DBRS Changes Trend on Subordinated Classes of Elizabeth Finance 2018 DAC to Negative from Stable, Confirms Ratings

DBRS Rating Limited (DBRS) changed the trend on the Class B, C, D and E Notes issued by Elizabeth Finance 2018 DAC (the Issuer) to Negative from Stable. The trend on the Class A Notes remains Stable. Additionally, DBRS confirmed the ratings on the classes of notes as follows:

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

The trend change is a result of the further deterioration of the UK retail sector, which could affect the performance of the Maroon loan by increasing: (1) the re-letting risk for the upcoming lease break options of some of the largest tenants in the portfolio and (2) the number of retailers entering into company voluntary arrangements or deciding to consolidate their space across the country.

Elizabeth Finance 2018 DAC is a securitisation of two British senior commercial real estate loans that were advanced by Goldman Sachs International Bank. The two loans are the GBP 68.9 million Maroon loan (GBP 69.6 million at inception), which was advanced to three borrowers, and the GBP 20.9 million (GBP 21.1 million at inception) MCR loan that was advanced to Cypresshawk Limited. Both loans were refinancing facilities and have partially amortised since the origination date. The collateral securing the Maroon loan comprises three shopping centres located in England and Scotland; each property is held by property holding companies under the respective Maroon borrower. The MCR loan is secured by a campus-style office building located in Manchester, England. Oaktree Capital Management is the sponsor for the Maroon loan while the sponsor of the MCR loan is Ms. Naeem Kauser as trustee of the Mussarat Children’s Trust.

The Maroon loan was transferred to special servicing on 4 June 2019 due to a loan-to-value (LTV) financial covenant breach based on the latest valuation dated on 31 January 2019, which saw the portfolio’s market value drop by 17.9% to GBP 86 million. However, the mezzanine lender cured the breach by depositing an equity cure amount of GBP 1.1 million to the cure account; as a result, the Maroon loan was transferred back to primary servicing on 15 July 2019 as a corrected loan. DBRS does not expect the servicer to commission another valuation in the next six months. As such, the LTV covenant breach will likely be cured by releasing the equity cure amount as well as the cash trap proceeds (currently at approximately GBP 1.0 million based on servicer’s data) as principal receipts in order to pay down the loan and ultimately the notes on a pro rata basis. The prepayment would bring the Maroon loan’s leverage within the 75.0% default-level covenant (DBRS’s LTV will also decrease from 94.7% to 90.4%), although DBRS anticipates surplus cash trapping to continue, as the loan would still be breaching its 70.0% cash trap covenant. In accordance with the senior cash trap mechanism, the payment of mezzanine interest would still be allowed.

In DBRS’s view, the current challenging UK retail environment coupled with an increased possibility of a hard Brexit are expected to maintain a strong downward pressure on the loan’s performance, hence the Negative trends. Conversely, the upcoming opening of an H&M at the Vancouver Shopping Centre (the asset registering the highest value decline since origination at -22.0%) as well as a weighted-average unexpired-lease-term-to-break (WAULTB) of over four years as at Q2 2019 are expected to stabilise the performance of the portfolio and reduce the cash flow volatility in the near future.

Contrary to the Maroon loan, the MCR loan has demonstrated good performance since inception. The vacancy at the MCR office property has decreased to 5.3% in Q2 2019 from 15.6% at issuance while the net rent has increased to GBP 3.2 million from GBP 2.7 million during the same period. The WAULTB of 3.3 years also provides DBRS with additional comfort regarding the cash flow stability. DBRS views a potential prepayment of the MCR loan as credit negative for the transaction, as it would leave the noteholders fully exposed to the performance of the Maroon loan.

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 surveillance section of the principal methodology.

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

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: https://www.dbrs.com/research/333487/rating-sovereign-governments.

The sources of data and information used for the ratings include CBRE Loan Services Limited quarterly servicer reports.

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 these ratings 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 is the first rating action since the Initial Rating Date.

The lead analyst responsibilities for this transaction have been transferred to Dinesh Thapar.

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 net cash flow (NCF), expected rating of Class A Notes maintained at AAA (sf)
--20% decline in DBRS NCF, expected rating of Class A Notes downgraded to A (high) (sf)

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

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

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

Class E Notes Risk Sensitivity:
--10% decline in DBRS NCF, expected rating of Class E Notes downgraded to B (high) (sf)
--20% decline in DBRS NCF, expected rating of Class E Notes downgraded 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: Dinesh Thapar, Assistant Vice President
Rating Committee Chair: Christian Aufsatz, Managing Director
Initial Rating Date: 28 August 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.