DBRS Morningstar Assigns Ratings to BAMLL Commercial Mortgage Securities Trust 2016-ISQR

DBRS, Inc. (DBRS Morningstar) assigned ratings to the Commercial Mortgage Pass-Through Certificates, Series 2016-ISQR issued by BAMLL Commercial Mortgage Securities Trust 2016-ISQR (the Issuer) as follows:

-- Class A at AAA (sf)
-- Class B at AA (low) (sf)
-- Class C at A (low) (sf)
-- Class D at BBB (low) (sf)
-- Class E at BB (low) (sf)
-- Class XA at AAA (sf)
-- Class XB at A (sf)

All trends are Stable.

These certificates are currently also rated by DBRS Morningstar’s affiliated rating agency, Morningstar Credit Ratings, LLC (MCR). In connection with the ongoing consolidation of DBRS Morningstar and MCR, MCR previously announced that it had placed its outstanding ratings of these certificates Under Review–Analytical Integration Review and that MCR intended to withdraw its outstanding ratings; such withdrawal will occur on or about May 4, 2020. In accordance with MCR’s engagement letter covering these certificates, upon withdrawal of MCR’s outstanding ratings, the DBRS Morningstar ratings will become the successor ratings to the withdrawn MCR ratings. Information about the MCR ratings, including the history of the MCR ratings, can be found at www.morningstarcreditratings.com.

On March 1, 2020, DBRS Morningstar finalized its “North American Single-Asset/Single-Borrower Ratings Methodology” (the NA SASB Methodology), which presents the criteria for which ratings are assigned to and/or monitored for North American single-asset/single-borrower (NA SASB) transactions, large concentrated pools, rake certificates, ground lease transactions, and credit tenant lease transactions. For further information on the NA SASB Methodology, please see the press release dated March 1, 2020, on the DBRS Morningstar website at www.dbrsmorningstar.com.

The subject rating actions are the result of the application of the NA SASB Methodology in conjunction with the “North American CMBS Surveillance Methodology,” as applicable. Qualitative adjustments were made to the final loan-to-value (LTV) sizing benchmarks used for this rating analysis.

The transaction consists of a $370.0 million trust loan secured by the fee interest in the Class A, 1.16 million square foot (sf) International Square office property in downtown Washington, D.C. The trust loan consists of a $166.7 million senior A-1 note and a $203.3 million junior note with an additional $80.0 million pari passu senior A-2 note split across three commercial mortgage-backed security (CMBS) conduit transactions. Sponsorship is provided by a joint venture between Tishman Speyer Properties (Tishman) and the Abu Dhabi Investment Authority, which purchased the subject in 2006 and returned $253.7 million of equity to the sponsors at closing. The loan is interest only (IO) throughout the 10-year loan term.

The property includes three separate office buildings connected by a 12-story atrium developed between 1978 and 1982 along I Street NW between 18th Street NW and 19th Street NW. The subject has direct access to Farragut West Metro Station and is four blocks northwest of the White House in the Golden Triangle area of Washington, D.C.’s central business district. In addition to the 1.1 million sf of office space, the collateral includes 67,000 sf of ground-floor retail space, 12,000 sf of storage space, and a 637-space subterranean parking garage.

According to the December 2019 rent roll, property occupancy declined to 79.3%, inclusive of the International Foundation of Electoral Systems’ (3.1% of the net rentable area (NRA)) planned departure in March 2020. The occupancy rate has steadily declined since issuance when the property was 94.2% occupied by 45 tenants as notable tenants, such as the World Bank, Morgan Stanley, and HQ Global Workspaces LLC, have either given back space or vacated the property. Positive leasing updates include the public relations firm, Edelman (5.4% of the NRA), signing an 11-year renewal in 2019 starting at its current in-place rental rate of $60.59 per sf (psf) gross. New leases include National Association of Real Estate Investment Trusts (10-year lease expiring in April 2029 for 1.4% of the NRA at a rental rate of $60.38 psf gross) and Wilkes Artis, Chartered (11-year lease beginning in May 2020 for 1.3% of the NRA whose rental rate information is pending). Tenant rollover risk in the next two years is minimal with no large space users rolling in 2020 and tenants combining to occupy only 6.8% of the NRA rolling in 2021.

The current largest tenants are the Federal Reserve System (the Fed; 33.6% of the NRA with various lease expiries ranging from March 2022 to May 2028) and Blank Rome LLP (14.5% of the NRA with a lease expiry in July 2029), which account for approximately 50.3% of the property’s rental revenue combined. In December 2019, the Fed’s Board of Governors announced a $450.0 million renovation and consolidation plan to move its operations in currently leased spaces throughout Washington, D.C. to its government-owned headquarters on Constitution Avenue NW. The planned move will significantly affect the subject’s cash flow beginning in 2022 as the Fed’s first lease expiry occurs in March 2022 (266,023 sf) with the remaining lease expiries occurring in January 2026 (25,621 sf) and May 2028 (98,589 sf). If and when the Fed formally announces its intent to vacate the subject, such action would be defined as a trigger event and, as such, the servicer will begin trapping cash 18 months before the Fed’s first lease expiry, subject to a $7.5 million limit. Currently, there are no outstanding leasing reserves as of April 2020 reporting.

