DBRS Morningstar Changes Trend to Negative from Stable on Three UK Hospitality CMBS Transactions

DBRS Ratings Limited (DBRS Morningstar) changed the trend to Negative from Stable on all classes of notes issued by Ribbon Finance 2018 Plc and Magenta 2020 Plc. Additionally, DBRS Morningstar changed the trend to Negative from Stable on the Class A. Class B, Class C, Class D, and Class E notes issued by Helios (European Loan Conduit No. 37) DAC. The trend on the Class RFN notes remains Stable. DBRS Morningstar currently rates the notes of the three transactions as follows:

Ribbon Finance 2018 Plc:
-- Class A notes at AAA (sf)
-- Class B notes at AA (low) (sf)
-- Class C notes at A (sf)
-- Class D notes at BBB (high) (sf)
-- Class E notes at BBB (low) (sf)
-- Class F notes at BB (high) (sf)
-- Class G notes at BB (sf)

Helios (European Loan Conduit No. 37) DAC:
-- Class RFN notes at AAA (sf)
-- 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 (high) (sf)

Magenta 2020 Plc:
-- 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 for the UK commercial mortgage-backed securities (CMBS) transactions secured by hospitality properties (i.e., Ribbon Finance 2018 Plc, Helios (European Loan Conduit No.37) DAC, and Magenta 2020 Plc) is a result of the expected deterioration of the UK hospitality sector following the recent outbreak of the Coronavirus Disease (COVID-19) across the country. For more information, please see the commentary: “Coronavirus (COVID-19) Impact Negative in the Short Term for UK CMBS Backed by Hotel Assets”: https://www.dbrsmorningstar.com/research/357906/coronavirus-covid-19-impact-negative-in-the-short-term-for-uk-cmbs-backed-by-hotel-assets. In DBRS Morningstar’s view, the lockdown put in place by the UK authorities, the travel restrictions for certain countries, the widespread cancellation of conventions and meetings, the personal travel disruptions, and related circumstances are expected to significantly impact the cash flow of the properties in the upcoming months. Because of the nature of advance booking cancellations, daily bookings, and reliance on tourism, it is uncertain if operators are prepared to manage these disruptions.

European CMBS transactions backed by hospitality assets are generally insulated from loss at the higher rating categories based on DBRS Morningstar’s stressed value approach outlined in its “European CMBS Rating and Surveillance Methodology”. However, at this stage, the coronavirus’s short-term impact on net cash flow (NCF) and the immediate and long-term recovery of NCF and its impact on values is unknown, in part because there are no historical precedents for this type of pandemic-driven economic downturn.

Despite the likely decrease of hotel revenue and the breach of loan covenants in the forthcoming months, even if all borrowers stopped paying interest due on the loans, DBRS Morningstar would not expect immediate transaction note events of default to materialise, mainly because the transactions benefit from liquidity facility (e.g., Ribbon Finance 2018 Plc) or liquidity reserves (e.g., Helios (European Loan Conduit No.37) DAC and Magenta 2020 Plc). DBRS Morningstar expects Ribbon Finance 2018 Plc’s liquidity facility provider, Goldman Sachs Banks USA, to still be required to perform its obligations. The key exceptions would be (1) the operation of any force majeure clauses in the contract (which DBRS Morningstar could not identify in the liquidity facility agreement of Ribbon Finance 2018 Plc) and (2) the common law concept of frustration (which should not be relevant). DBRS Morningstar notes that in case of payment shortfalls of interest due on the securitised loans, there could be interest deferrals on bonds that are not covered by the liquidity facility or liquidity reserve, respectively (for more details, please refer to the respective DBRS Morningstar rating reports).

