DBRS Morningstar Downgrades Rating on One Class of A10 Permanent Asset Financing 2015-I, LLC

DBRS Limited (DBRS Morningstar) downgraded its rating on the following class of notes issued by A10 Permanent Asset Financing 2015-I, LLC:

-- Class C Notes to BB (sf) from BBB (low) (sf)

In addition, DBRS Morningstar confirmed the remaining classes of notes as follows:

-- Class A Notes at AAA (sf)
-- Class B Notes at A (high) (sf)

The trend on Class B was changed to Negative from Stable, and the trend on Class C was maintained at Negative. The trend on Class A remains Stable. The rating downgrade and Negative trends reflect DBRS Morningstar’s concerns with the high concentration of loans secured by office collateral, which report declining occupancies, low in-place cash flows, and are located in soft submarkets. In total, there are 10 loans, representing 44.2% of the pool, secured by office properties, of which seven loans, representing 38.9% of the pool, are being monitored on the servicer’s watchlist or are in special servicing, having experienced occupancy declines following the departure of large tenants. Given the shift in demand for office space following the Coronavirus Disease (COVID-19) pandemic, DBRS Morningstar anticipates upward pressure on vacancy rates in the broader office market, presenting an additional challenge in retenanting the aforementioned properties and increasing the potential for value declines. As part of this review, DBRS Morningstar increased the probability of default for all of the distressed loans to reflect their current risk profile and, in certain cases, applied stressed loan-to-value (LTV) ratios.

The only loan in special servicing, Northwood Crossing (Prospectus ID#23, 5.0% of the pool), is secured by an office property in Harrisburg, Pennsylvania. The loan transferred to special servicing in April 2022 because of imminent payment default. The property’s largest tenant, United Concordia Companies, Incorporated, which previously comprised 89.4% of the net rentable area (NRA), vacated its space at the end of May 2022. The property is nearly entirely vacant, and the borrower has stated it is unwilling to commit fresh equity and does not have sufficient liquidity to support the debt. The borrower is now in the latter stages of a deed in lieu of foreclosure. The loan reports over $3.7 million of reserves, including $1.3 million in excess cash reserves and $2.2 million in rollover reserves, which DBRS Morningstar notes serves as additional collateral on the loan. DBRS Morningstar assumed a liquidation scenario for this loan, based on a haircut to the June 2022 appraised value of $7.4 million, which is lower than the current loan balance of $11.8 million. The liquidation scenario gave credit to the $3.5 million of excess cash and rollover reserves, resulting in a loss severity in excess of 30.0%. Based on this analysis, liquidated losses would be contained to the unrated first loss piece, but would erode cushion for the Class C Notes, supporting the downgrade for that class with this review.

The largest loan on the watchlist, 610 West Ash (Prospectus ID#35, 13.4% of the pool), is secured by an office property in San Diego. The property’s largest tenant, ESET (37.0% of NRA), recently gave notice that it would not renew its lease that is set to expire in August 2023. This notice initiated a cash sweep, which will remain active until the space is retenanted. The servicer notes that there are no funds in the excess cash reserve; however, as of February 2023, the loan reports $2.0 million in a rollover reserve, $570,000 in a capex reserve, and $404,000 in a tax reserve. According to the Q3 2022 financials, the loan reported a debt service coverage ratio (DSCR) of 1.38 times (x) with an occupancy of 88.0%. Following ESET’s departure, physical occupancy will decrease to 51.0% and, in absence of any additional leasing, cash flow will not be sufficient to cover the loan’s debt service. ESET is currently paying a rental rate of $26.39 per square foot (psf). Per Reis, the downtown San Diego office submarket reported a Q4 2022 vacancy rate of 21.0% with asking rents of $38.96 psf. Given the soft submarket and upcoming vacancy, DBRS Morningstar increased the probability of default for this loan in its analysis. In addition, DBRS Morningstar derived a stressed value based on the property’s in-place cash flow adjusted for the loss of ESET’s rent, using the high end of DBRS Morningstar’s cap rate range for office properties, resulting in a modeled LTV of more than 200.0%.

DBRS Morningstar also remains concerned with the 205 W Wacker loan (Prospectus ID#5, 6.1% of the pool), which is secured by a 271,233-square-foot, 23-story Class B office building within the West Loop submarket of downtown Chicago. The occupancy decreased to 60.5% when the property’s former largest tenant Salesforce, Inc. (Salesforce; 8.4% of NRA) exercised an early termination option and vacated in September 2021. Salesforce paid a termination fee of $581,987. While the borrower has exhibited an ability to attract new tenants and sign new leases over the past two years, bringing occupancy to 74.8% as of YE2022, occupancy is expected to decline following the departure of two tenants, representing 4.4% of NRA and paying an average rental rate of $24.67 psf, that have exercised termination options and will be vacating in the first half of 2023. Termination fees totaling $602,000 were paid and, in addition to the $582,000 collected from Salesforce, are held in reserve and can be used to help retenant the property. As of the Q3 2022 financials, the loan reported a DSCR of 0.58x and is still operating under a fixed-cash sweep of $37,000 per month. As of February 2023, the excess cash reserve and rollover reserve, inclusive of collected termination fees, totaled $629,000 and $2.5 million, respectively. Per Reis, the West Loop office submarket reported a Q4 2022 vacancy rate of 11.8% with asking rents of $46.52 psf. Given the expected occupancy decline and softening submarket, DBRS Morningstar increased the probability of default for this loan in its analysis. To further stress the loan’s expected loss, DBRS Morningstar applied an LTV of 100.0% to this loan in the model run for this transaction, accounting for the potential for future value decline.

The transaction originally had a maximum funded balance of $300.0 million, which was fully funded in May 2017, initiating a sequential paydown; however, earn-out facilities were drawn upon through May 2018. As of the February 2023 remittance, there has been a collateral reduction of 20.4% from scheduled loan amortization and the repayment of five loans. None of the remaining loans are scheduled to mature until 2024.

ENVIRONMENTAL, SOCIAL, 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).

DBRS Morningstar materially deviated from its North American CMBS Insight Model when determining the rating assigned to Class B, as the quantitative results suggest a lower rating on that class. The material deviation is warranted given the uncertain loan-level event risk tied to the loans of concern, specifically those on the watchlist and in special servicing, which are secured by office properties with low in-place cash flows and declining occupancy.

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.

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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