Morningstar DBRS Confirms Credit Ratings on All Classes of BAMLL Commercial Mortgage Securities Trust 2016-ISQR

DBRS, Inc. (Morningstar DBRS) confirmed its credit ratings on all classes of Commercial Mortgage Pass-Through Certificates, Series 2016-ISQR issued by BAMLL Commercial Mortgage Securities Trust 2016-ISQR as follows:

-- Class XA at BBB (sf)
-- Class A at BBB (low) (sf)
-- Class B at BB (low) (sf)
-- Class XB at B (sf)
-- Class C at B (low) (sf)
-- Class D at CCC (sf)
-- Class E at CCC (sf)

The trends on Classes XA through C are Stable. There are no trends on Classes D and E as those classes have a credit rating that does not typically carry a trend in commercial mortgage-backed securities (CMBS) credit ratings.

The credit rating confirmations reflect the performance of the underlying collateral, which is in line with Morningstar DBRS' expectations since its previous credit rating action in July 2024, when the credit ratings on all classes were downgraded to reflect increased risks in the challenged office sector, particularly in the subject's city of Washington, and the performance declines since issuance, driven by lower occupancy rates for the collateral property, as further described below. Morningstar DBRS notes the loan is scheduled to mature in August 2026 and given the high loan-to-value ratio (LTV) implied by the Morningstar DBRS Value, it is expected that a refinance could be difficult to obtain without a significant equity contribution from the sponsor.

The collateral for the underlying loan, International Square, is an office property consisting of three buildings connected by a central atrium, totaling 1.2 million square feet (sf) in downtown Washington. The subject includes 67,000 sf of ground-floor retail space, 12,000 sf of storage space, and a 637-space subterranean parking garage. The property, developed between 1978 and 1982, is on I Street NW, between 18th Street NW and 19th Street NW, with direct access to Farragut West Metro Station. Sponsorship is provided by a joint venture between Tishman Speyer Properties and the Abu Dhabi Investment Authority, which has owned the property since 2006.

Total debt held against the property is $450.0 million, with the trust debt of $370.0 million consisting of a $166.7 million senior A-1 note and a $203.3 million junior note. There is an additional $80.0 million pari passu senior A-2 note split across three CMBS multiborrower transactions; none of the multiborrower transactions are rated by Morningstar DBRS.

In the July 2024 analysis of the transaction, Morningstar DBRS updated its property net cash flow (NCF) and LTV-sizing benchmarks to account for the secular shift in office use and demand as well as the subject property's prolonged declines in occupancy and cash flow. While recent NCF trends at the subject are positive, with a YE2024 figure of $20.5 million (debt service coverage ratio of 1.24 times), representing a 10.9% increase over the YE2023 NCF of $18.5 million, performance remains significantly below the issuer's NCF of $39.0 million derived at loan closing in 2016.

According to the December 2024 rent roll, the property was 76.9% occupied with a weighted-average rental rate of $59.85 per square foot (psf). Individual building occupancy rates ranged from 71.0% (1850 K Street) to 86.0% (1825 I Street). In comparison, the property was 76.4% occupied as of the March 2024 rent roll. The largest tenant at the property continues to be the Federal Reserve System (the Fed), which occupies 33.7% of the total property net rentable area (NRA) with leases across all three buildings, paying an average base rental rate of $62.96 psf across all leased space. The Fed previously renewed its lease for approximately 270,000 sf (22.6% of the total property NRA) in 2022 with those leases scheduled to expire in 2029 and 2033. The rental abatements associated with those lease renewals were scheduled to end by YE2024, which should result in increased property cash flow in 2025.

According to the servicer, the Fed has also extended its lease for approximately 77,000 sf (6.5% of total NRA) of additional space scheduled to expire in January 2026 (2.2% of total NRA; Option 1 space) and April 2028 (4.3% of total NRA; Option 2 space). The leases were extended to March 2029, with all leased space by the Fed now having scheduled lease expiration dates in 2029 (23.9% of the total NRA) and 2033 (9.8% of total NRA). Upon review of the provided lease terms, the effective starting base rental rate for the Option 1 space will decrease to $45.28 psf from $64.58 psf as the provided tenant incentive package of $15.00 psf was amortized and deducted from base rent. The effective base rental rate for the Option 2 space will decrease to $52.83 psf from $66.57 psf as leasing commissions were amortized and deducted from base rent. The rent on the Option 1 space will have annual 2.5% escalations while the rent on the Option 2 space will remain fixed over the lease term. The Fed also received separate one-year abatements for reimbursable operating expenses on the extensions, commencing in February 2026 (Option 1 space) and May 2028 (Option 2 space), respectively.

The Fed can terminate all or a portion of its space with a 2029 lease expiration date with 24 months' notice, and it can terminate all or a portion of its space with a 2033 lease expiration date effective May 2030 with 24 months' notice. The remaining tenant roster across the property remains unchanged year-over-year. The second-largest tenant at the property, Blank Rome LLP, occupies 14.5% of the total property NRA on a lease expiring in July 2029, and the third-largest tenant, Daniel J. Edelman, Inc., occupies 5.4% of the total property NRA on a lease expiring in July 2030.

