DBRS Assigns Provisional Ratings to Salus (European Loan Conduit No. 33) DAC

DBRS Ratings Limited (DBRS) assigned provisional ratings to the following classes of notes to be issued by Salus (European Loan Conduit No. 33) DAC (the Issuer):

-- Class A at AAA (sf)
-- Class B at AA (sf)
-- Class C at A (low) (sf)
-- Class D at BBB (sf)

All trends are Stable.

Salus (European Loan Conduit No. 33) DAC is the third ELOC transaction arranged by Morgan Stanley & Co. International plc (Morgan Stanley) in 2018. The transaction is backed by a GBP 367.5 million senior loan, which is split into two facilities: Facility A, which totals GBP 354.0 million, and Facility B (the capex facility), which totals GBP 13.5 million. Facility A refinanced the borrower’s existing debt whereas the capex facility will finance planned capital expenditure (capex) work and tenant incentives and letting commissions. The senior loan is advanced by Morgan Stanley Bank, N.A. to CityPoint Holdings I Ltd., which is controlled by Brookfield Asset Management Inc. (Brookfield). There is an additional GBP 91.9 million mezzanine facility provided by Morgan Stanley Bank N.A. to Brookfield; however, the mezzanine facility is contractually and structurally subordinated to the senior loan and is not part of the transaction.

The senior loan closed on 27 November 2018 and is secured by the CityPoint tower in the City of London. Originally built for British Petroleum Plc in 1967, the asset went through significant redevelopment between 1998-2000. The building was also securitised in a pre-crisis CMBS transaction: Ulysses (ELOC 27) Plc with a senior securitised loan balance of GBP 429 million at inception. Brookfield, which had acquired the junior loan in the Ulysses transaction from Mount Keller in 2014, also acquired the senior loan in YE2016 thus subsequently repaid the Ulysses Notes. Facility A refinanced the debts that Brookfield undertook through its acquisition of the then-defaulted senior loan in 2016.

The CityPoint building is located on 1 Ropemaker Street by Finsbury Circus and the Moorgate tube station. The 35-storey office tower has four basement floors and ground floor retail space with shops and restaurants. However, the majority of the 709,236 square foot (sf) lettable area in the building is office space, which totals 627,887 sf. DBRS understands that the sponsor plans to refurbish various floors, including the lobby, over the next five years with a GBP 22.6 million capex budget dedicated to the refurbishment works.

Jones Lang LaSalle IP, Inc. valued the CityPoint building at GBP 600 million in October 2018, representing a 61.3% day-one loan-to-value (LTV) ratio. The appraiser also estimated the current market rent of the building to be GBP 37.7 million whereas the current contracted rent is only GBP 30.6 million. The building’s below-market rent coupled with its 3.7% vacancy rate and the currently low 4.4% average vacancy rate in the prime London office sector suggest upside potential for the sponsor to increase cash flow by raising rental rates to market levels.

According to the business plan provided to DBRS, the sponsor plans to achieve reversionary rental income by re-letting under-rented spaces after the building’s renovation. DBRS gave credit to the sponsor’s business plan, recognising Brookfield’s experience as a commercial real estate manager and the high historical occupancy of the building dating prior to Brookfield’s acquisition.

It should be noted that DBRS’s ratings are based on (1) the sponsor’s successful execution of the planned capex programme,(2) the ongoing attractiveness of the London office market to tenants and (3) the analysis and reports provided by the appraiser and legal counsel of the Issuer to date. Should either factor change, (i.e., a change of control or a hard Brexit), DBRS may downgrade the notes.

The senior loan carries a floating rate of three-month LIBOR (subject to zero floor) plus 2.15% margin and can be extended, subject to certain conditions, twice after its initial three-year term. Prior to a permitted change of control, there is no financial default covenant—only a cash trap covenants are applicable, which are set at 6.75% DY and 75.0% LTV for the initial three-year loan term, 7.5% DY for year four, 8.0% DY for year five while the LTV cash trap covenant remains at 72.5% for these two years. It should be noted that the DY is calculated based on different rental incomes: prior to a permitted change of control, DY is based on contracted rental income (pre-rent free deduction) and post a permitted change of control, DY is based on passing rent (post-rent free deduction). DBRS noted that the cash trap covenants from year four (7.5%) exceed the current DBRS debt yield (based on DBRS underwritten result following the DY calculation rule prior to a permitted change of control) of 7.1% (or 7.4% based only on Facility A). As such, and considering the current under-rented situation, DBRS has adjusted its rating hurdles to reflect the tightening DY from the fourth year. On or after the permitted change of control date, the financial default covenants on DY and LTV will apply, the financial covenants are set in line with cash trap covenants with 1% below DY cash trap covenants and 5% above LTV cash trap covenants. After a permitted change of control, the cash trapped amount will be released to paydown the loan should the cash trap continue for two consecutive interest periods. DBRS understands that the borrower will procure hedging within 90 days from the rating agency selection date (3 December 2018) for 100% of the loan amount at a cap strike rate of 2.5%.

All investment-grade notes will benefit from a liquidity facility of GBP 20 million, which equals to 5.4 % of the total outstanding balance of the covered notes and vertical risk retention (VRR) loan and will be provided by Wells Fargo Bank, N.A., London Branch. The liquidity facility can be used to cover interest shortfalls on the Class A, B, C and D notes. According to DBRS’s analysis, the commitment amount, as at closing, could provide interest payment on the covered notes up to 16 months or ten months based on the interest rate cap strike rate of 2.5% or on the LIBOR cap of 5%, respectively.

The transaction is expected to repay on or before 23 January 2024, three days after the fully-extended loan maturity. Should the loan not repay on the senior loan maturity date, a senior obligor become subject to insolvency or a default arises out of a creditor’s process or cross default, a special servicing transfer event will occur in respect of the defaulted loan and the proceeds from the defaulted loan will be applied sequentially to the notes. Should the notes fail to be fully redeemed by the expected note maturity, the Issuer will make principal payments on a sequential basis. The transaction will be structured with a five-year tail period to allow the special servicer to work out the loan at maturity by 23 January 2029 at the latest, which is the final legal maturity of the notes.

The transaction includes a Class X diversion trigger event, meaning that if the loans’ DY and/or LTV deteriorates over the levels set out in the financial default covenants, any interest and prepayment fees due to the Class X noteholders will instead be diverted into the Issuer transaction account and credited to the Class X diversion ledger. However, once the trigger is cured, the held amount will be released back to the Class X noteholder and only following the sequential payment trigger event and enforcement of note security can such funds be used to amortise the notes.

Morgan Stanley will retain 5% material interest in the transaction through the VRR loan.

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 different final ratings to the notes.

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

The principal methodology applicable to the ratings 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 the ratings include Morgan Stanley and its delegates.

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

DBRS was not 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.

These ratings concerns a newly issued financial instrument. These are the first DBRS ratings 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”):

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

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

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

Class D Notes Risk Sensitivity:
--10% decline in DBRS NCF, expected rating of Class D notes to BB (high) (sf)
--20% decline in DBRS NCF, expected rating of Class D notes to BB (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, Assistant Vice President
Rating Committee Chair: Christian Aufsatz, Managing Director
Initial Rating Date: 11 December 2018

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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.