DBRS Assigns Provisional Ratings to FROSN-2018 DAC

DBRS Ratings Limited (DBRS) assigned provisional ratings to the following classes of notes to be issued by FROSN-2018 DAC (the Issuer):

--Class RFN at AAA (sf)
--Class A1 at AAA (sf)
--Class A2 at AAA (sf)
--Class B at AA (low) (sf)
--Class C at A (low) (sf)
--Class D at BBB (low) (sf)
--Class E at BB (low) (sf)

All trends are Stable.

The Issuer is the securitisation of one Finnish commercial real estate (CRE) loan jointly advanced by Citibank, N.A., London Branch (Citi), Morgan Stanley Bank, N.A. and Morgan Stanley Principal Funding, Inc. (Morgan Stanley) to 72 borrowers (Borrowers) owned by Sponda Plc (Sponda). The loan, which closed on 15 December 2017, refinanced the existing indebtedness of the Borrowers (including financing costs) and is available to finance permitted capital expenditure (capex) projects.

The aggregate balance of the senior loan is EUR 590.9 million, consisting of a EUR 577 million senior term loan and a EUR 13.9 million senior capex facility (66.6% loan-to-value (LTV)). In addition, there are also EUR 103.8 million mezzanine facilities, split into a EUR 101.7 million mezzanine term loan and a EUR 2.1 million mezzanine capex facility (together with the senior facilities 78.3% LTV). The mezzanine facilities are structurally and contractually subordinated to the senior loan and are not part of the contemplated transaction. The total amount of the senior loan to be securitised is equal to EUR 540.87 million or [92%] of the total senior loan. However, the Issuer will advance EUR 27.94 million (5% of the securitised senior loan) back to Morgan Stanley and Citi in the form of vertical risk retention (VRR) loan interest to comply with risk retention requirement. The senior loans bear interest at a floating rate equal to three-month Euribor (subject to zero floor) plus a 2.45% per annum margin.

The underlying portfolio is composed of 63 CRE assets located across Finland that are owned by individual property-owning companies (propcos). The portfolio’s total market value (MV) is EUR 887.7 million, resulting in a 66.6% senior LTV. Office space represents 61.7% of the total lettable area of the portfolio while retail space makes up 17.4% and other commercial assets the remaining 20.0%.

In terms of MV, the portfolio is heavily concentrated in Helsinki, where 73.8% of MV is located, and Tampere, the most populated Nordic inland city, which contributes 30.0% to the MV. More specifically, within the Helsinki Metropolitan Area (HMA), 11.5% MV is located in Ruoholahti, 17% MV in Espoo and 45.3% in other HMA locations. The remaining 6.2% of MV is located in other regions across Finland. As of 30 September 2017, the portfolio was generating EUR 60.3 million of net rent, which equates to a 10.2% debt yield (DY).

The assets are part of Sponda’s portfolio, previously one of the largest listed real estate firms in Finland, which was recently acquired and delisted by The Blackstone Group L.P. (Blackstone or the Sponsor). Blackstone viewed the acquisition as a strategic move into the Nordic CRE market. Sponda was originally founded by the Bank of Finland in 1991 to take over the Finnish and foreign real estate properties held by the Skopbank Group, together with its sizeable equity portfolio, before listing the company on the Helsinki Stock Exchange on 6 January 1998.

The transaction includes a new structural feature in the form of reserve fund notes (RFN), which fund the note share part (95%) of the liquidity reserve. After issuance, the EUR 16.7 million RFN proceeds and EUR 878,947.37 VRR Loan Interest contribution will be deposited into the transaction’s liquidity reserve, which works similarly to a typical liquidity facility providing liquidity to pay property protection advances, senior costs and interest shortfalls (if any) in relation to the corresponding VRR Loan Interest, RFN, Class A1, Class A2 and Class B notes (for further details please see section “Liquidity Support” in DBRS Presale Report). According to DBRS’s analysis, the liquidity reserve amount will be equivalent to approximately 27 and 11 months coverage on the covered notes, based on the interest rate cap strike rate of 1.0% per annum and the EURIBOR cap after loan maturity of 4.25% per annum, respectively.

In addition to the liquidity reserve, the transaction also features a senior expenses reserve to cover senior expenses. DBRS notes that the senior expense reserve will be funded to EUR [200,000] which should cover one interest period’s senior fees in case the liquidity reserve has been fully depleted or released upon full repayment of the covered notes.

It is expected to have EUR 71,917 proceeds exceeding the total securitised loan amount due to rounding. The arrangers have informed DBRS that such amount will be distributed to the noteholders on the first interest payment period. Class E is subject to an available funds cap where the shortfall is attributable to an increase in the weighted average margin of the notes and lost Issuer liquidity reserve amount due to issuer account bank insolvency.

