DBRS Morningstar Assigns Provisional Ratings to Helios (European Loan Conduit No. 37) DAC

DBRS Ratings Limited (DBRS Morningstar) assigned provisional ratings to the following classes of commercial mortgage-backed floating-rate notes to be issued by Helios European Loan Conduit No. 37 (the Issuer):

-- Class RFN at AAA (sf)
-- Class A 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 (high) (sf)

All trends are Stable.

Helios (European Loan Conduit No. 37) DAC is the securitisation of a GBP 350 million senior loan advanced by Morgan Stanley Bank N.A. to Titan Acquisition Limited (the borrower). The senior loan is secured against a portfolio of 49 limited-service hotels located across the United Kingdom. Loan proceeds will refinance existing portfolio debt and permitted transactions of the reorganisation, including the acquisition of all the shares of the Exeter city centre asset; finance planned extension projects; and fund general corporate purposes. The ultimate beneficial owner of the portfolio is London & Regional Group (L&R), which acquired the hotels from Lone Star Funds (the seller) in 2016. The hotels are managed by the Atlas Hotels Group (Atlas), which was also acquired as part of the transaction in 2016 and is now a wholly owned operating company of L&R.

Since 1997, the number of guestrooms in the portfolio has grown through both hotel expansions and acquisitions. The majority of the hotels are branded under Intercontinental Hotels Group’s (IHG) Holiday Inn Express while one hotel in Liverpool operates as a Hampton by Hilton and another hotel in York as a Park Inn by Radisson. Two of the hotels in the portfolio (i.e., the Park Inn in York and Holiday Inn Express in Poole) are leased and not operated by Atlas. Since L&R’s acquisition, it has expanded the portfolio to include 253 additional guestrooms at new hotels in Exeter and Portsmouth Park and 43 new rooms through renovating existing hotels.

The hotels are managed directly by Atlas and operate under separate franchise agreements with IHG and Hilton Worldwide Holdings Inc. at the Liverpool asset. Cushman & Wakefield estimated the portfolio’s total market value (MV) to be GBP 546.9 million (net of standard asset sale purchaser’s costs, which vary between English and Scottish jurisdictions) or GBP 91,577 per room based on the portfolio’s 5,972 rooms. Inclusive of escrowed capital expenditure (capex) monies within lender control, the portfolio’s valuation is GBP 561.1 million. The portfolio’s resulting senior loan-to-value (LTV) is 62.4%.

The portfolio is located across England, Wales, and Scotland. Five of the hotels are located within Greater London (25% of MV), six hotels are located in Scotland (10% of MV), and two are in South Wales (1% of MV). The remainder of the portfolio are primarily located in city centres or near infrastructure hubs, such as motorway junctions or airports, in England.

The borrower has both leasehold and freehold interests in the portfolio assets: 25 properties are freehold, 22 are held on long leasehold agreements, and two properties in York and Bath are part freehold and part leasehold. Most of the ground leases have terms that are longer than 100 years, with Bristol City Centre (ground lease of 77 years), Holiday Inn Portsmouth (94 years), and Luton Airport (82 years) as exceptions. DBRS Morningstar understands that in conjunction with the refinancing, a simultaneous carve out of a ground lease strip for 43 hotels in the portfolio (of which three are deferred) will be granted in favour of an institutional investor for 125 years with a GBP 1 buy back option in year 65 for Atlas, which will enter into separate leases for the respective properties. The initial ground rent payable by Atlas under the lease agreements (the leaseback lease) is GBP 7.0 million per year, which is 15% of the adjusted net operating income (NOI) for the 2018 financial year. The lessor will review the rent annually and increases will be linked to increases in the Retail Price Index subject to a 0% floor and 5% cap. DBRS Morningstar made a reflective adjustment to its net cash flow and value assumptions.

