DBRS Morningstar Downgrades Ratings on Two Classes, Changes Trends on Six Classes of Morgan Stanley Capital I Trust 2018-BOP

DBRS Limited (DBRS Morningstar) downgraded its ratings on two classes of the Commercial Mortgage Pass-Through Certificates, Series 2018-BOP issued by Morgan Stanley Capital I Trust 2018-BOP as follows:

-- Class E to BB (sf) from BBB (low) (sf)
-- Class F to B (sf) from BB (sf)

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

-- Class A at AAA (sf)
-- Class B at AA (high) (sf)
-- Class C at A (high) (sf)
-- Class X-EXT at A (sf)
-- Class D at A (low) (sf)

The trends on all classes were changed to Negative from Stable, with the exception of Class A, which remains Stable. The rating downgrades and the Negative trends are reflective of the persistent declines in performance metrics as a result of tenants vacating upon lease expiration and a lack of leasing activity to back-fill vacant spaces. Although the sponsor continues to cover the loan’s debt service payments out-of-pocket, the loan was recently transferred to special servicing with the April 2023 remittance as a result of monetary default. 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 subject properties and increasing the potential for value declines. In addition, the sponsor will be especially challenged to back-fill the portfolio given the collateral’s Class B construction and suburban locations as office users continue with the ongoing “flight-to-quality” trend, thus making refinance prospects increasingly unlikely as the loan’s August 2023 final maturity date approaches.

At issuance, the loan was secured by the fee-simple interest in a portfolio of 12 suburban Class B office properties comprising nearly 1.8 million square feet (sf) of office space in four different states. The loan benefits from strong sponsorship in Brookfield Asset Management Inc. (Brookfield; (rated A (low) with a Stable trend by DBRS Morningstar) and has experienced principal paydown of 27.7% following the release of three of the original 12 collateral properties. These three properties collectively represented $38.9 million of the allocated loan balance (ALB) (17.4% of the issuance ALB), and, based on the release provisions outlined in the transaction documents, $62.0 million of principal was repaid, therefore increasing credit enhancement levels across the capital stack.

The terms of the loan agreement allow for properties to be released from the collateral for the loan at a repayment amount of 105% of the ALB for the first 20% of the initial loan balance with a 110% release price thereafter, subject to a debt yield requirement of 12.5% following the release of the property in question, as well as other criteria. DBRS Morningstar believes the 105% release price for the first 20% is a weaker structure, and the updated sizing completed as part of this review incorporated a penalty to reflect the increased risk.

Initial proceeds of $278.4 million, including $55.0 million of mezzanine debt, were primarily used to refinance existing debt of approximately $259.4 million, fund $8.3 million of upfront reserves, pay $9.5 million of closing costs, and return $1.1 million of equity to the sponsor. The loan sponsor is Brookfield Strategic Real Estate Partners II, a global real estate opportunity fund controlled by Brookfield. The loan is interest only (IO) through its initial two-year term, with three one-year extension options and a final maturity in August 2023.

Based on the December rent roll, portfolio occupancy declined to 53.1% from the December 2021 figure of 62.3% and the issuance figure of 78.0%. Approximately 7.6% of the portfolio net rentable area (NRA) is scheduled to roll over in 2023. In 2022, the sponsor successfully signed Eating Recovery Center, LLC (7.9% of portfolio NRA) to a 15-year lease scheduled to commence in January 2023. The tenant, now the largest in the portfolio, occupies the entirety of the University Corporate Center III property, bringing the implied portfolio occupancy to 61.0%. No other tenant comprises more than 3.0% of the portfolio NRA.

According to the YE2022 financials, net cash flow (NCF) was reported at $12.2 million, in comparison with the YE2021 figure of $19.0 million. The decline is predominantly due to decreases in gross potential revenue and expense reimbursements, both of which have been driven by the occupancy declines as previously outlined. It is noteworthy that the YE2022 NCF includes cash flow attributed to a property that was released from the collateral in October 2022, while the YE2021 NCF includes cash flow from two released properties and individual property financials were not provided.

Given the sustained performance declines since issuance and near-term maturity, the risk for this loan has substantially increased. As such, DBRS Morningstar took a conservative approach when updating the LTV Sizing in its analysis and applied an 8.0% cap rate to the YE2022 NCF of $12.2 million, resulting in a DBRS Morningstar Value of $152.1 million. This value represents a 49.1% variance from the issuance appraised value of $298.7 million for the remaining properties in the collateral. The DBRS Morningstar Value implies an loan-to-value ratio (LTV) of 106.1% on the A note debt, as compared with the LTV on the issuance appraised value of 61.8%. The cap rate and qualitative adjustments applied to the sizing were unchanged from DBRS Morningstar’s last sizing completed in July 2020.

The DBRS Morningstar ratings assigned to all classes, with the exception of Class A, are higher than the results implied by the LTV sizing benchmarks. These variances are warranted given the value assumed in the analysis was based on a stressed approach that supported the downgrades and Negative trends, as outlined above. DBRS Morningstar also considered mitigated factors in the strong sponsorship and principal paydown greater than the released properties’ ALBs.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental, Social, and 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/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022).

Class X-EXT is an interest-only (IO) certificate that references 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 (March 16, 2023; https://www.dbrsmorningstar.com/research/410912/north-american-cmbs-surveillance-methodology).

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 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 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 rating action.

This is a solicited credit rating.

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.

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577

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

North American Single-Asset/Single-Borrower Ratings Methodology (February 23, 2023)
https://www.dbrsmorningstar.com/research/410191/north-american-single-assetsingle-borrower-ratings-methodology

Rating North American CMBS Interest-Only Certificates (December 19, 2022)
https://www.dbrsmorningstar.com/research/407577/rating-north-american-cmbs-interest-only-certificates

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 (August 30, 2022)
https://www.dbrsmorningstar.com/research/402153.

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

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