According to Reis, Inc. (Reis), the Downtown Washington, D.C. submarket remains stable for Class A office properties as of YE2019 with an average vacancy rate of 9.5% and an asking rental rate of $58.97 psf gross. By 2025, Reis projects new supply in the submarket totaling over 2.2 million sf, and expects the vacancy rate to increase to 11.0% while rental rates also grow to $64.36 psf gross. In terms of recent sales transactions, Reis identified 12 properties sold within a 2.0-mile radius of the subject since Q2 2018 with sales prices ranging from $500 psf to $1,150 psf. In its H2 2019 report, CBRE Group, Inc. stated that stabilized Class A office properties were trading at capitalization (cap) rates ranging from 5.25% to 5.75%. While the subject’s current occupancy rate is below market, tenants are generally paying rental rates in line with or above market and the current total debt load of $388 psf is reasonable.

While the property’s future expected loss of the Fed as a tenant will result in a significant loss of cash flow and increase in available space, the property benefits from a strong sponsorship and management as both sponsors continue to invest in the subject and Tishman has a large portfolio nationwide, including eight additional office properties in Washington, D.C. totaling 1.8 million sf. In December 2019, the property’s first-floor food court closed as sponsorship plans to renovate the first floor and a portion of the below-grade space to add a food hall, three restaurants, a specialty grocer, a conference center, and an updated and expanded fitness center at an unspecified cost. Construction was slated to begin in Q1 2020 with the amenity upgrades projected to be completed within one year and the retail upgrades projected to be completed within two years. Additionally, the October 2019 servicer inspection report noted that the sponsors are also completing speculative build-outs for select office vacancies to spur leasing momentum.

According to Q3 2019 financials, the loan reported a year-to-date debt service coverage ratio (DSCR) of 2.07 times (x), which remains consistent with the YE2018 and YE2017 figures of 1.85x and 1.89x, respectively. Though the property’s occupancy rate has declined since issuance, DBRS Morningstar expects financial performance to remain stable over the next two years before the Fed’s first lease expiry, given the IO debt service payments and the contractual rental rate increases for the majority of tenants. Net cash flow (NCF) will decline in 2022 if the sponsors cannot find replacement tenants; however, given the lead time, the cash-trap trigger, the sponsors’ experience in Washington, D.C., and the submarket’s stability, DBRS Morningstar expects the loan to continue to perform.

In the analysis for these rating actions, DBRS Morningstar used the Q3 2019 NCF figure of $34.3 million and applied a cap rate of 6.75%, resulting in a DBRS Morningstar Value of $507.4 million, a variance of -33.0% from the appraised value of $757.0 million at issuance. The DBRS Morningstar Value implies an LTV of 88.7% compared with the LTV of 59.4% on the appraised value at issuance.

DBRS Morningstar applied the cap rate in the middle of its Cap Rate Ranges for office properties, which reflects property quality and market fundamentals. In addition, the 6.75% cap rate DBRS Morningstar applied is above the implied cap rate of 5.0% based on the Issuer’s underwritten NCF and appraised value.

DBRS Morningstar made positive qualitative adjustments to the final LTV sizing benchmarks used for this rating analysis, totaling 2.5% to account for property quality and market fundamentals.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

Classes XA and XB are 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 ratings are subject to surveillance, which could result in ratings being upgraded, downgraded, placed under review, confirmed, or discontinued by DBRS Morningstar.

DBRS Morningstar provides updated analysis and in-depth commentary in the DBRS Viewpoint platform for this transaction.

For complimentary access to this content, please register for the DBRS Viewpoint platform at www.viewpoint.dbrsmorningstar.com The platform includes loan-level data for most outstanding CMBS transactions (including non-DBRS Morningstar-rated), as well as loan-level and transaction-level commentary for most DBRS Morningstar-rated and -monitored transactions.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal methodologies are the North American Single-Asset/Single-Borrower Ratings Methodology and North American CMBS Surveillance Methodology, which can be found on dbrsmorningstar.com under Methodologies & Criteria. For a list of the structured-finance-related methodologies that may be used during the rating process, please see the DBRS Morningstar Global Structured Finance Related Methodologies document, which can be found on dbrsmorningstar.com in the Commentary tab under Regulatory Affairs. Please note that not every related methodology listed under a principal structured finance asset class methodology may be used to rate or monitor an individual structured finance or debt obligation.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

For more information regarding structured finance rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/358308.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Please see the related appendix for additional information regarding the sensitivity of assumptions used in the rating process. Please note a sensitivity analysis is not performed for CMBS bonds rated CCC or lower. The DBRS Morningstar long-term rating scale definition indicates that 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.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

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