Prior to Blackstone’s acquisition, Sponda issued unsecured senior notes (Polar Notes) on three occasions: EUR 95 million subordinated bonds (hybrid bonds) in 2012, which are no longer outstanding; EUR 150 million senior bonds in 2013 and EUR 175 million in 2015, which, instead, remain outstanding. Blackstone provided an investor fund guarantee, via its BREP Europ V and BREP VIII, on all the Polar Notes (EUR 325 million in total) should a failure to pay on the same notes arise.

DBRS also understands that following the acquisition by Blackstone, the minority shareholders of Sponda have been squeezed out. Following the issuance of FROSN 2018 DAC the Sponsor will take reasonable effort to reorganise Sponda’s company structure.

The senior loan is expected to be repaid in February 2020; however, the Borrowers can exercise three one-year extension options, subject to certain conditions. The final maturity of the notes is on 21 May 2028, approximately five years after the date of the fully extended senior loan maturity. A prepayment fee equal to one-year make-whole interest is also payable by the Borrowers should they prepay the senior loan in the first year.

Morgan Stanley and Citi (together, in the capacity as the VRR Loan Interest Owners) will retain no less than 5% material interest in the transaction via the VRR Loan Interest issued by the Issuer. Moreover, Morgan Stanley will retain an additional EUR 50 million of the senior loan, which it is free to deal with in its sole discretion. All amounts payable to the VRR Loan Interest Owners (the VRR Loan Interest Amounts) in respect of the VRR Loan Interest will rank pari-passu with amounts payable in respect of the Notes.

The ratings will be finalised upon receipt of execution version of the governing transaction documents. To the extent that the documents and information provided to DBRS as of this date differ from the executed version of the governing transaction documents, DBRS may assign a different final rating to the rated notes.

Notes:
All figures are in euros unless otherwise noted.

The principal methodology applicable to the rating is: European CMBS Rating and Surveillance Methodology.

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

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

These may be found on www.dbrs.com at: http://www.dbrs.com/about/methodologies.

For a more detailed discussion of the sovereign risk impact on Structured Finance ratings, please refer to “Appendix C: The Impact of Sovereign Ratings on Other DBRS Credit Ratings” of the “Rating Sovereign Governments” methodology at: http://dbrs.com/research/319564/rating-sovereign-governments.pdf.

The sources of data and information used for this rating include Citigroup Global Markets Limited, Morgan Stanley & Co. International plc and their delegates.

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

At the time of the initial rating, DBRS was supplied with third-party assessments. However, this did not impact the rating analysis.

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

DBRS does not audit or independently verify the data or information it receives in connection with the rating process.

This rating concerns a newly issued financial instrument. This is the first DBRS rating on this financial instrument.

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

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

A decrease of 10% and 20% in the DBRS NCF, derived by looking at comparable market rents, market occupancies in addition to expense ratios, and capital expenditure, would lead to a downgrade in the transaction, as noted below for each class respectively.

Class RFN Notes Risk Sensitivity:
--10% decline in DBRS NCF, expected rating of Class RFN Notes to AAA (sf)
--20% decline in DBRS NCF, expected rating of Class RFN Notes to AAA (sf)

Class A1 Notes Risk Sensitivity:
--10% decline in DBRS NCF, expected rating of Class A Notes to AA (high) (sf)
--20% decline in DBRS NCF, expected rating of Class A Notes to A (sf)

Class A2 Notes Risk Sensitivity:
--10% decline in DBRS NCF, expected rating of Class B Notes to A (high) (sf)
--20% decline in DBRS NCF, expected rating of Class B Notes to A (low) (sf)

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

Class C Notes Risk Sensitivity:
--10% decline in DBRS NCF, expected rating of Class D Notes to BBB (sf)
--20% decline in DBRS NCF, expected rating of Class D Notes to BB (high) (sf)

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

Class E Notes Risk Sensitivity:
--10% decline in DBRS NCF, expected rating of Class D Notes to B (sf)
--20% decline in DBRS NCF, expected rating of Class D Notes to CCC (sf)

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 and US regulations only.

Lead Analyst: Rick Shi, Senior Financial Analyst
Rating Committee Chair: Christian Aufsatz, Managing Director, Head of European Structured Finance
Initial Rating Date: 22 March 2018

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.

-- Legal Criteria for European Structured Finance Transactions
-- Derivative Criteria for European Structured Finance Transactions
-- Interest Rate Stresses for European Structured Finance Transactions
-- European CMBS Rating and Surveillance Methodology

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.

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