DBRS Morningstar Downgrades Rating on One Class, Changes Trends to Negative on Four Classes of Bank of America Merrill Lynch Commercial Mortgage Trust 2016-UBS10

DBRS Limited (DBRS Morningstar) downgraded its rating on the following class of the Commercial Mortgage Pass-Through Certificates, Series 2016-UBS10 issued by Bank of America Merrill Lynch Commercial Mortgage Trust 2016-UBS10:

-- Class G to CCC (sf) from B (low) (sf)

DBRS Morningstar also confirmed its ratings on the remaining classes as follows:

-- Class A-3 at AAA (sf)
-- Class A-4 at AAA (sf)
-- Class A-S at AAA (sf)
-- Class A-SB at AAA (sf)
-- Class X-A at AAA (sf)
-- Class X-B at AA (high) (sf)
-- Class B at AA (sf)
-- Class C at A (sf)
-- Class X-D at BBB (high) (sf)
-- Class D at BBB (sf)
-- Class X-E at BBB (low) (sf)
-- Class E at BB (high) (sf)
-- Class X-F at BB (sf)
-- Class F at BB (low) (sf)

In addition, DBRS Morningstar discontinued its rating on Class X-G as it now references a CCC (sf)-rated class. The trends on Classes X-E, E, X-F, and F were changed to Negative from Stable. The trends on the remaining classes are Stable, with the exception of Class G, which has a rating that does not carry a trend.

The rating downgrade and Negative trends primarily reflect DBRS Morningstar’s concerns surrounding the resolution of the Belk Headquarters loan (Prospectus ID#3, 9.1% of the pool balance), which transferred to special servicing at the borrower’s request in January 2023 to negotiate a potential deed-in-lieu of foreclosure. The rating confirmations and Stable trends reflect the continued performance of the transaction, with the remaining loans in the pool generally having experienced minimal changes since the last rating action.

As of the February 2023 remittance, 42 of the original 52 loans remain in the trust, with an aggregate principal balance of approximately $591.7 million, representing a collateral reduction of 32.4% since issuance as a result of loan repayments, scheduled amortization, and one loan liquidation. There are 30 loans, representing 71.0% of the pool balance, that are currently amortizing, which will lead to strong deleveraging over time. In addition, four loans, representing 5.2% of the pool balance, are secured by collateral that has been fully defeased. There are three loans in special servicing, representing 12.0% of the pool, and eight loans on the servicer’s watchlist, representing 19.3% of the pool.

The Belk Headquarters loan is secured by a 473,698-square-foot (sf) Class B office property in suburban Charlotte, North Carolina, which previously served as the headquarters for Belk, a regional department store chain that estimated 1,200 employees working at the property as of February 2021. As of July 2021, however, Belk shifted to a fully remote policy for its corporate-level employees, leaving its space vacant. Belk paid an annual rate of $12.30 per sf (psf), well below the Airport/Parkway submarket Q4 2022 average asking rental rate of $24.51 psf; however, the borrower has been unable to sublease the space given the soft market conditions. According to Reis, the submarket reported an average vacancy rate of 21.6% as of Q4 2022, an increase from the pre-Coronavirus Disease (COVID-19) pandemic rate of 16.5% in Q4 2019. A cash flow sweep was triggered as a result of the Belk’s failure to occupy its space; however, the borrower has requested a transfer to special servicing with negotiations for a potential deed-in-lieu of foreclosure.

While the loan remains current with a Q3 2022 annualized debt service coverage ratio (DSCR) of 1.42 times (x), DBRS Morningstar anticipates the loan will ultimately be liquidated from the trust upon resolution. No updated value has been provided since issuance, when the loan was appraised at a value of $96.9 million. DBRS Morningstar’s liquidations scenario for this loan was based on a haircut to the issuance appraised value with consideration given to the outdated appraisal and soft market conditions, resulting in an analyzed loss severity approaching 20.0%. When factoring in assumed losses for the REO Comfort Inn – Cross Lanes, WV loan (Prospectus ID#34, 1.1% of the pool), which DBRS Morningstar also liquidated from the trust, implied losses totaled nearly $13.0 million. Based on these results, the credit enhancement provided to Class G was significantly eroded, warranting the downgrade action, while suggesting increased credit risk to Classes E and F.

Excluding defeasance, the pool is most concentrated by office and retail properties, representing 34.9% and 31.3% of the pool, respectively. In recent months, there has been further concern and scrutiny around loans secured by office properties. Office supply is on the rise because of low space utilization amid the pandemic and the resulting change in workers’ preferences, a dynamic which has led to an increase in space being offered for sublease and tenants downsizing or vacating. Loans secured by office properties had a weighted-average debt yield of 9.7% based on the most recent financials available.

One notable office loan that DBRS Morningstar is continuing to monitor is 2100 Ross (Prospectus ID#7, 5.6% of the pool balance), which is secured by a Class A high-rise office building in the central business district (CBD) of Dallas. The loan was added to the servicer’s watchlist following the loss of the property’s largest tenant, CBRE Group, Inc. (CBRE; formerly occupied 15.2% of the net rentable area (NRA)), which consolidated its operations and relocated after its lease expiration in March 2022. According to the September 2022 rent roll, the property was 60.0% occupied, falling from 79.8% in December 2021 and 85.1% at issuance. As of Q4 2022 data, Reis reported that office properties in the Dallas CBD submarket reported a vacancy rate of 30.3% with an average rental rate of $22.50 psf compared with the subject’s average rental rate of $20.45 psf. During the next 12 months, only three tenants, representing 1.0% of NRA, have scheduled lease expirations.

The loan includes a specified tenant trigger event, which includes CBRE, with the cash flow sweep to be capped at $2.2 million (approximately $17 psf on CBRE’s space). While the cash flow sweep triggered by CBRE’s departure is a benefit, DBRS Morningstar does not expect the amount to fully cover a tenant improvement package for a new tenant. As per the trailing nine-month financial reporting ended September 30, 2022, the loan reported an annualized DSCR of 1.17x, a decline from 1.32x at YE2021 and 1.36x at issuance. The property is likely to perform near breakeven if the sponsor can’t backfill CBRE’s vacant space.

The prior $61.0 million loan on the subject property was securitized in WBCMT 2007-C34, and the owner at the time defaulted on its debt service payment in 2011 after the largest tenant, Ernst & Young (29.0% of NRA), vacated in 2009. After acquiring the property in a foreclosure auction for $59.2 million, the seller invested $18.8 million into capital improvements, upgrading the property’s interior, exterior, and mechanicals. Whole loan proceeds of $98.0 million, in addition to $44.5 million of borrower equity, served as acquisition financing for the subject’s purchase price of $131.0 million, reflecting a moderate going-in loan-to-value ratio of 74.8%. Given the increased vacancy and softening submarket conditions, property value has likely declined significantly, elevating the loan’s leverage and credit risk to the trust. As a result, DBRS Morningstar analyzed this loan with an elevated probability of default to increase the loan’s expected loss.

Environmental, Social, and Governance Considerations
There were no environmental, social, or 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 (May 17, 2022).

Classes X-A, X-B, X-D, X-E, and X-F are interest-only (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.

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

The principal methodology is the 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. 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.

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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