DBRS Morningstar Finalizes Provisional Ratings on SFO Commercial Mortgage Trust 2021-555

DBRS, Inc. (DBRS Morningstar) finalized its provisional ratings on the following classes of notes issued by SFO Commercial Mortgage Trust 2021-555.

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

All trends are Stable.

SFO 2021-555 is a single-asset/single-borrower transaction collateralized by the borrower’s fee-simple interest in the 555 California Street Campus (the Campus), a 1.8 million-sf Class A office complex in the North Financial District of San Francisco. J.P. Morgan will fund the total debt of $1.2 billion for the refinancing of the Campus. The IO floating-rate $1.2 billion loan has an initial term of two years with five one-year extension options. The total capitalization of $2.0 billion includes $850.0 million of sponsor equity, which will be used to refinance $532.7 million of existing debt, return $616.0 million of sponsor equity, fund $19.8 million of outstanding TI/LC reserves and $12.5 million of free rent, fund capital improvement reserves for Bank of America for $6.9 million, and pay $12.0 million of closing costs. The transaction has a slightly elevated DBRS Morningstar Issuance LTV of 90.21%, based on the trust debt. The loan-to-value ratio (LTV) based on the appraised value of $2.1 billion is 58.5%.

The sponsor is a 70/30 joint venture between Vornado Realty L.P. and Donald J. Trump. The loan is 100% controlled by Vornado Realty Trust, a publicly traded real estate investment trust and a member of the S&P 500 Index. Vornado’s portfolio is concentrated in New York City, Chicago, and San Francisco. Vornado acquired the Campus in 2007 and has invested $164.8 million ($90.63 per square foot (psf)) into the Campus since 2016.

DBRS Morningstar has a positive view on the near- to midterm sustainability of the Campus’ net cash flow (NCF), based on its location, tenancy, and historical performance. The Campus is in the North Financial District in the San Francisco central business district (CBD) market. According to the Q4 2020 appraisal information, the North Financial District has 26.3 million sf of inventory with an overall occupancy rate of 82.4% and a direct weighted-average (WA) Class A rent of $85.96 psf, compared with the South Financial District’s total inventory of 27.9 million sf, occupancy rate of 87.7%, and direct WA Class A rent of $85.44 psf. The North Financial District has no office space under construction at this time.

Although the North Financial District has a high overall vacancy rate, the Campus significantly outperforms the submarket. As of the February 1, 2021, rent roll, the Campus was 92.7% occupied, including the vacant property, 345 Montgomery, which has completed its renovation. The Campus has a WA occupancy rate of 95.3% since 2010 and benefits from a granular rent roll with only one tenant, Bank of America at 18.1% of net rentable area (NRA), accounting for more than 10.0% of NRA. Additionally, Bank of America is the only investment-grade-rated tenant receiving any DBRS Morningstar Long Term Credit Tenant (LTCT) treatment. The second-largest tenant is Kirkland & Ellis LLP, which accounts for 8.4% of NRA. The rent roll is well diversified, consisting of 41 unique tenants with 19 investment-grade tenants, accounting for 34.4% of NRA. Such diversification is credit positive as the cash flow will be less susceptible to revenue swings, making it more resilient during economic downturns such as during the Coronavirus Disease (COVID-19) pandemic.

Although the ongoing pandemic continues to pose challenges and risks to virtually all major commercial real estate property types, the property has shown strong performance during these unprecedented times with approximately 2.1% of the tenants based on total NRA requesting rent relief and a current vacancy rate of 7.3%. The Campus has demonstrated very strong performance with an 11-year historical occupancy rate of 95.3%, greater than the Reis submarket’s 91.7%. Tenants plan to bring employees back to the office around May or June for those who want to come into the office. Currently, the Campus is averaging 200 people per day at 555 California and approximately 15 per day at 315 Montgomery; pre-pandemic, 555 California averaged approximately 4,500-5,200 people per day.

The Campus has great exposure with a full block frontage on California Street, a primary two-way, four-lane major arterial that runs east to west in downtown San Francisco with the San Francisco Streetcar line, along with full frontage on Pine Street, Montgomery Street, and Kearny Street. Additionally, the location affords excellent access to public transportation, with four BART subway lines that stop twice in the Financial District and transport commuters to and from San Francisco to the East Bay.

