DBRS Morningstar Takes Rating Action on ME Funding, LLC, Series 2019-1

DBRS, Inc. (DBRS Morningstar) placed the following classes of securities issued by ME Funding, LLC, Series 2019-1 Under Review with Negative Implications:

-- Series 2019-1, Class A-1 VFN rated BBB (high) (sf)
-- Series 2019-1, Class A-2 Notes rated BBB (sf) (together, the 2019-1 Transaction)

Due to the widespread shutdown of economic activity throughout the U.S. due to the Coronavirus Disease (COVID-19) pandemic, significant stress on the whole-business sector is expected to continue during the upcoming months. Consequently, DBRS Morningstar expects the performance of certain whole-business securitization transactions to be negatively affected. The ultimate severity and length of revenue decline is still uncertain at this point.

DBRS Morningstar’s review of the most recent reported collateral performance (as of the December 31, 2019, Trustee report) for the 2019-1 Transaction demonstrated compliance with transaction performance triggers. However, DBRS Morningstar believes non-essential business closures and stay-at-home measures driven by coronavirus are likely to adversely affect companies in the spa and wellness industry, including Massage Envy.

The rating actions by DBRS Morningstar are based on the following analytical considerations:

(1) Spa and wellness businesses, including Massage Envy, are especially vulnerable to the impact from the coronavirus pandemic given the revenue decline from nonexistent consumer foot traffic and the increased probability of membership cancellations, a key component of Massage Envy’s business model. The resulting unexpected decline in revenue is expected to negatively affect Massage Envy’s franchisees and their ability to make payment obligations to ME Funding, LLC.

(2) The information about the extent of impact of coronavirus on Massage Envy’s businesses to date, which was shared with DBRS Morningstar by Massage Envy.

(3) DBRS Morningstar’s assessment as to how collateral performance could deteriorate due to macroeconomic stresses brought about by the coronavirus pandemic. This assessment was guided by DBRS Morningstar’s set of macroeconomic scenarios for select economies related to the coronavirus pandemic that can be found in the publication titled “<a href="https://www.dbrsmorningstar.com/research/359679/" target="_blank">Global Macroeconomic Scenarios: Implications for Credit Ratings</a>” published on April 16, 2020.

(4) Transaction stresses were applied consistent with the Moderate Scenario for the United States whereby it is anticipated the coronavirus will begin to be contained during Q2 2020, resulting in a gradual relaxation of stay-at-home measures and nonessential business closures, allowing a gradual economic recovery to begin starting in Q3 2020. As a result, the applicable stresses to the ME Funding, LLC transaction include a sharp decline in revenues over the next six months, followed by a gradual but limited improvement in revenues over 12 months to simulate consistent with the gross domestic product and unemployment estimates in the Moderate Scenario. These stresses result in breakeven revenue decline thresholds that the transaction can sustain for the remainder of the transaction’s life that are only slightly lower than those at deal closing.

It is likely the recovery period for this industry could be protracted as consumers may consciously defer non-essential clinic visits to avoid close contact with others, possibly even after the immediate period when state and local guidelines on quarantine and social distancing end. Any resulting paradigm shift in consumer behavior triggered by the coronavirus may weaken customer loyalty and retention rates, thus affecting the ability of the brand and business model to be successful in the long run.

(5) A potential material impact of the US Government intervention on the ability of many small businesses to survive through the shutdown in the short term, until the economy starts to re-open. Signed into law on March 27, 2020, the Coronavirus Aid, Relief, and Economic Security (CARES) Act included a $349 billion appropriation for a significant expansion of guaranteed lending under Section 7(a) of the Small Business Act through a new Paycheck Protection Program (PPP). Eligible businesses began applying on April 3, 2020, and the entire amount has already been allocated by the lenders. While exact impact of these efforts by the Government remains uncertain, they are expected to benefit franchise businesses and soften the impact of the coronavirus by allowing companies to keep employees to be able to restart operations faster and more seamlessly and to use other available liquidity to support non-payroll business needs. Massage Envy is listed in the Small Business Administration’s Franchise Directory, which should support their eligibility for this government assistance.

(6) Some mitigation potentially provided by the franchise businesses membership-based business model which gives flexibility in terms of modifying their offering to their customers to continue to retain them. Franchisees are expected to reach out to all members to present them the option to either continue to bill, or waive the current month’s bill, or putting their membership on hold throughout locations that are closed.

When a rating is placed Under Review with Negative Implications, DBRS Morningstar seeks to complete its assessment and remove the rating from this status as soon as appropriate. Upon the resolution of the Under Review status, DBRS Morningstar may confirm or downgrade the ratings on the affected classes.

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.

This press release was amended on March 3, 2021, to reflect the U.S. ABS General Ratings Methodology (December 2018), as the previously released press release inadvertently mislabeled the methodology used.

Notes:
The principal methodology is the U.S. ABS General Ratings Methodology (December 2018), which can be found on dbrsmorningstar.com under Methodologies & Criteria.

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.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Please see the related appendix for additional information regarding the sensitivity of assumptions used in the rating process.

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

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