DBRS Morningstar Corrects and Downgrades Ratings of FMB Issued by SEC LP and ARCI Ltd. (Suncor Energy Centre)

DBRS Limited (DBRS Morningstar) corrected an error in a July 10, 2020, press release for SEC LP and ARCI Ltd. (Suncor Energy Centre), in which DBRS Morningstar inaccurately referred to the ratings of Suncor Energy Inc. (Suncor) as “rated A (low) and Under Review with Negative Implications by DBRS Morningstar.” In fact, DBRS Morningstar removed Suncor’s ratings from Under Review with Negative Implications on June 18, 2020. Consequently, the credit rating of the first mortgage bonds issued by SEC LP and ARCI Ltd. (Suncor Energy Centre) was affected and is hereby corrected accordingly. As of July 29, 2020, the previous incorrect press release issued on July 10, 2020, is being removed from circulation to avoid confusion. This correction press release is being issued as a replacement.

DBRS Morningstar downgraded the following first mortgage bonds (the Bonds) issued by SEC LP and ARCI Ltd. (Suncor Energy Centre):

-- 5.188% Series 1 Senior Secured Bonds due August 29, 2033 to A (low) (sf) from A (sf)

The trend is Negative.

The rating has been removed from Under Review with Developing Implications, where it was placed on November 14, 2019.

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.

Prior to the finalization of the NA SASB Methodology, the DBRS Morningstar ratings for the subject transaction and all other DBRS Morningstar-rated transactions subject to the methodology in question were previously placed Under Review with Developing Implications, as the proposed methodology changes were material.

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 to reflect updated performance of the asset including market fundamentals. Qualitative adjustments were made to the final loan-to-value (LTV) sizing benchmarks used for this rating analysis.

The Bonds are secured by the Issuer’s ownership interest in Suncor Energy Centre (the Property) and have a current outstanding balance of $466.4 million with a maturity date of August 29, 2033. Recourse to the Issuer is limited to the Property only. 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 Leadership in Energy and Environmental Design Gold certification. The overall property occupancy and net operating income (NOI) have improved over the past couple of years, though the overall property occupancy and NOI have declined since 2015. As per the December 31, 2019, rent roll, the property had an overall physical vacancy of only 1.9%, which included 1.8% for the office component and 12.5% for the retail component. The average in-place office rent was $33.84 per sf (psf). However, as per CBRE Limited’s Calgary Downtown Office Marketview Q1 2020, the market vacancy and market rent for Class AA office in Calgary’s central core submarket were 14.8% and $21.94 psf, respectively. The sustained decline in the performance of the Calgary office market over the last several years, and the diminished outlook for a meaningful recovery amid the coronavirus pandemic were considered as part of these rating actions.

The DBRS Morningstar net cash flow (NCF) was based on the December 31, 2019, rent roll and YE2019 operating statement adjusted to reflect current market vacancy and market rent for non-long-term credit tenants, and further adjusted for DBRS Morningstar normalized management fees, capital expenditures (capex), and leasing costs. The resulting NCF figure was $36.6 million and a cap rate of 7.25% was applied, resulting in a DBRS Morningstar Value of $504.8 million, a variance of -48.7% from the Issuer’s 2019 estimated fair market value of $984.8 million or -57.9% from the 2012 appraised value of $1.2 billion. The DBRS Morningstar Value implies an LTV of 92.4%, as compared with the LTV on the Issuer’s 2019 estimated fair market value of 47.4%. The NCF figure applied as part of the analysis represents a -48.0% variance from the Issuer’s YE2019 reported NOI, primarily driven by lower rental income as DBRS Morningstar is concluding to office market rent between $20.00 psf and $24.00 psf (as compared with in-place rents, which are in excess of $30 psf), higher vacancy, normalized capex, and leasing costs.

The cap rate applied is at the middle of the range of DBRS Morningstar Cap Rate Ranges for office properties, reflective of the age and quality of the property and market fundamentals. In addition, the 7.25% cap rate applied is above the implied cap rate of 7.1% based on the Issuer’s 2019 reported NOI and estimated fair market value.

DBRS Morningstar made negative qualitative adjustments to the final LTV sizing benchmarks used for this rating analysis totalling -1.00% to account for property quality and market fundamentals. However, the contractual rents from Suncor (rated A (low) with a Negative trend by DBRS Morningstar)—which, as the largest tenant, has 80.5% of total net rentable area and 76.2% of in-place rents with lease expiration on November 30, 2028—are sufficient to cover debt service after operating expenses, capex, and leasing costs. The credit quality of the debt during Suncor’s lease term is supported by the credit quality of Suncor. DBRS Morningstar adjusted the analyzed debt amount to $305.3 million, which represents the outstanding balance at Suncor’s lease maturity. This effectively gives full credit to the expected amortization of the debt prior to Suncor’s expiry. DBRS Morningstar notes that any change to the rating of Suncor during its lease terms will likely have an effect on the ratings of the Bonds.

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.

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

Notes:
All figures are in Canadian dollars unless otherwise noted.

The principal methodologies are the North American Single-Asset/Single-Borrower Ratings Methodology (March 1, 2020) and North American CMBS Surveillance Methodology (March 6, 2020), 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.

The DBRS Morningstar Sovereign group released on April 16, 2020, a set of macroeconomic scenarios for the 2020-22 period in select economies. These scenarios were last updated on July 22, 2020. For details see the following commentaries: https://www.dbrsmorningstar.com/research/364318/global-macroeconomic-scenarios-july-update and https://www.dbrsmorningstar.com/research/359903/global-macroeconomic-scenarios-application-to-credit-ratings. DBRS Morningstar analysis considered impacts consistent with the moderate scenario in the referenced reports.

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.

For more information regarding the structured finance rating approach and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/359905.

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@dbrsmorningstar.com.

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.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are monitored.

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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