Fitch: Second Kyo-Ya CMBS in Last Year is Another Example of Increasing Leverage

NEW YORK--()--The most recent financing of the Kyo-Ya hotel portfolio, a little more than a year after its last refinancing, again demonstrates the increasing leverage being offered by U.S. CMBS lenders, according to Fitch Ratings. This is a troubling trend that Fitch highlighted in a special report published earlier this month.

The higher debt levels associated with the COMM 2014-KYO transaction which was initially reviewed but ultimately not rated by Fitch, combined with a reduced collateral pool compared to last year's transaction, a management transition, and potentially peak performance would likely result in subordinate bond ratings by Fitch lower than those assigned. This assumption is based on the preliminary review of the portfolio financials. Fitch last visited the properties in December 2012.

Total debt in the new CMBS transaction is $300,000,000 above last year's refinancing taking advantage of a significant uptick in net cash flow over the past year, despite the removal of the 1,142-room Sheraton Princess Kaiulani from the pool. Although the Princess Kaiulani was the weakest property in the previous pool, the increase in total debt and the reduction in supporting collateral should give investors pause. Both transactions had mezzanine debt outside of the trust.

Kokusai Kogyo Holdings Co. acquired Cerberus's 55% hotel ownership interest in Kyo-ya Hotels & Resorts LP in conjunction with the current acquisition financing. The two parties previously shared ownership in the company.

Along with divestment of Cerberus in the portfolio, the president of Kyo-Ya hotels, Greg Dickhens, departed the company. Dickhens was appointed by Cerberus, which bought a portion of the portfolio in 2004 when the Japanese parent entity was facing financial pressures, to manage the portfolio thru redevelopment and financial turnaround efforts. Fitch believes that Dickhens was instrumental in gaining approval from local authorities for various redevelopment plans and stabilizing the financial performance and reporting of the portfolio. Beginning in 2005, the partnership invested approximately $333.5 million ($83,048 per room) to renovate the six hotel portfolio. The impact of Dickhens departure on future performance is uncertain. Fitch has not met with new property management.

The 2013 refinancing of the hotel portfolio followed an increase of over $25 million in Net Operating Income between 2007 and October 2012. The portfolio included the Sheraton Waikiki, The Royal Hawaiian, the Westin Moana Surfrider and the Sheraton Princess Kaiulani, each located in Waikiki Beach in Honolulu, the Sheraton Maui Resort & Spa on the island of Maui, and The Palace Hotel in San Francisco, CA. The current iteration of the Kyo Ya Hotel Portfolio is comprised of five hotels and no longer includes the 1,142-room Sheraton Princess Kaiulani.

The Kyo-Ya hotel portfolio remains a highly compelling portfolio of real estate given the high quality and prime location of the three Waikiki hotels plus one in Maui and another in San Francisco. That said, the rapid growth in a highly cyclical sector and lack of clarity on the impact of key man risk are factors investors should consider.

Fitch rated the previous Kyo-Ya refinancing (GSMS 2013 KYO), which issued $552 million in 'AAA' rated debt or $106,977 per key. The trust debt totaled $1.1 billion or $213,178 per room. Fitch did not rate any classes below the 'AAA' rated class. In comparison, the current COMM 2014-KYO transaction, which does not include the Sheraton Princess Kaiulani, totals $1.4 billion or $348,606 per room. It is important to note that the 1,142 room Sheraton Princess was arguably the weakest hotel in the 2013 portfolio and had the second largest room count, so the per room statistics can be slightly misleading.

Unquestionably, portfolio cash flow has continued to increase at a torrid pace. After growing to approximately $158.3 million across the six hotels when refinanced in 2013, the new five hotel portfolio reached $169.2 million as of April 2014, shortly after Cerberus' divestment in the portfolio. However, previous growth was fueled by the Waikiki assets completing property and room overhauls corresponding with increased tourism after post-recession declines, and the implementation of resort fees for the Hawaiian assets. Although current ownership plans to continue investing in the properties, Fitch believes these factors are not likely to be replicated.

Through its repositioning, the Kyo-Ya portfolio has benefited from the presence of both its Japanese ownership and Starwood in the Japanese tourism market. Further, Hawaii is experiencing increased visits from other Asian markets due to the implementation of less restrictive visa rules, especially in China, Korea and Taiwan.

It should be noted, however, that recent reporting by the Hawaiian Tourism Bureau for the first four months of 2014 shows that total visitor expenditures fell 2.9% to $4.9 billion and total arrivals dropped 2.6% to 2.72 million. This was the eighth month of negative growth in total visitor expenditures. Visitors from the US West and the US East declined 5.6% and 1%, respectively, during the four month period.

Based on a Fitch NCF $147.6 million and a cap rate of 10.25%, the $551 million ($137,201 per room) Class A in the COMM 2014-KYO transaction is consistent with a Fitch 'AAA' rating. However, the $1.073 billion ($267,181 per room) class E would imply a 'BB-' rating by Fitch vs. the 'BBB-' ratings assigned by the other agencies. Fitch's stresses would result in a maximum of $936 million ($233,068 per room) in investment grade debt, nearly $140 million less than the proposed amount.

Further, the total securitization of $1.4 billion would be nearly $250 million above Fitch's maximum rated debt thresholds. Fitch's 'B-' rated debt would total $1.159 billion, an 80.5% stressed LTV.

Additional information on large loan CMBS concerns is available in Fitch's June 9 report 'Risks in Large Loan Deals, Revisited', available at 'www.fitchratings.com' or by clicking on the link at the end of the press release.

Additional information is available at 'www.fitchratings.com'

Applicable Criteria and Related Research:

Risks in Large Loan Deals, Revisited (Risks Shift from Property Quality to Too Much Debt)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749562

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Contacts

Fitch Ratings
Huxley Somerville
Managing Director, Head of U.S. CMBS
+1-212-908-0381
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Eric Rothfeld
Managing Director
+1-212-908-0761
or
Jeff Watzke
Senior Director
+1-312-606-2358
or
Media Relations
Sandro Scenga, New York, +1-212-908-0278
sandro.scenga@fitchratings.com

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Contacts

Fitch Ratings
Huxley Somerville
Managing Director, Head of U.S. CMBS
+1-212-908-0381
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Eric Rothfeld
Managing Director
+1-212-908-0761
or
Jeff Watzke
Senior Director
+1-312-606-2358
or
Media Relations
Sandro Scenga, New York, +1-212-908-0278
sandro.scenga@fitchratings.com