DBRS Morningstar Confirms Ratings of Notes Issued by Scorpio (European Loan Conduit No. 34) DAC

DBRS Ratings Limited (DBRS Morningstar) confirmed its ratings of the following classes of notes of the Commercial Mortgage-Backed Floating Rate Notes due May 2029 issued by Scorpio (European Loan Conduit No. 34) DAC:

-- Class RFN at AAA (sf)
-- Class A1 at AAA (sf)
-- Class A2 at AAA (sf)
-- Class B at AA (sf)
-- Class C at A (low) (sf)
-- Class D at BBB (low) (sf)
-- Class E at BB (sf)

All trends remain Stable.

Scorpio (European Loan Conduit No.34) DAC is the securitisation of 82.5% (GBP 236.4 million) of a GBP 286.4 million floating-rate senior commercial real estate loan (the senior loan) advanced by Morgan Stanley Bank N.A. (the Loan Seller) to borrowers sponsored by Blackstone Group L.P. (Blackstone or the Sponsor). The remaining 17.5% of the senior loan is retained by the original senior lender and is ranked pari passu with the securitised senior loan. The financing is also accompanied by a GBP 57.3 million (80% loan-to-value or LTV) mezzanine loan granted by BSRECP III Joint International S.à r.l. and Broad Street Credit Holdings S.à r.l. The mezzanine loan is structurally and contractually subordinated to the senior facility and is not part of the transaction.

The senior loan (66.8% LTV) is backed by a portfolio of 112 multilet, last-mile industrial properties located throughout the United Kingdom. Blackstone acquired the assets through 16 subportfolio transactions between Q2 2018 and Q1 2019. Blackstone and M7 Real Estate Ltd. (M7) manage the portfolios, leveraging their asset and investment management platforms.

Since issuance, the overall performance of the portfolio has been stable even amidst the prevailing Coronavirus Disease (COVID-19) pandemic. As of May 2020, approximately 850 tenants occupied 90.6% of the portfolio’s net lettable area (NLA). The top five tenants contribute 8.0% of the gross rental income (GRI) with no tenant lease in the portfolio representing more than 2.25% of GRI. Investment-grade tenants comprise 8.5% of the GRI, adding further support to a highly granular tenant base. The assets are geographically concentrated across the UK: in Scotland (22.3% market value or MV), Northern England (26.5% MV), and the Midlands (26.1% MV). Properties accounting for a combined 25.1% of the portfolio MV are located in Southern England and Wales.

The current quarter’s debt yield was 9.3%, which is 0.2% lower than the previous quarter’s 9.5%; this is largely due to the impact of the coronavirus pandemic. The borrower reported that it had received 58 requests from tenants seeking amendments to the terms of their leases, including rent deferrals and requests to switch to monthly payments. 36 of the requests had been agreed to, equating to approximately GBP 385,000 of relief being granted. DBRS Morningstar views this reduction of approximately 1% of GRI as low. Given the asset class of the portfolio of last-mile industrial properties and the granularity of the tenants, any future impact of the coronavirus on the portfolio is estimated to be limited, particularly now that restrictions to the lockdown are being lifted; however, DBRS Morningstar will monitor the performance of the portfolio with regard to lease amendment requests in the run up to the next interest payment date and pending initial loan maturity in November 2020. The borrower has three annual loan extension options available, if all extensions are exercised the final loan maturity will be in May 2024.

The loan structure does not include financial default covenants prior to a permitted change of control, but provides other standard events of default including: (1) any missing payment, including failure to repay the loan by the maturity date; (2) borrower insolvency; (3) a loan default arising as a result of any creditors’ process or cross-default. DBRS Morningstar notes that the lack of default financial covenants makes it easier for the borrower to exercise the loan maturity extension options included in the facility agreement, and, as a result, reduces the refinancing risk of the loan.

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 10.4 million RFN proceeds and the GBP 0.5 million Vertical Risk Retention (VRR) loan contribution was deposited into the transaction’s liquidity reserve, which works similarly to a typical liquidity facility by providing liquidity to pay property protection advances, senior costs, and interest shortfalls (if any) in relation to the corresponding VRR loan, Class A1, Class A2, Class B, Class C, and Class D notes (for further details, please see the “Liquidity Support” section in DBRS Morningstar’s rating report for this transaction).
According to DBRS Morningstar’s analysis, the liquidity reserve amount will be equivalent to approximately 15 months on the covered notes, based on the interest rate cap strike rate of 2.0% per year and nine months based on the Libor cap after the loan maturity of 5.0% per year.

The final legal maturity of the notes is expected to be in May 2029, five years after the fully extended loan term. The latest loan maturity date, considering potential extensions, is 15 May 2024. In DBRS Morningstar’s view, such structural feature provides further benefit to the securitisation with regard to loan refinancing risk and property value declines.

Class E is subject to an available funds cap where the shortfall is attributable to an increase in the weighted-average margin of the notes.

COVID-19 CONSIDERATIONS

The Coronavirus Disease (COVID-19) and the resulting isolation measures have caused an economic contraction, leading to sharp increases in unemployment rates and income reductions for many tenants and borrowers. DBRS Morningstar anticipates that vacancy rate increases and cash flow reductions may arise for many CMBS borrowers, some meaningfully. In addition, commercial real estate values will be negatively affected, at least in the short-term, impacting refinancing prospects for maturing loans and expected recoveries for defaulted loans. The ratings are based on additional analysis as a result of the global efforts to contain the spread of the coronavirus.

The DBRS Morningstar Sovereign group released on 16 April 2020 a set of macroeconomic scenarios for the 2020-22 period in select economies. These scenarios were updated on 1 June 2020. For details see the following commentaries: https://www.dbrsmorningstar.com/research/361867/global-macroeconomic-scenarios-june-update and https://www.dbrsmorningstar.com/research/359903/global-macroeconomic-scenarios-application-to-credit-ratings. DBRS Morningstar analysis considered impacts consistent with the moderate scenario in the referenced reports.

On 16 June 2020, DBRS Morningstar published a commentary outlining how the coronavirus crisis is likely to affect DBRS Morningstar-rated CMBS in Europe. For more details, please see https://www.dbrsmorningstar.com/research/362693/european-cmbs-transactions-risk-exposure-to-coronavirus-covid-19-effect and https://www.dbrsmorningstar.com/research/362712/european-structured-finance-covid-19-credit-risk-exposure-roadmap.

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.

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.

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 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.dbrsmorningstar.com 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 provided by Mountstreet LLP since issuance (last 12 months).

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

At the time of the initial rating, 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 this transaction took place on 19 June 2019, when DBRS Morningstar finalised its provisional ratings.

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):

Class A1 Notes Risk Sensitivity:
-- a 10% decline in DBRS Morningstar’s net cash flow (NCF) would lead to an expected rating of the Class A1 notes at AAA (sf)
-- a 20% decline in DBRS Morningstar’s NCF would lead to an expected rating of the Class A1 notes at AA (low) (sf)

Class A2 Notes Risk Sensitivity:
-- a 10% decline in DBRS Morningstar’s NCF would lead to an expected rating of the Class A2 notes at AA (low) (sf)
-- a 20% decline in DBRS Morningstar’s NCF would lead to an expected rating of the Class A2 notes at A (low) (sf)

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

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

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

For further information on DBRS Morningstar’s 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.

Lead Analyst: Dinesh Thapar, Assistant Vice President
Rating Committee Chair: Christian Aufsatz, Managing Director
Initial Rating Date: 17 May 2019

DBRS Ratings Limited
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The rating methodologies used in the analysis of this transaction 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.

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