DBRS Morningstar Upgrades Ratings on Three Classes of KKR Industrial Portfolio Trust 2021-KDIP, Confirms Remaining Ratings

DBRS Limited (DBRS Morningstar) upgraded its ratings on three classes of Commercial Mortgage Pass-Through Certificates, Series 2021-KDIP issued by KKR Industrial Portfolio Trust 2021-KDIP as follows:

-- Class B to AAA (sf) from AA (high) (sf)
-- Class C to AA (sf) from AA (low) (sf)
-- Class D to A (sf) from A (low) (sf)

In addition, DBRS Morningstar confirmed its ratings on the remaining classes as follows:

-- Class A at AAA (sf)
-- Class E at BBB (low) (sf)
-- Class F at BB (low) (sf)
-- Class G at B (low) (sf)

All trends are Stable.

The rating upgrades reflect the increased credit support to the trust as a result of property releases and prepayments, as well as the results of the stressed scenario DBRS Morningstar considered as part of this review, further described below. Since DBRS Morningstar’s last review of the transaction in January 2022, an additional 13 properties were released, further deleveraging the transaction, which converted to a sequential-pay structure in Q4 2021. As of the December 2022 reporting, 45 properties had been released in total, resulting in a $324.9 million principal prepayment to the senior debt for a collateral reduction of 46.7% since issuance. The remaining portfolio continues to perform in line with issuance expectations.

At issuance, the interest-only loan was secured by the fee-simple interest in a portfolio of 96 industrial/distribution properties totaling approximately 10.9 million square feet (sf) across nine U.S. states. The whole loan of $740.0 million consisted of $695.0 million of senior debt held in the trust and $45.0 million of mezzanine debt held outside of the trust. The sponsor, KKR Real Estate Partners Americas II L.P., is an affiliate of KKR & Co. Inc., a global investment firm with more than $496 billion in assets under management as of Q3 2022. Whole-loan proceeds along with approximately $300.4 million of cash equity facilitated the acquisition of the portfolio at a purchase price of $989.5 million, funded upfront reserves of $36.8 million, and covered closing costs. The borrower submitted a request to exercise the first of three one-year extension options to extend the loan’s maturity to December 2023. While there seems to be no formal approval, the December 2022 reporting shows the new maturity date as December 2023.

The transaction was structured with weak release premiums and a pro rata prepayment structure for the first 25% of the initial loan balance. The release provisions allow the borrower to release one or more preapproved release parcels at a release price equal to 100% of the allocated loan amount (ALA) (aggregate releases not to exceed 10% of the original principal balance). Otherwise, the prepayment premium to release individual assets is 105% of the ALA (aggregate releases not to exceed 15% of the original principal balance). As of the December 2022 reporting, the total amount of aggregate releases has surpassed 15% of the original principal balance, and the prepayment premium to release individual assets is now 110% of the ALA.

Per the December 2022 reporting, 51 industrial/distribution properties remain as collateral, totaling approximately 6.2 million sf, with the largest state concentrations in Texas (38.5% of the ALA), Pennsylvania (25.2% of the ALA), and Georgia (21.5% of the ALA). By property subtype, the portfolio is primarily classified as distribution space, which represents 86.8% of the portfolio’s net rentable area (NRA), while 6.5% of NRA is classified as general industrial and 4.2% of NRA is warehouse space.

As of Q2 2022, the portfolio reported an occupancy rate of 98.0%. While it is notable that leases representing 7.5% of the NRA are scheduled to expire in 2023, with another 15.1% scheduled to expire in 2024, the loan has upfront reserves to help mitigate future tenant rollover and aid with leasing costs. According to the December 2022 loan-level reserves report, the borrower had access to $5.0 million in reserves, between reserves for tenant improvements and leasing commissions ($2.2 million), capital improvements ($0.9 million), and other items ($1.9 million).

The servicer-reported consolidated financial statement for the portfolio showed a Q2 2022 annualized net cash flow (NCF) of $32.9 million (a debt service coverage ratio of 3.15 times); however, that figure includes revenue and expenses for properties released during that time frame. In the analysis for this review, DBRS Morningstar excluded the 45 released properties from the pool, resulting in a DBRS Morningstar NCF of $27.9 million. DBRS Morningstar further applied a blended capitalization rate of 7.0%, which resulted in a DBRS Morningstar value of $390.4 million, a variance of -32.1% from the issuance appraised value of $575.2 million for the remaining collateral.

The DBRS Morningstar value implies a loan-to-value ratio (LTV) of 94.9% compared with the LTV of 55.0% on the issuance appraised value for the remaining collateral. Leverage increased since issuance given the weak collateral release provisions, but it remained within the DBRS Morningstar LTV benchmarks. DBRS Morningstar made positive qualitative adjustments to the final LTV sizing benchmarks it used for this rating analysis to account for cash flow volatility, property quality, and market fundamentals. DBRS Morningstar also made other negative adjustments to account for the weak deleveraging premium.

To evaluate the potential for rating upgrades given the significant paydown in the past year, DBRS Morningstar further considered a haircut to the DBRS Morningstar NCF that generally represents a peak-to-trough NCF decline. Based on the LTV sizing benchmarks resulting from that stressed analysis, the upgrades to Classes B, C, and D were warranted.

The DBRS Morningstar ratings assigned to Classes D, E, and F are lower than the results implied by the LTV sizing benchmarks. These variances are warranted as current loan performance trends may not be sustainable given the possibility of adverse selection following the significant amount of property releases in the past year.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

There were no environmental, social, and governance factors that had a significant or relevant effect on the credit analysis.

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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022).

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 U.S. dollars unless otherwise noted.

The principal methodology is North American CMBS Surveillance Methodology (October 3, 2022), 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 releases baseline macroeconomic scenarios for rated sovereigns. DBRS Morningstar analysis considered impacts consistent with the baseline scenarios as set forth in the following report: https://www.dbrsmorningstar.com/research/384482.

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.

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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