According to Q4 2024 Reis data, office properties in the Downtown District of Columbia reported an average asking rental rate of $56.72 psf with vacancy at 14.8%. Class A properties reported figures of $62.08 psf and 13.9%, respectively. Overall, the submarket has shown minor improvement in the last year, as Reis reported Q1 2024 metrics of $55.69 psf and 16.5%, respectively; however, the occupancy rate at the subject remains significantly below market. Morningstar DBRS notes overall demand is likely to remain tenuous within Washington D.C., given the current administration's focus on cost cutting and reducing the size of the federal government.

Throughout 2025, rollover risk at the subject property is limited to two tenants, occupying 5.6% of the total NRA, including Milbank, LLP, which occupies approximately 55,000 sf (5.4% of total NRA). The tenant has been at the property since 2005, with its lease scheduled to expire in August 2025. Morningstar DBRS was not provided an update regarding the tenant's intention to renew its lease or vacate the property for purposes of this review. An additional four tenants (3.0% of total NRA) have scheduled lease expiration dates prior to loan maturity in August 2026.

The property continues to struggle to attract and sign leases with new tenants as only one new lease, with Legal Services Corporation (3.2% of the total property NRA), has been executed since 2024. The tenant executed a 15-year lease, which commenced in January 2025. The tenant received 10 months of rental abatements over the lease term and a tenant improvement allowance of $200.00 psf ($7.4 million), indicating how expensive it is to execute new leases in the submarket. It pays a starting base rental rate of $59.20 psf. The servicer confirmed there is no pending new leasing activity at the property and the current leasing reserve balance is zero. Given the current occupancy rate across the property combined with property cash flow below issuance levels, the borrower is likely to encounter difficulty in selling the subject or securing refinance capital prior to loan maturity in August 2026.

As noted above, Morningstar DBRS completed an updated collateral valuation at the previous credit rating action in July 2024. For purposes of this credit rating action, Morningstar DBRS maintained the valuation approach from the July 2024 review, which was based on a capitalization rate of 7.75% applied to the Morningstar DBRS NCF of $25.1 million. Morningstar DBRS also maintained positive qualitative adjustments to the LTV-sizing benchmarks, totaling 1.5% to reflect the subject property's cash flow stability and property quality. The Morningstar DBRS Value of $323.3 million represented a -57.3% variance from the issuance appraised value of $757.0 million, and results in an LTV of 139.2% on the whole-loan debt amount of $450.0 million.

CREDIT RATING RATIONALE/DESCRIPTION
Morningstar DBRS' credit ratings on the applicable classes address the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents. Where applicable, a description of these financial obligations can be found in the transactions' respective press releases at issuance.

Morningstar DBRS' long-term credit ratings provide opinions on risk of default. Morningstar DBRS considers risk of default to be the risk that an issuer will fail to satisfy the financial obligations in accordance with the terms under which a long-term obligation has been issued. The Morningstar DBRS short-term debt rating scale provides an opinion on the risk that an issuer will not meet its short-term financial obligations in a timely manner.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factor(s) 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 Factors in Credit Ratings (August 13, 2024) https://dbrs.morningstar.com/research/437781.

Classes XA and XB 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 Morningstar DBRS.

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

The principal methodology is North American CMBS Surveillance Methodology (February 28, 2025), https://dbrs.morningstar.com/research/448963.

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

The credit rating assigned to Class B is higher than the result implied by the LTV-sizing benchmarks by three or more notches. The variance is warranted as the loan is expected to remain current throughout the remaining term with improvement in cash flow expected as rental abatement periods to the Fed end. Morningstar DBRS also notes the sponsor continues to fund leasing costs, though, new leasing activity is minimal.

The credit ratings were initiated at the request of the rated entity.

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

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

These are solicited credit ratings.

For more information on Morningstar DBRS' policy regarding the solicitation status of credit ratings, please refer to the Credit Ratings Global Policy, which can be found in the Morningstar DBRS Understanding Ratings section of the website: https://dbrs.morningstar.com/understanding-ratings

DBRS, Inc.
22 West Washington Street
Chicago, IL 60602 USA
Tel. +1 312 332-3429

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

-- North American Single-Asset/Single-Borrower Ratings Methodology (February 28, 2025)
https://dbrs.morningstar.com/research/448962
-- Morningstar DBRS North American Commercial Real Estate Property Analysis Criteria (September 19, 2024)
https://dbrs.morningstar.com/research/439702
-- Legal Criteria for U.S. Structured Finance (December 3, 2024)
https://dbrs.morningstar.com/research/444064
-- North American Commercial Mortgage Servicer Rankings (August 23, 2024)
https://dbrs.morningstar.com/research/438283

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