The portfolio is largely stabilised but DBRS Morningstar notes that three properties—while still operational—are undergoing renovations. The renovations are expected to be completed in early 2020 and will result in 157 additional rooms across three hotels (i.e., Hammersmith, Cambridge, and Edinburgh Waterfront). To fund the hotel expansions, on the utilisation date, GBP 14.2 million of the senior loan proceeds will be placed into a cash trap account under the capex ledger and remain under control of the lender. Upon sale of these assets, any remaining balance will be transferred to the purchaser of the respective hotel. DBRS Morningstar understands that GBP 4 million has been spent and qualifies to be released from the capex ledger. In its assessment, DBRS Morningstar assumed that the delivery of additional guestrooms will occur in early 2020, which was corroborated by its site visit to Hammersmith and the valuation report. To account for the additional guestroom supply, DBRS Morningstar applied further stresses to the occupancy rates for these respective hotels. DBRS Morningstar’s stressed net cash flow (NCF) assumption for the portfolio, inclusive of the ground lease payments, is GBP 40.6 million and the respective value for the portfolio is GBP 448.72 million, implying a capitalisation rate of 9%, LTV of 77%, and a debt yield of 11.6% (the issuer debt yield at the cutoff date was 13.4%).

As of the T-12 ending June 2019, the occupancy rate of the portfolio was 82.9% and the ADR was GBP 69.63, resulting in a RevPAR of GBP 57.64. In 2018, the highest ADR of GBP 106 and RevPAR of GBP 87.51 were both achieved at the Hammersmith hotel. For the T-12 ending June 2019, the portfolio generated GBP 131.7 million of revenue, after deducting costs and expenses. The EBITDA for the same period was GBP 53.8 million and the NOI was GBP 42.9 million after management fees, FF&E, and a ground lease payment of GBP 7.1 milllion, which to DBRS Morningstar’s understanding is yet to be paid.

The IHG franchise agreements typically have 15- to 20-year terms and give the hotels access to IHG’s operating and revenue management system, Holidex. In 2014, a Master Development Agreement between IHG and the owner was introduced that set out to increase the number of guestrooms in the portfolio; this was superseded by the Portfolio Agreement in October 2017 between IHG and Atlas, which extended the franchise agreement expiry dates by 15 years and provided franchise cost savings on the condition that 400 rooms are added to the portfolio by the end of 2020.

The senior loan bears interest at a floating rate equal to three-month Libor (subject to zero floor) plus a margin of 3.25% annually. The expected maturity date is 16 December 2024. The notes are expected to have a final maturity date in 2 May 2030, providing a tail period of five years.

The borrower is required to amortise the senior loan by GBP [656,250] on each interest payment date or by GBP 2,625,000 per year, which is 0.75% of the senior loan amount at issuance. Scheduled amortisation proceeds will be distributed pro rata to the noteholders unless a sequential payment trigger is continuing, in which case, the proceeds will be distributed sequentially. Before a sequential payment trigger event, equity funded voluntary prepayments will be applied pro rata to the notes and the VRR loan. In the case of mandatory prepayments after property disposals, the senior allocated loan amounts (ALA) and release premiums will also be allocated pro rata to the notes and the VRR loan. The senior release price for the corresponding property is set between 15% and 25% above the ALA of the disposed property. The borrower is allowed to dispose of properties in the portfolio which cumulatively must not exceed 10% of the principal balance of the senior loan.

The senior loan has LTV and debt yield covenants for cash traps and events of default. The LTV cash-trap covenant is set at 67.4% in years 1-2, 64.9% in years 3-4 and 62.4% thereafter, while the debt-yield cash-trap covenant is triggered if the debt yield is below 10.0% in year 1, 10.3% in year 2, 11.3% in year 3, 11.5% in year 4, and 11.8% thereafter. The LTV default covenants are set at 72.4% for years 1 through 3, 69.9% in year 4 and then 67.4% thereafter. The senior obligors are required to ensure that the senior debt yield is no less than 9.3% in year 1, 9.5% in year 2, 10.0% in year 3, 10.5% in year 4, and 10.5% thereafter.

