DBRS Morningstar Confirms Credit Ratings on All Classes of Morgan Stanley Capital I Trust 2017-HR2

DBRS Limited (DBRS Morningstar) confirmed its ratings on all classes of the Commercial Mortgage Pass-Through Certificates Series 2017-HR2 issued by Morgan Stanley Capital I Trust 2017-HR2 as follows:

-- Class A-3 at AAA (sf)
-- Class A-4 at AAA (sf)
-- Class A-SB 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 (low) (sf)
-- Class X-D at A (low) (sf)
-- Class D at BBB (high) (sf)
-- Class E-RR at BBB (low) (sf)
-- Class F-RR at BB (high) (sf)
-- Class G-RR at BB (low) (sf)
-- Class H-RR at B (sf)

All trends are Stable.

The rating confirmations reflect DBRS Morningstar’s stable outlook for the transaction, which remains relatively unchanged from last review. Overall, the pool continues to exhibit healthy credit metrics, as evidenced by the weighted-average (WA) debt service coverage ratio (DSCR) of nearly 2.70 times (x) for all non-defeased loans, based on the YE2022 financial reporting.

Per the September 2023 reporting, 39 of the original 42 loans remain in the trust, reflecting a collateral reduction of 14.4% since issuance as a result of loan amortization and loan repayment. Since last review, the concentration of loans on the servicer’s watchlist has been reduced by nearly 15.0%, while Eagle Village Apartments (Prospectus ID#28) repaid in full and Meadow Creek Apartments (Prospectus ID#20) was fully defeased. Three loans, representing 3.5% of the pool, are now fully defeased. No loans are delinquent or in special servicing. Six loans, representing 10.9% of the pool, are on the servicer’s watchlist, all because of low DSCRs and/or increased vacancy.

The pool is concentrated by property type with loans backed by retail and office properties representing 34.4% and 19.5% of the current pool balance, respectively. In general, the office sector has been challenged, given the low investor appetite for the property type and high vacancy rates in many submarkets as a result of the shift in workplace dynamics.
While several office loans in the transaction continue to perform as expected, select loans are exhibiting increased risk. To account for this risk, DBRS Morningstar conducted an analysis to determine office loans that could be exposed to value declines for the collateral properties based on the current performance or future challenges that could arise given rollover concentrations through the loan term. In the analysis for this review, DBRS Morningstar applied stressed loan-to-value (LTV) ratios or elevated probability of default (POD) assumptions for four loans exhibiting declines in performance, resulting in a WA expected loss (EL) approximately 1.25x of the pool average.

The largest of these loans, One Ally Center (Prospectus ID#8; 4.0% of the pool), is secured by a 976,095 square foot (sf), Class A office property in Detroit. While performance experienced some volatility during 2021, coverage remained healthy as of YE2022 at 2.72x based on the whole loan; however, since issuance occupancy has fallen from 94.3% to 86.7% as of YE2022. In addition, five tenant tenants (7.7% of the net rentable area (NRA)) have leases that are scheduled to expire prior to YE2024. Tenant Price Waterhouse Coopers LLP (7.2% of the NRA; lease expiration in October 2023) has renewed its lease according to the servicer’s most recent update; however, renewal terms has not been disclosed. While a recent news article published by DBusiness indicated that Miller Johnson, a legal services provider, planned to relocate to the subject property in June 2023, terms and rates have not yet been provided, and LoopNet currently shows an availability rate of 16.7%. Despite the long term tenancy in the property’s largest tenant, Ally Financial (41.3% of the NRA; lease expiration in December 2028), and the property’s low going-in LTV of 55.1%, DBRS Morningstar has a cautious outlook on this loan given the increased vacancy and upcoming tenant rollover, coupled with the soft market conditions, as vacancy in the Detroit central business district submarket was reported at 23.3% as of Q2 2023. In its analysis for this review, DBRS Morningstar analyzed this loan with a stressed LTV and an increased POD assumption, resulting in an EL that was 1.50x of the pool average.

Another loan that DBRS Morningstar is monitoring is Totowa Commons (Prospectus ID#5; 6.3% of the pool), which is secured by an anchored retail center in Totowa, New Jersey. At issuance, the property was fully occupied by six tenants and anchored by Home Depot (37.0% of the NRA; lease expiration in April 2025), Bed, Bath & Beyond (formerly 34.5% of the NRA; lease expiration in November 2023), Staples (7.6% of the NRA), and Marshalls (formerly 16.6% of the NRA). Since then, however, three tenants (51.1% of the NRA) have vacated the property, including Bed, Bath & Beyond in July 2023, and Marshalls in June 2022. Buy Buy Baby initially subleased approximately 30,000 sf (11.1% of the NRA) of Bed, Bath & Beyond’s space; however, the servicer has confirmed that Buy Buy Baby has signed a direct lease for the space, which would increase the physical occupancy from 48.9% as of July 2023 to approximately 60.0%. In addition, the borrower has executed a new lease with Lidl (10.0% of the NRA; lease expiration in June 2034), with would further improve occupancy to 70%; however the lease will not commence until July 2024, and no terms or rates have been provided. Per the most recent financials, the loan reported an annualized NCF $3.4 million (reflecting a DSCR of 1.54x) as of Q2 2023, a notable drop from $4.1 million (reflecting a DSCR of 1.84x) at issuance, with performance anticipated to decline further following Bed Bath & Beyond’s departure given the tenant accounted for nearly 25.0% of the base rent; however, based on DBRS Morningstar’s analysis, the implied DSCR will remain above breakeven. To recognize the increased credit risk for this loan, DBRS Morningstar applied an elevated POD adjustment in its analysis, resulting in an EL that was more than 3.0x the pool’s average.

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 at https://www.dbrsmorningstar.com/research/416784 (July 4, 2023).

Classes X-A, X-B, and X-D 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 the 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 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 credit 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.

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 (August 23, 2023; https://www.dbrsmorningstar.com/research/419592)

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.