DBRS Changes Trend to Negative from Stable on Debussy DTC plc

DBRS Ratings Limited (DBRS) has today confirmed the rating on the Class A of the Commercial Real Estate Loan Backed Fixed-Rate Notes due July 2025 (the Class A Notes) issued by Debussy DTC plc as follows:

-- Class A Notes at BBB (low) (sf)

The trend on the Class A Notes was changed to Negative from Stable.

The decision to change the trend on the Class A Notes is a result of the potential decline in commercial real estate property values and the slowdown of investments in the United Kingdom (U.K.) following the EU Referendum in June 2016 (also known as Brexit).

The collateral consists of 30 mega retail stores operated by Toys “R” Us (TRU) and one distribution centre, which are primarily located in secondary and tertiary markets in the U.K. All properties are registered under Toys “R” Us Properties (UK) Limited (the Borrower or the Prop Co) and are operated under individual triple-net leases to Toys “R” Us Ltd (the Op Co), with leases expiring in February 2036 or February 2037.
All the properties are leased above market rent with an annual rental rate increase based on the retail price index and subject to a 1.0% floor and a 2.5% cap. Both the Prop Co and the Op Co are fully owned subsidiaries of Toys “R” Us Holdings Ltd (the Hold Co). In lieu of a third-party liquidity facility, Borrower has established the Borrower Security Reserve Account and funded it with £19,300,000 to provide liquidity support to the Class A and Class C Note Senior Interest Amount. The final expected maturity date for the Debussy DTC plc transaction is July 2020 and the rated final maturity date is July 2025.

Due to the cyclical and discretionary nature of the toy retail industry and the lagging financial performance of TRU, the transaction is particularly vulnerable in an economic slowdown, hence the trend change on the class A Notes. Toys and baby products, the only revenue sources of TRU, are highly discretionary goods, the consumption of which declines exponentially as consumers’ disposable incomes decrease. As a result of Brexit, a potential economic slowdown in the UK and the already fragile financial covenants of the Hold Co, could add additional stress on the Class A Notes.

To verify the financial strength of TRU, DBRS has conducted a financial analysis based on public filings of the Hold Co, Op Co and Prop Co. The result shows a low consolidated EBIT margin of 0.72% in 2014, which improved from -1.21% in 2013. The Op Co, however, has plunged into a negative EBIT margin since 2010. DBRS also notes that the overall earnings of the Op Co, and therefore the Hold Co, have improved since issuance. Nevertheless, a decrease in revenue may halt, if not revert, the improving financial performance of TRU and ultimately increase the insolvency probability of the Borrower.

Other external events, such as trade treaty negotiations between the U.K. and the European Union and debt restructuring of TRU in the United States, could also influence the transaction in different directions.
DBRS will monitor the impact of such events on the transaction as they unfold.

DBRS has completed a review of all DBRS-rated transactions with collateral within the United Kingdom following the recent EU Referendum in June 2016. This impact has been addressed on a deal-by-deal basis. For more information on the impact of Brexit on the U.K. commercial real estate market, please see the press release “DBRS Takes Several Rating Actions on UK CMBS.” Individual press releases are available on www.dbrs.com.

Notes:
All figures are in British pounds sterling unless otherwise noted.

The principal methodology applicable is European CMBS Surveillance.

The applicable methodologies are European CMBS Surveillance, European CMBS Rating Methodology, Legal Criteria for European Structured Finance Transactions, Derivative Criteria for European Structured Finance Transactions and Unified Interest Rate Model for European Securitisations, which can be found on www.dbrs.com under Methodologies.
Other methodologies referenced in this transaction are listed at the end of this press release.

DBRS has applied the principal methodology consistently and conducted a review of the transaction in accordance with the principal methodology.

A review of the transaction legal documents was not conducted as the documents have remained unchanged since the most recent rating action.

For a more detailed discussion of the sovereign risk impact on Structured Finance ratings, please refer to the DBRS commentary “The Effect of Sovereign Risk on Securitisations in the Euro Area” found at http://www.dbrs.com/industries/bucket/id/10036/name/commentaries.

The sources of information used for this rating include Situs Asset Management Ltd., CBRE Limited and company accounts filings.

DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

DBRS was not supplied with third party assessments. However, this did not impact the rating analysis.

DBRS does not rely upon third-party due diligence in order to conduct its analysis.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

The last rating action on this transaction took place on 28 July 2015, when DBRS confirmed the rating of the Class A Notes.

Information regarding DBRS ratings, including definitions, policies and methodologies, is available on www.dbrs.com.

The lead responsibilities for this transaction have been transferred to Rick Shi.

To assess the impact of changing the transaction parameters on the rating, DBRS considered the following stress scenarios, as compared with the parameters used to determine the rating (the Base Case):

-- A decrease of 10% and 20% in the DBRS net cash flow (NCF), derived by looking at comparable properties, market rents and market occupancies, in addition to expenses ratios, capital expenditures and re-tenanting costs, would lead to the following ratings in the transaction, as noted below for each class, respectively:

Class A Note Risk Sensitivity:
-- 10% decline in DBRS NCF, expected rating of Class A Notes to BB (low) (sf)
-- 20% decline in DBRS NCF, expected rating of Class A Notes to B (low) (sf)

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS’s outlooks and ratings are monitored.

For further information on DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see http://cerep.esma.europa.eu/cerep- web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Initial Lead Analyst: Scott Goedken
Initial Rating Date: 19 July 2013
Rating Committee Chair: Mary Jane Potthoff

Lead Surveillance Analyst: Rick Shi, Senior Financial Analyst
Rating Committee Chair: Erin Stafford, Managing Director

DBRS Ratings Limited
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Registered in England and Wales: No. 7139960

The rating methodologies used in the analysis of this transaction can be found at http://www.dbrs.com/about/methodologies:
-- European CMBS Rating Methodology
-- European CMBS Surveillance
-- Legal Criteria for European Structured Finance Transactions
-- Unified Interest Rate Model for European Securitisations
-- Derivative Criteria for European Structured Finance Transactions

A description of how DBRS analyses structured finance transactions and how the methodologies are collectively applied can be found at http://www.dbrs.com/research/278375.