Fitch Upgrades Two Classes of N-Star VIII
OREANDA-NEWS. Fitch Ratings has upgraded two and affirmed 13 classes of N-Star REL CDO VIII, Ltd./LLC (N-Star VIII). Fitch's performance expectation incorporates prospective views regarding commercial real estate (CRE) market value and cash flow declines. A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS
The upgrades reflect increased credit enhancement (CE) and significantly better recoveries than previously modeled on loans disposed of since the last rating action. Fitch's base case loss expectation is 61.6% of the current collateral balance, compared to 62.4% of the collateral balance at the last rating action.
There were three variances from the surveillance criteria related to classes A-1, A-R and A-2. The surveillance criteria indicated further rating upgrades were possible for these classes; however, given overall pool concentrations in subordinate CRE debt positions and non-traditional property types, Fitch determined they are not warranted at this time, although as the Positive Outlook on class A-2 reflects, upgrades are likely in the future.
Since the last rating action and as of the May 2016 trustee report, principal paydowns to classes A-1 and A-R were $133.4 million, primarily from four assets repaying in full. The asset manager indicated two additional loans, 86 Chambers A-Note and 86 Chambers Mezz (combined 7.2% of pool), repaid in full at the end of April, which was not yet reflected in the May trustee report. Realized losses since the last rating action were $8.4 from the disposition of two loans at a full loss, the majority of which was modeled in Fitch's previous rating action. The combined percentage of defaulted assets and assets of concern has decreased to 36.7% from 64.5% at the last rating action. As of the May 2016 trustee report, all overcollateralization and interest coverage ratios were in compliance.
N-Star VIII is collateralized by CRE loans, consisting of both senior and subordinate debt positions, as well as rated securities, consisting of CRE collateralized debt obligation (CDO) bonds. As of the May 2016 trustee report and per Fitch categorization, the CDO was substantially invested as follows: whole loans/A-notes (35.1%), preferred equity (32.5%), mezzanine debt (26.4%), and CRE CDOs (6.1%). The portfolio collateral comprises a high percentage of non-traditional property types, including loans secured by construction (17.3%), hotels (14.8%), healthcare (11.9%), and undeveloped land (6.3%).
Under Fitch's methodology, approximately 76% of the portfolio is modeled to default in the base case stress scenario, defined as the 'B' stress. In this scenario, the modeled average cash flow decline is 10% from, generally, third-quarter 2015 and year-end (YE) 2015 cash flows. Modeled recoveries are low at 18.9% reflecting the junior position of the majority of the CRE loans and the poor credit quality of the rated securities (weighted average rating of 'CCC+').
The largest contributor to modeled losses, which has remained the same since the last rating action, is preferred equity (17.3% of pool) on a planned construction project of a super-regional mall and retail/entertainment facility located in East Rutherford, New Jersey. The project's original business plan stalled due to the economic downturn and multiple delays and cost overruns. The overall project designs have been updated with the selection of a new replacement developer to include a planned amusement/water park and the originally planned entertainment/retail center. The original loan was restructured whereby the existing lender debt was subordinated to additional debt from new construction financing and new equity contributions by the selected replacement developer. Although construction activity is progressing and leases have been executed, Fitch remains concerned with the uncertainty and timing surrounding the ultimate completion of the project. A full loss was modeled in the base case stress scenario.
The next-largest contributor to modeled losses is preferred equity (11.8%) on a portfolio of healthcare properties totaling 5,514 beds located throughout the U.S. The portfolio consists of skilled nursing, assisted living, and independent living facilities operated by six different companies. Portfolio occupancy averaged 80% as of September 2015 with over 55% of the revenue stream coming from Medicare/Medicaid. A significant loss was modeled in the base case stress scenario.
The third-largest contributor to modeled losses is mezzanine debt (6.4%) secured by interests in a portfolio of 11 retail properties totaling 1.57 million square feet located throughout Phoenix, AZ. Portfolio occupancy as of September 2015 was approximately 74%. Recent leasing on approximately 4% of the portfolio square footage includes Beall's Outlet, BBB Fashion, and Humana. The portfolio has begun to show signs of retailer distress as a large tenant, Fry's (5.4% of portfolio NRA), intends to vacate at its December 2016 lease expiration. In addition, another large tenant, Safeway (3.5% of portfolio NRA), vacated in September 2015, but is expected to pay rent through its December 2017 lease expiration. Fitch considers the CDO's position to be highly leveraged and modeled a full loss in its base case stress scenario.
This transaction was analyzed according to the 'Surveillance Criteria for U.S. CREL CDOs', which applies stresses to property cash flows and debt service coverage ratio tests to project future default levels for the underlying portfolio. Recoveries are based on stressed cash flows and Fitch's long-term capitalization rates. Updated cash flow modeling was not performed as no material impact to the analysis was anticipated. Given the high percentage of subordinate debt positions and non-traditional property types, the rating for classes A-1 and A-R was capped at 'BBBsf' and the rating for class A-2 was capped at 'Bsf' due to significant concentration risks. The rating for class B is guided by the class' CE compared with the rating stresses expected losses.
The ratings for classes C through N are based on a deterministic analysis that considers Fitch's base case loss expectation for the pool and the current percentage of defaulted assets and assets of concern, factoring in anticipated recoveries relative to each class' CE.
The Rating Outlook on classes A-1 and A-R was revised to Stable from Negative due to increasing credit enhancement and expected continued paydowns. If the collateral continues to repay at or near par, the Positive Outlook on class A-2 indicates the class may be upgraded. The Negative Outlook on class B reflects the potential for future downgrades if there is deterioration of loan performance or if the ratings of the underlying rated securities migrate downward. The distressed classes C through N may be subject to downgrade as losses are realized or if realized losses exceed Fitch's expectations.
N-Star VIII was initially issued as a $900 million CRE CDO managed by NS Advisors, LLC. The transaction had a five-year reinvestment period during which principal proceeds may be used to invest in substitute collateral which ended in February 2012. In November 2009, $31.1 million in notes was surrendered to the trustee for cancellation.
DUE DILIGENCE USAGE
No third party due diligence was provided or reviewed in relation to this rating action.
Fitch has upgraded and revised Rating Outlooks on the following classes as indicated:
--$24.8 million class A-1 to 'BBBsf' from 'BBsf'; Outlook Stable;
--$64.4 million class A-R to 'BBBsf' from 'BBsf'; Outlook Stable.
In addition, Fitch has affirmed and revised Rating Outlooks on the following classes as indicated:
--$103.1 million class A-2 at 'Bsf'; Outlook to Positive from Negative;
--$60.3 million class B at 'Bsf'; Outlook Negative;
--$24.3 million class C at 'CCCsf'; RE 0%;
--$17.1 million class D at 'CCCsf'; RE 0%;
--$22.1 million class E at 'CCCsf'; RE 0%;
--$25.2 million class F at 'CCCsf'; RE 0%;
--$9.1 million class G at 'CCCsf'; RE 0%;
--$20.7 million class H at 'CCCsf'; RE 0%;
--$12 million class J at 'CCCsf'; RE 0%;
--$18.9 million class K at 'CCCsf'; RE 0%;
--$22.1 million class L at 'CCsf'; RE 0%;
--$14.9 million class M at 'CCsf'; RE 0%;
--$22.5 million class N at 'CCsf'; RE 0%.
Fitch does not rate the preferred shares.