Morningstar DBRS Changes Trends on Three Classes of LCCM 2021-FL2 Trust to Negative from Stable, Confirms All Credit Ratings

DBRS, Inc. (Morningstar DBRS) confirmed its credit ratings on all classes of notes issued by LCCM 2021-FL2 Trust as follows:

-- Class A at AAA (sf)
-- Class A-S at AAA (sf)
-- Class B at AA (low) (sf)
-- Class C at A (low) (sf)
-- Class D at BBB (sf)
-- Class E at BBB (low) (sf)
-- Class F at BB (low) (sf)
-- Class G at B (low) (sf)

Morningstar DBRS also changed the trends on Classes E, F, and G to Negative from Stable. The trends on the remaining classes remain Stable.

The trend changes reflect the increased credit risk to the transaction as a result of Morningstar DBRS’ increased loan-level expected losses for the majority of the loans in the transaction, particularly for the four loans secured by office properties, which represent 25.8% of the current trust balance. An additional seven loans, representing 36.5% of the current trust balance, are secured by mixed-use properties with a material office collateral component. The majority of these 11 loans are sponsored by borrowers, which have been generally unable to successfully execute the stated business plans to date.

Throughout 2024, 17 loans, representing 81.9% of the current trust balance, are scheduled to mature. Seven of these loans, representing 41.7% of the current trust balance, are secured by office and mixed-use properties. Given lenders and investors have been hesitant to finance or own for that property type in 2023, Morningstar DBRS expects borrowers to face difficulties in executing exit strategies over the near to medium term. While the majority of the loans include extension options, the borrowers will likely need loan modifications as most loans will be unable to achieve the performance-based extension requirements. The credit rating confirmations reflect the increased credit support to the bonds as a result of successful loan repayments, with collateral reduction of 11.2% since issuance.

In conjunction with this press release, Morningstar DBRS has published a Surveillance Performance Update report with in-depth analysis and credit metrics for the transaction as well as business plan updates on select loans. For access to this report, please click on the link under Related Documents below or contact us at info-DBRS@morningstar.com.

At issuance, the initial collateral consisted of 23 floating-rate mortgages or pari passu participation interests in mortgage loans secured by 27 mostly transitional properties, with a cut-off balance totaling $607.5 million. As of the April 2024 remittance, the pool comprises 22 loans secured by 22 properties with a cumulative trust balance of $539.7 million. Most loans are in a period of transition with plans to stabilize and improve the asset’s value. The transaction had a Reinvestment Period that expired with the August 2023 payment date. Since the previous Morningstar DBRS credit rating action in July 2023, five loans with a current trust balance of $111.0 million have been added into the transition, while three loans with a former trust balance of $124.0 million were paid in full.

Beyond the office concentration noted above, the transaction also comprises four loans, representing 12.8% of the current trust balance, secured by multifamily properties and two loans, representing 7.1% of the pool, secured by retail properties. In comparison with June 2023 reporting, office and mixed-use properties represented 50.6% of the collateral, multifamily properties represented 27.1% of the collateral, and retail properties represented 3.3% of the collateral.

The loans are secured primarily by properties in urban and suburban markets. Seven loans, representing 41.9% of the pool, are secured by properties in urban markets, as defined by Morningstar DBRS, with a Morningstar DBRS Market Rank of 6, 7, or 8. Nine loans, representing 29.4% of the pool, are secured by properties in suburban markets, as defined by Morningstar DBRS, with a Morningstar DBRS Market Rank of 3, 4, or 5. The remaining six loans, representing 28.7% of the pool, are secured by properties with a Morningstar DBRS Market Rank of 1 or 2, denoting rural and tertiary markets, respectively. In comparison, as of June 2023, properties in urban markets represented 38.6% of the collateral, suburban markets represented 34.5% of the collateral, and properties in rural and tertiary markets represented 26.9% of the collateral.

Based on the as-is appraised value, leverage across the pool has increased slightly from issuance, with a current weighted-average (WA) loan-to-value ratio (LTV) of 70.1%, up from 65.9% at issuance. However, the WA stabilized LTV decreased over that same period, dropping to 63.7% from 64.1% at issuance. Morningstar DBRS recognizes that select property values may be inflated as the majority of the individual property appraisals were completed in 2021 and 2022 and may not reflect the current rising interest rate or widening capitalization rate (cap rate) environments. In the analysis for this review, Morningstar DBRS applied upward LTV adjustments across 16 loans, representing 85.5% of the current trust balance.