Force majeure clauses in a contract will usually deal specifically with how the party’s obligations are affected by an event that affects one of the party’s ability to perform the contract. Events such as a flu pandemic could, subject to the specific words of the clause, be covered by the standard force majeure clause; however, it is uncertain that a party will be able to rely on it to protect against claims of nonperformance as these clauses are interpreted strictly by the English courts. Typically a party will also need to satisfy a number of tests to the court. In the absence of a force majeure clause, the legal concept of frustration enables a party to be discharged from its contractual obligations if a significant change in circumstances makes it physically or commercially impossible to perform the contract or would mean performing radically different obligations from those originally agreed. Mere inconvenience, hardship, or financial loss involved in performing the contract is insufficient to amount to frustration.

Each of the loans have cash trap and default covenants; because of the lack of revenue being generated, the debt yield (DY) and interest coverage ratio (ICR) covenants could be breached at the next respective interest payment date (IPD). Longer term pressure could also arise on loan-to-value (LTV) covenants. DBRS Morningstar understands that the servicer for each of the transactions are in active dialogue with the respective borrowers.

Falling short of the DY loan covenant, in respect to Helios (European Loan Conduit No. 37), the servicer could call a loan default resulting in a sequential payment trigger event. In respect to Ribbon Finance 2018 Plc and Magenta 2020 Plc the servicer could transfer the loan into special servicing which in turn will result in a sequential payment trigger event. Excess spread which would ordinarily benefit the Class X noteholders would be diverted to the Class X diversion ledger wherever applicable. Any payment to the Class X notes will become fully subordinated.

The liquidity facility, RFN, and issuer liquidity reserve provide liquidity support for those notes which are covered by it: Classes A-E for Ribbon Finance 2018 Plc, Classes A-D for Helios (European Loan Conduit No. 37) DAC, and Classes A-C for Magenta 2020 plc.

Ribbon Finance 2018 Plc
Ribbon Finance 2018 Plc is a securitisation of a GBP 449.8 million senior loan advanced by Goldman Sachs Bank USA (GS) to the borrower to provide partial acquisition financing for the Dayan family (the sponsor) to acquire 20 hotels (or 4,840 rooms) located across the UK and Lapithus Hotels Management UK (LHM), which acts as property manager for the same assets. GS also advanced a mezzanine loan of GBP 69.2 million to Ribbon Mezzco Limited, which was later sold to funds advised and/or managed by Apollo Global Management LLC.

The sponsor of Ribbon Finance 2018 Plc had an organisational restructure separating the direct ownership of the operations from the direct ownership of the properties, forming a conventional PropCo/OpCo structure. The ultimate controlling beneficial ownership of both the operations and the properties remained the same. No changes were made to the commercial terms of the senior facility agreement and the mezzanine facility agreement.

At the end of 2019, the sponsor sold one property, the Bloomsbury Hotel, resulting in net proceeds to partially repay the loan by GBP 49,749,621. Since issuance, GBP 59,870,121 has been repaid in total (the sale proceeds were distributed pro rata along with scheduled amortisation/release premium allocated sequentially). Following the January 2020 IPD, the outstanding principal loan balance was GBP 388.0 million, resulting in a senior LTV of 63.1% based on the August 2019 valuation of GBP 618.0 million. Performance metrics were in line with expectations, with occupancy at 80%, an EBITDA of GBP 47 million, and a reported NOI of GBP 40.7 million.

It is still uncertain of what magnitude the final impact on cash flow will be for the transaction as the length of time under lockdown is currently unknown. As of the last IPD in January 2020, all debt obligations were met in full, with a reported ICR of 2.57 times (x) and DY of 10.4%. The next IPD is 15 April 2020, the ICR must exceed 1.78x and the DY must be greater than 9.26% in order to be compliant with its loan covenants. The loan expected maturity date is 2 April 2023 with no extension option available.

Helios (European Loan Conduit No. 37) DAC
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), which is ultimately owned by London & Regional Group (L&R). The senior loan refinanced a portfolio of 49 limited-service hotels (with 5,972 rooms) located across the United Kingdom, which were acquired by the sponsor in 2016. The hotels are managed by the Atlas Hotels Group, which was also acquired as part of the transaction in 2016 and is now a wholly owned operating company of L&R.