The interest rate risk will be fully hedged over the first three years of the senior loan’s five-year term by way of a prepaid cap provided by SMBC Nikko Capital Markets Limited. The hedge has an initial term of three years; however, there is an obligation to extend the hedge for an additional year, prior to expiry of the hedge and then again for another one year, prior to the expiry of the extended hedge. If the hedge is not extended as described, there will be a loan event of default and sequential payment trigger event on the notes.

The transaction includes a Reserve Fund Note (RFN), which funds 95% of the liquidity reserve (i.e., the note share part). After issuance, the GBP 15.5 million RFN proceeds and the GBP 815,789.47 million vertical risk retention (VRR) loan contribution will be deposited into the transaction’s liquidity reserve. The liquidity reserve will provide liquidity to pay property protection advances, senior costs, and interest shortfalls (if any) in relation to the corresponding VRR loan interest and the Class A, Class B, Class C, and Class D notes. The RFN notes rank pari passu with the Class A notes. According to DBRS Morningstar’s analysis, the liquidity reserve amount is equivalent to approximately [13]-months of coverage on the covered notes, based on the interest rate cap strike rate of 3.0% per year, and 12 month’s coverage based on the Libor cap after loan maturity or the occurrence of a loan-level cap event of 5.0% annually.

The borrower has an option to add mezzanine debt provided that (1) when aggregated with the senior loan, the mezzanine debt is limited to 70% of the aggregate portfolio MV and (2) written confirmation from each rating agency then rating the notes, that the mezzanine financing would not result in a downgrade of each class of notes or withdrawn; or the restoration of any original rating, having been downgraded. To maintain compliance with applicable regulatory requirements, the seller will retain an ongoing material economic interest of no less than 5% of the securitisation via a VRR loan that the seller will advance to the Issuer at closing.

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 Morningstar 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 “Global Methodology for Rating Sovereign Governments” at: https://www.dbrs.com/research/350410/global-methodology-for-rating-sovereign-governments.

The sources of data and information used for these ratings include Morgan Stanley Bank N.A. and its affiliates.

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

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

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

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

These ratings concern a newly issued financial instrument. These are the first DBRS Morningstar ratings on this financial instrument.

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

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

Class A Notes Risk Sensitivity:
-- a 10% decline in DBRS Morningstar NCF would lead to an expected rating of the Class A notes at AA (high) (sf)
-- a 20% decline in DBRS Morningstar NCF would lead to an expected rating of the Class A notes at AA (sf)

Class B Notes Risk Sensitivity:
-- a 10% decline in DBRS Morningstar NCF would lead to an expected rating of the Class B notes at A (sf)
--a 20% decline in DBRS Morningstar NCF would lead to an expected rating of the Class B notes at BBB (high) (low) (sf)

Class C Notes Risk Sensitivity:
-- a 10% decline in DBRS Morningstar NCF would lead to an expected rating of the Class C notes at BBB (sf)
-- a 20% decline in DBRS Morningstar NCF would lead to an expected rating of the Class C notes at BB (high) (sf)

Class D Notes Risk Sensitivity:
-- a 10% decline in DBRS Morningstar NCF would lead to an expected rating of the Class C notes at BBB (low) (sf)
-- a 20% decline in DBRS Morningstar NCF would lead to an expected rating of the Class C notes at BB (sf)

Class E Notes Risk Sensitivity:
-- a 10% decline in DBRS Morningstar NCF would lead to an expected rating of the Class C notes at BB (high) (sf)
-- a 20% decline in DBRS Morningstar NCF would lead to an expected rating of the Class C notes at BB (high) (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: 16 December 2019

DBRS Ratings Limited
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The rating methodologies used in the analysis of this transaction can be found at: http://www.dbrs.com/about/methodologies.

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

A description of how DBRS Morningstar 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 [email protected].

This press release was amended on 17 January 2020 to indicate that the sources of data used for the ratings were from Morgan Stanley Bank N.A. and its affiliates.