Although 315 Montgomery was built in 1921 and 555 California Street and 345 Montgomery were built in 1971, the Campus has received approximately $164.8 million or $90.63 psf of capital improvements. 555 California received $64.3 million ($42.72 psf) in capital improvements for concourse renovation and retail enhancements, the opening of the Vault restaurant, roof replacement, new lobby furnishings, HVAC upgrades, and modernizations to the restrooms. 315 Montgomery received $39.7 million ($168.74 psf), and 345 Montgomery received $60.8 million ($779.56 psf) to complete a full renovation and restoration transforming the building into a new creative office building with a five-story atrium. Additionally, 555 California has 30,000-sf office plates with 700,000 sf of protected, unobstructed views, twice as much as its direct competitors.

The highly granular rent roll is well diversified, consisting of 41 unique tenants with 19 investment-grade tenants and AM Law rated tenants, accounting for 68.7% of NRA. Bank of America, at 18.1% of NRA, is the only tenant at the property accounting for more than 10.0% of NRA. Bank of America recently executed a lease extension commencing in October 2025 for 10 years. Additionally, only 1.4% of NRA (25,701 sf) of leases are subleased for a WA rent of $90.12 psf to FTV Management Company (962 sf), KKR Credit Advisors (4,673 sf), and LendingHome Corporation (20,066 sf), greater than the in-place WA rent of $79.85 psf. Five tenants, accounting for 2.1% of NRA (37,544 sf), have requested rent relief between May 2020 and July 2020 and are scheduled to repay in 2021.

Since 2019, the Campus has renewed or signed approximately 512,825 sf with a WA rent psf of $101.56 equal to $27.0 million of total net. Most recently, the Goldman Sachs Group (Goldman Sachs) executed a five-year lease renewal for 90,000 sf at 555 California, increasing its rent to $110 psf from a base rent of $59-$75 psf. Additionally, Kohlberg Kravis Roberts & Co. L.P. recently executed a four-year renewal for 50,515 sf at a base rent of $110 psf.

The ongoing coronavirus pandemic has created an element of uncertainty around future demand for office space, even in gateway markets that have historically been highly liquid. While some tenant spaces are not completely occupied as employees have continued to work from home during the pandemic, all tenants are now open and operating. Approximately 2.1% of the tenants based on total NRA have requested rent relief, most of which are retail tenants. Between December 2020 and March 2021, collections equated to approximately 98.0% with deferrals and abatements combined equating to less than 1% of total revenue. According to management, daily headcount at the property is still much lower than average.

The Campus has three years during the loan term with tenant rollover exceeding 10% of NRA: 2023, 2025, and 2026 with 10.4%, 22.6%, and 18.8% rollover, respectively. Leases representing approximately 64.3% of the NRA at the property will roll over through 2028. The loan’s cash management provisions are based on a simple 5.5% debt yield trigger in order to sweep excess cash flow or collect reserves for re-tenanting expenses. Furthermore, the tenant rollover reserve is capped at $3,637,800 in aggregate, and the replacement reserve is capped at $1,000,000 in the aggregate. Also, the borrower is allowed to replace any actual cash reserves with a letter of credit or guaranty from an affiliate as further detailed in the loan document.

345 California is currently 100% vacant after undergoing a $60.8 million renovation. The space is not easily subdivided and is best suited for a single tenant. Management indicates there are no tenant letters of intents (LOI) issued. However, during the site inspection on-site management stated there has been interest by prospective tenants.

The aggregate probable maximum loss (PML) for 555 California and 345 Montgomery according to the seismic consultant is 14%, and the 315 California building PML is 19% due to its much older construction. The borrower carries an all-risk blanket insurance policy that includes earthquake coverage.

The loan is IO for the entire term. The lack of principal amortization during the loan term can increase the refinance risk at maturity. The loan leverage is considered moderate at a 58.5% LTV based upon the market appraised value and a DBRS Morningstar Issuance LTV of 90.21%. Furthermore there is no additional debt allowed other than trade payables capped at 4% of the initial loan amount.

Additionally, the sponsor is cashing out approximately $616.0 million of equity, equal to 30.1% of the cost basis. Although the sponsor is extracting an exceptional amount of capital out of the assets, it has also invested substantially in the properties since 2016, spending an estimated $164.8 million on the campus to improve it.