As the transaction was recently issued in December 2019, DBRS Morningstar only has available the performance figures at the time of closing. At inception, the transaction’s LTV was 64%, based on Cushman & Wakefield’s valuation of GBP 546.9 million (or GBP 91,577 per room) from May 2019. The LTV is 62.4% including escrowed capital expenditure monies within lender control of GBP 14.2 million. At issuance, the debt service coverage ratio (DSCR) was 2.0x, and DBRS Morningstar estimates that across the portfolio, occupancy would have to stay at or above 50% from the reported 82% in order to maintain debt service. The expected loan maturity date is in December 2024. The trend on the RFN note remains unchanged; DBRS Morningstar notes that it ranks senior to all other notes and is currently backed by cash held on account, which is controlled by the Issuer. The next IPD is in May 2020 and the DY must exceed 10% in order to be compliant with its covenant.

Magenta 2020 PLC
The portfolio securing Magenta 2020 PLC (the most-recent UK hospitality securitisation transaction) is made up of 17 hotels located across the UK. Valor Europe manages these hotels and operates them under various franchise agreements with InterContinental Hotels Group, Hilton, and Marriott. The portfolio comprises three hotels operated under the Hilton Double Tree brand, seven hotels flagged by Crowne Plaza, three by Hilton Garden Inn, two AC by Marriott, one Holiday Inn, and one Indigo.

The valuer, Savills - London Office (Savills), has estimated the total market value to be GBP 435.5 million, or GBP 128,747 per room based on the 3,383 rooms in the portfolio, resulting in a LTV of 62.2% based on the current senior loan balance of GBP 270.9 million. The actual DY and DSCR at issuance were 11.8% and 3.0x, respectively, which provide some coverage to withstand any short-term downward pressure on revenues caused by the impact of the coronavirus. However, in a prolonged lockdown situation, DBRS Morningstar is of the opinion that the transaction could fall under significant refinancing pressure because of the initial loan maturity in December 2021 and without the opportunity to exercise the three one-year extension options due to potential breaches in LTV and/or DY covenants. The next IPD is in June 2020 and the DY must exceed 8.75% in order to be compliant with its covenant.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

For more information regarding structured finance rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/358308.

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” (13 December 2019).

DBRS Morningstar has applied the principal methodology consistently and conducted a review of the transactions 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 these transactions are listed at the end of this press release.

These may be found at: http://www.dbrsmorningstar.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.dbrsmorningstar.com/research/350410/global-methodology-for-rating-sovereign-governments.

The sources of data and information used for these ratings include servicer reports from CBRE Loan Services and cash manager reports from US Bank.

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

At the time of the initial ratings, 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 these 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.

The last rating action on Ribbon Finance 2018 plc. took place on 16 July 2019 when DBRS Morningstar confirmed its ratings on all classes of notes. The last rating action on Helios (European Loan Conduit No. 37) DAC took place on 17 January 2020 when DBRS Morningstar finalised its provisional ratings on the notes. The last rating action on Magenta 2020 Plc took place on 6 March 2020 when DBRS Morningstar finalised its provisional ratings on the notes.

The lead analyst responsibilities for all three transactions have been transferred to Dinesh Thapar.

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

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

Ribbon Finance 2018 Plc
Class A Notes Risk Sensitivity:
--A 10% decline in DBRS Morningstar NCF would not be expected to impact the rating of the Class A notes at AAA (sf)
--A 20% decline in DBRS Morningstar NCF would lead to an expected downgrade of Class A notes to AA (sf)

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

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

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

Class E Notes Risk Sensitivity:
--A 10% decline in DBRS Morningstar NCF would lead to an expected downgrade of the Class E notes to BB (high) (sf)
--A 20% decline in DBRS Morningstar NCF would lead to an expected downgrade of the Class E notes to BB (sf)

Class F Notes Risk Sensitivity:
--10% decline in DBRS Morningstar NCF would lead to an expected downgrade of the Class F Notes to BB (sf)
--20% decline in DBRS Morningstar NCF would lead to an expected downgrade of the Class F Notes to B (sf)

Class G Notes Risk Sensitivity:
--A 10% decline in DBRS Morningstar NCF would lead to an expected downgrade of the Class G notes to BB (low) (sf)
--A 20% decline in DBRS Morningstar NCF would lead to an expected downgrade of the Class G notes to B (sf)

These ratings included participation by the rated entity or any related third party. DBRS Morningstar had no access to relevant internal documents for the rated entity or a related third party.

