DBRS Morningstar Downgrades Ratings on Two Classes of LSTAR Commercial Mortgage Trust 2016-4, Changes Trend on One Class to Negative From Stable

DBRS Limited (DBRS Morningstar) downgraded its ratings on two classes of the Commercial Mortgage Pass-Through Certificates, Series 2016-4 issued by LSTAR Commercial Mortgage Trust 2016-4 as follows:

-- Class F to CCC (sf) from BB (low) (sf)
-- Class G to C (sf) from B (low) (sf)

DBRS Morningstar also confirmed its ratings on the following classes:

-- Class A-2 at AAA (sf)
-- Class A-3 at AAA (sf)
-- Class A-S 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 (high) (sf)
-- Class D at BBB (sf)
-- Class E at BBB (low) (sf)

DBRS Morningstar changed the trend on Class E to Negative from Stable. Classes F and G have ratings that generally do not carry trends in commercial mortgage-backed securities (CMBS). All other trends are Stable.

The rating actions reflect DBRS Morningstar’s increased loss expectations for the pool since the last rating action. The increased loss expectations are primarily driven by the largest loan in the pool, Charlotte Plaza (Prospectus ID#1, 13.9% of the pool), which is in special servicing, and the fourth-largest loan in the pool, 995 Market Street (Prospectus #4, 12.3% of the pool), which is on the servicer’s watchlist. Both loans are secured by office properties and have exhibited significant performance declines from issuance. To date, one loan has been liquidated from the trust, incurring a realized loss of approximately $0.3 million. In its analysis for this review, DBRS Morningstar liquidated three loans (27.5% of the pool) from the trust, including the two loans noted above and 310 Superior Street (Prospectus ID#22, 1.3% of the pool) as the special servicer is actively pursuing foreclosure, resulting in an implied loss of more than $28.0 million. Based on these results, the balance of Class G would be written down by nearly 20.0%, significantly eroding the transaction’s credit support, particularly toward the bottom of the capital stack, and supporting the rating actions.

The pool is concentrated by property type, with hotel and office properties representing 32.9% and 27.6% of the pool, respectively. Given the uncertainty related to the end-user demand and investor appetite for office properties, DBRS Morningstar anticipates upward pressure on vacancy rates in the broader office market, challenging landlords’ efforts to backfill vacant space. In certain instances, this pressure can contribute to value declines, particularly for assets in noncore markets and/or with disadvantages in location, building quality, or amenities offered. Additional information and the analytical approach for the two office loans is discussed in more detail below.

The Charlotte Plaza loan is secured by a 632,171-square-foot (sf) office building in downtown Charlotte, North Carolina, and was transferred to special servicing in January 2023 for maturity default. The subject property has experienced significant declines in occupancy since the departure of the former largest tenants, Charlotte School of Law, LLC and Grant Thornton, which collectively represented around 50.0% of the property’s net rentable area (NRA). As of the February 2023 rent roll, the subject was 63.6% occupied, compared with the YE2021 and issuance occupancy figures of 69.9% and 91.4%, respectively.

The largest tenant, Lowe’s Home Improvement (Lowe’s; 31.8% of NRA), went dark and is actively marketing roughly 150,000 sf (23.0% of NRA) of its space as available for sublease, although the tenant continues to honor the terms of the lease, which expires in July 2024. According to various news outlets, Lowe’s completed the construction of a new building in late 2022, in South End Charlotte, that will serve as its new headquarters. When accounting for the eventual departure of Lowe’s, occupancy may dip as low as 30.0%, without consideration for potential future leasing momentum.

According to the Q1 2023 Reis report, office properties in the Uptown submarket had an average vacancy rate of 20.5% with an effective rental rate of $29.25 per square foot (psf), compared with the Q1 2022 figures of 17.0% and $29.27 psf, respectively. Per the February 2023 rent roll, the property had an average rental rate of $35.50 psf, with Lowe’s paying a rental rate of $37.71 psf, suggesting replacement tenants will likely be signed at lower rental rates. Based on the most recent financials, the loan reported a debt service coverage ratio (DSCR) of 1.88 times (x) for the trailing three-month period ended March 31, 2023, compared with the YE2021 DSCR of 2.09x and the DBRS Morningstar DSCR of 1.61x derived at issuance. When removing Lowe’s rent from the net cash flow, the loan’s DSCR drops below break-even.

