted an updated stabilized value scenario wherein, if the property were to be re-leased at market rent today and reflected current market occupancy, its net cash flow would decline to $37.4 million. Assuming a stressed capitalization rate of 9.25% based on market rates, the resulting value is $405.7 million, which would be adequate to cover today's outstanding debt and will also continue to benefit from planned amortization over the next three years, prior to Suncor's first lease expiry.

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 factor(s) 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; https://dbrs.morningstar.com/research/437781/morningstar-dbrs-criteria-approach-to-environmental-social-and-governance-factors-in-credit-ratings).

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 (December 13, 2024; https://dbrs.morningstar.com/research/444617/north-american-cmbs-surveillance-methodology).

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.

Please see the related appendix for additional information regarding the sensitivity of assumptions used in the credit rating process.

DBRS Limited
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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 (December 13, 2024; https://dbrs.morningstar.com/research/444612/north-american-single-assetsingle-borrower-ratings-methodology)

Morningstar DBRS North American Commercial Real Estate Property Analysis Criteria (September 19, 2024; https://dbrs.morningstar.com/research/439702/morningstar-dbrs-north-american-commercial-real-estate-property-analysis-criteria)

Legal and Derivatives Criteria for Canadian Structured Finance (August 12, 2024; https://dbrs.morningstar.com/research/437761/legal-and-derivatives-criteria-for-canadian-structured-finance)

North American Commercial Mortgage Servicer Rankings (August 23, 2024; https://dbrs.morningstar.com/research/438283/north-american-commercial-mortgage-servicer-rankings)

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/410863.

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