Three of the top five tenants, Bank of America, Kirkland & Ellis LLP, and UBS Financial Services (collectively 32.0% of NRA and 33.1% of UW base rent) have the options to terminate their leases. DBRS Morningstar did not give LTCT credit for the Bank of America spaces on floors 11 and 44 that carry the early termination options. All of the tenants have spent considerable amounts of their own capital to improve their spaces, and Bank of America is currently undertaking a full renovation of its space.

There is no recourse carve-out guarantor for the loan, and certificateholders must look solely to the net revenues from the operation of the property and any net proceeds from the refinancing or sale of the property for payment of amounts due on the loan. The borrower “Bad Boy” guarantees and consequent access to a guarantor help mitigate the risk and increased loss severity of bankruptcy, additional encumbrances, unapproved transfers, fraud, misappropriation of rents, physical waste, and other potential bad acts of the borrower or its sponsor. The borrower is a recycled special purpose entity (SPE) indirectly owned and controlled by a joint venture between Vornado Realty L.P. (VRLP or Vornado) (70.0% of the equity interest) and Donald J. Trump or one or more trusts for such individual or any affiliate (30.0% of the equity interest).

Transfer of the indirect beneficial interests in the borrower owned by Trump may occur, provided that Vornado and/or eligible qualified owners will still control the borrower and directly or indirectly own at least 20% of the direct or indirect beneficial interests in borrower in the aggregate. If any transfer results in any person (together with its affiliates and family members) acquiring more than 49% of the direct or indirect equity interest in borrower, an additional insolvency opinion must be delivered that in the lender’s (servicer’s) reasonable judgment satisfies the then-current rating agency criteria. The transfer must meet all legal requirements including OFAC, the Patriot Act, and ERISA. Any person that acquires, directly or indirectly, 50% or more of the equity interests in borrower must be an institutional investor. The eligible qualified owner and institutional investor definitions generally require real estate assets owned to be in excess of $2 billion and net worth in excess of $1 billion. The borrower may not permit any transfer of any Vornado direct or indirect interest in the borrower to Trump without the express written consent of the lender, which can granted or withheld in the lender’s sole and absolute discretion, and any such transfer of any direct or indirect interest in the Borrower held by Vornado to Trump will not be considered a permitted transfer.

The underlying mortgage loan for the transaction will pay floating rate, which presents potential benchmark transition risk as the deadline approaches for the elimination of Libor. The transaction documents provide for the transition to an alternative benchmark rate, which is primarily contemplated to be either Term Secured Overnight Financing Rate (SOFR) or Compounded SOFR plus the applicable Alternative Rate Spread Adjustment. Term SOFR does not currently exist and there is no assurance it will fully develop or be widely adopted. Compounded SOFR, which is expected to be a backward-looking rate generally calculated using actual rates during the applicable interest accrual period, is considered by some servicers to be less practical to implement. The servicer for the transaction will have sole discretion over various aspects of a benchmark transition. Any uncertainty or delay in transitioning to an alternative to Libor could lead to unforeseen issues for both the mortgage loan borrower and certificateholders. Additionally, in order to extend the loan, the borrower must also obtain a replacement interest rate cap agreement. If a replacement agreement is not commercially available, the borrower can propose an alternative hedging instrument that would provide substantially equivalent protection from increases in the interest rate. However, the servicer can reject any proposal and impose its own hedging solution, if any.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

For supporting data and more information on this transaction, please log into www.viewpoint.dbrsmorningstar.com DBRS Morningstar provides analysis and in-depth commentary in the DBRS Viewpoint platform.

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

With regard to due diligence services, DBRS Morningstar was provided with the Form ABS Due Diligence-15E (Form-15E), which contains a description of the information that a third party reviewed in conducting the due diligence services and a summary of the findings and conclusions. While due diligence services outlined in Form-15E do not constitute part of DBRS Morningstar’s methodology, DBRS Morningstar used the data file outlined in the independent accountant’s report in its analysis to determine the ratings referenced herein.

The principal methodology is North American Single-Asset/Single-Borrower Ratings Methodology (March 2, 2021), 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.

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 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.

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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