Helios (European Loan Conduit No. 37) DAC
Class A Notes Risk Sensitivity:
-- A 10% decline in DBRS Morningstar NCF would lead to an expected downgrade of the Class A notes to AA (high) (sf)
-- A 20% decline in DBRS Morningstar NCF would lead to an expected downgrade of the Class A notes to AA (sf)

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

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

Class D Notes Risk Sensitivity:
-- A 10% decline in DBRS Morningstar NCF would not be expected to impact the rating of the Class D notes at BBB (low) (sf)
-- A 20% decline in DBRS Morningstar NCF would lead to an expected downgrade of the Class D notes to BB (sf)

Class E Notes Risk Sensitivity:
-- A 10% decline in DBRS Morningstar NCF would not be expected to impact the rating of the Class E notes at BB (high) (sf)
-- A 20% decline in DBRS Morningstar NCF would not be expected to impact the rating of the Class E notes at BB (high) (sf)

Magenta 2020 Plc
Class A Notes Risk Sensitivity:
--A 10% decline in DBRS Morningstar NCF would not be expected to impact the Class A notes’ AAA (sf) rating
--A 20% decline in DBRS Morningstar NCF would lead to an expected downgrade of the Class A notes to AA (high) (sf)

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

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

Class D Notes Risk Sensitivity:
--A 10% decline in DBRS Morningstar NCF would lead to an expected downgrade of the Class D notes to BB (high) (sf)
--A 20% decline in DBRS Morningstar NCF would lead to an expected downgrade of the Class D notes to BB (high) (sf)

Class E Notes Risk Sensitivity:
-- A 10% decline in DBRS Morningstar NCF would not be expected to affect the BB (sf) rating of the Class E notes
--A 20% decline in DBRS Morningstar NCF would lead to an expected downgrade of the Class E notes to B (high) (sf)

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

For further information on DBRS Morningstar 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 U.S. regulations only.

Ribbon Finance 2018 Plc
Lead Analyst: Dinesh Thapar, Assistant Vice President
Rating Committee Chair: Christian Aufsatz, Managing Director
Initial Rating Date: 9 May 2018

Helios (European Loan Conduit No. 37) DAC
Lead Analyst: Dinesh Thapar, Assistant Vice President
Rating Committee Chair: Christian Aufsatz, Managing Director
Initial Rating Date: 16 December 2019

Magenta 2020 Plc
Lead Analyst: Dinesh Thapar, Assistant Vice President
Rating Committee Chair: Christian Aufsatz, Managing Director
Initial Rating Date: 13 February 2020

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

The rating methodologies used in the analysis of these transactions can be found at: http://www.dbrsmorningstar.com/about/methodologies/.

-- European CMBS Rating and Surveillance Methodology (13 December 2019), https://www.dbrsmorningstar.com/research/354637/european-cmbs-rating-and-surveillance-methodology.
-- Legal Criteria for European Structured Finance Transactions (11 September 2019), https://www.dbrsmorningstar.com/research/350234/legal-criteria-for-european-structured-finance-transactions.
-- Interest Rate Stresses for European Structured Finance Transactions (10 October 2019), https://www.dbrsmorningstar.com/research/351557/interest-rate-stresses-for-european-structured-finance-transactions.
-- Derivative Criteria for European Structured Finance Transactions (26 September 2019), https://www.dbrsmorningstar.com/research/350907/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.dbrsmorningstar.com/research/278375.

For more information on these credits or on this industry, visit www.dbrsmorningstar.com or contact us at [email protected].