Through April 2024, the lender has advanced cumulative loan future funding of $71.8 million to 14 individual borrowers to aid in property stabilization efforts. The majority of this amount has been released to the borrowers of the Regions Harbert ($22.6 million) and the Puerto Rico Industrial Portfolio ($18.7 million) loans. The Regions Harbert loan is secured by an office property in Birmingham, Alabama. The borrower used the advanced funds to complete its capital improvement program and finance leasing costs, with $12.1 million associated with re-leasing the largest tenant. As of the January 2024 rent roll, the property was 71.3% occupied, up from 65.4% as of YE2022. Since closing, the loan has been modified several times, which included extending loan maturity as the borrower needed more time to complete its business plan. In exchange for the maturity extensions, the borrower was required to make two separate principal payments of $1.25 million along with two separate deposits of $1.0 million into a shortfall reserve. The most recent modification occurred in March 2024, which extended loan maturity an additional two months through May 2024. Given the upcoming maturity risk, Morningstar DBRS applied an upward LTV adjustment, reflecting an in-place LTV of 100.0%. Morningstar DBRS also increased the loan’s probability of default in its current analysis to bring the loan’s expected loss above the transaction’s expected loss.

The Puerto Rico Industrial Portfolio loan is secured by five industrial parks totaling 21 properties throughout Puerto Rico. The borrower used the advanced funds to complete capital improvement projects and to fund leasing cost across the portfolio. The loan has no future funding remaining. The portfolio was 88.8% occupied as of the November 2023 rent roll. The loan has an upcoming final maturity in June 2024. In its analysis, Morningstar DBRS applied an upward cap rate adjustment, increasing the loan’s LTV and expected loss.

An additional $69.0 million of loan future funding allocated to 12 individual borrowers remains available. Of this amount, $29.3 million is allocated to the borrower of the Citigroup Center loan, which is secured by an office tower in downtown Miami. The funds are available to the borrower to fund costs associated with the borrower’s ongoing capital improvement and lease-up plan. The loan, which represents the largest loan in the pool at 12.0%, is on the servicer’s watchlist for the upcoming July 2024 maturity date. While the loan has two 12-month extension options available to the borrower, loan performance has remained flat in recent years as the property was 60.4% occupied as of the November 2023 rent roll, down slightly when compared with the February 2023 occupancy of 62.4%. However, Morningstar DBRS expects occupancy to improve to 68.8% after the sponsor executed 12 leases totaling 64,702 square feet (sf), including 3,584 sf of renewals. In its analysis, Morningstar DBRS applied an upward LTV adjustment, reflecting an in-place LTV approaching 100.0%. Morningstar DBRS also increased the loan’s probability of default in its current analysis to bring the loan’s expected loss to be in line with the pool’s expected loss.

As of the April 2024 remittance, there are no delinquent loans or loans in special servicing; however, four loans, representing 27.7% of the current trust balance, are on the servicer’s watchlist for a variety of reasons, including upcoming loan maturity as well as low debt service coverage ratios and occupancy rates. All affected borrowers have outstanding maturity date extension options on the respective loans. At issuance, Morningstar DBRS expected temporary declines in property performance in some cases as borrowers worked toward completing the respective business plans; however, select borrowers may face additional challenges because of specific property type and current economic challenges.

Three loans, representing 18.9% of the current trust balance, have been modified. The modifications have generally allowed borrowers to exercise loan extension options by amending loan terms in return for fresh equity deposits and the purchase of a new interest rate cap agreement. The most common amendments include the removal of performance-based tests and changes to the required strike price on the purchase of a new interest rate cap agreement.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) at https://dbrs.morningstar.com/research/427030.

All credit ratings are subject to surveillance, which could result in credit ratings being upgraded, downgraded, placed under review, confirmed, or discontinued by Morningstar DBRS.

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

The principal methodology is North American CMBS Surveillance Methodology (March 1, 2024), https://dbrs.morningstar.com/research/428798.

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

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.

Morningstar DBRS 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.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS’ outlooks and credit ratings are monitored.

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

-- North American CMBS Multi-Borrower Rating Methodology (March 1, 2024)/North American CMBS Insight Model version 1.2.0.0, https://dbrs.morningstar.com/research/428797

-- DBRS Morningstar North American Commercial Real Estate Property Analysis Criteria (September 22, 2023), https://dbrs.morningstar.com/research/420982

-- North American Commercial Mortgage Servicer Rankings (August 23, 2023), https://dbrs.morningstar.com/research/419592

-- Interest Rate Stresses for U.S. Structured Finance Transactions (February 26, 2024), https://dbrs.morningstar.com/research/428623

-- Legal Criteria for U.S. Structured Finance (April 15, 2024), https://dbrs.morningstar.com/research/431205

For more information on this credit or on this industry, visit dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.