The servicer noted a loan modification as the resolution strategy, but discussions surrounding the workout are ongoing. Given the soft submarket, low occupancy rate, and general challenges in backfilling the current vacant space, the value of the property has likely declined significantly from the issuance figure of $181.5 million. In its analysis for this review, DBRS Morningstar liquidated the loan from the trust based on a stressed value, resulting in an implied loss of nearly $16.0 million, or a loss severity in excess of 30%.

The 995 Market Street loan is secured by a 91,000-sf, Class B office property in downtown San Francisco. The loan has been on the servicer’s watchlist since April 2022 for occupancy and DSCR-related declines. The original three tenants at the subject, WeWork (74.7% of NRA), Compass Family Services (13.2% of NRA), and CVS (9.7% of NRA), vacated ahead of their lease expirations, although CVS continues to honor its lease, which expires in January 2031. According to LoopNet, the majority of the property is listed as available for lease. The subject property is on the border of three separate office submarkets where vacancy rates range from 12.9% to 32.2%, according to Reis.

WeWork’s lease was guaranteed under a $6.5 million corporate guarantee from WeWork Companies. The corporate guarantee was set to decrease each year until it reached $2.0 million in 2025, where it was to remain until the expiration of the lease in August 2027. The lease was also secured by a $3.25 million letter of credit (LOC), which was posted by WeWork. The status of the LOC and questions on whether the corporate guarantee is being used to cover WeWork’s rent was sent to the servicer, and a response is currently pending. According to the July 2023 loan-level reserve report, $4.0 million remains in leasing reserves.

Although the sponsor contributed $18.2 million of equity to purchase the property at issuance and has kept the loan current despite the significant performance declines, it is uncertain whether the sponsor will continue to be committed to the property given the challenged office sector, particularly in the San Francisco area. Considering the subject is nearly vacant and reporting negative cash flows, value has likely deteriorated significantly from the issuance value of $64.4 million and the loan is likely to transfer to special servicing in the near term. For this review, DBRS Morningstar liquidated the loan from the trust based on a stressed value, resulting in an implied loss of nearly $12.0 million and a loss severity of almost 30.0%.

As of the July 2023 remittance, 14 of the original 22 loans remain in the transaction with an outstanding trust balance of $359.7 million, representing a collateral reduction of 29.0% since issuance. Two loans, representing 8.4% of the pool, are secured by collateral that has been fully defeased. There are two loans in special servicing and two loans on the servicer’s watchlist, representing 15.2% and 14.2% of the pool balance, respectively.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/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 (July 4, 2023) at https://www.dbrsmorningstar.com/research/416784.

Classes X-A and X-B 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 credit ratings are subject to surveillance, which could result in credit 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 (March 16, 2023; https://www.dbrsmorningstar.com/research/410912).

Other methodologies referenced in this transaction are listed at the end of this press release.

The credit ratings assigned to Classes C and D materially deviated from the credit ratings implied by the predictive model. DBRS Morningstar typically expects there to be a substantial likelihood that a reasonable investor or other user of the credit ratings would consider a three-notch or more deviation from the credit rating stress(es) implied by the predictive model to be a significant factor in evaluating the credit ratings. The rationale for the material deviations is due to the uncertain loan-level event risk surrounding the loans in special servicing and the largest watchlisted loan, as discussed above. In addition, the transaction is concentrated with 14 loans remaining in the pool and is susceptible to adverse selection.

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 credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process for this credit rating action.

DBRS Morningstar had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

Please see the related appendix for additional information regarding the sensitivity of assumptions used in the credit rating process. Please note a sensitivity analysis is not performed for CMBS bonds rated CCC or lower. The DBRS Morningstar Long-Term Obligation Rating Scale definition indicates that credit 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 credit ratings are monitored.

DBRS Limited
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Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

North American CMBS Multi-Borrower Rating Methodology (March 16, 2023)/North American CMBS Insight Model v 1.1.0.0 (https://www.dbrsmorningstar.com/research/410913)

Rating North American CMBS Interest-Only Certificates (December 19, 2022; https://www.dbrsmorningstar.com/research/407577)

DBRS Morningstar North American Commercial Real Estate Property Analysis Criteria (September 12, 2022; https://www.dbrsmorningstar.com/research/402646)

North American Commercial Mortgage Servicer Rankings (September 8, 2022; https://www.dbrsmorningstar.com/research/402499)

Interest Rate Stresses for U.S. Structured Finance Transactions (June 9, 2023; https://www.dbrsmorningstar.com/research/415687)

Legal Criteria for U.S. Structured Finance (December 7, 2022; https://www.dbrsmorningstar.com/research/407008)

A description of how DBRS Morningstar analyses structured finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/417279.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.