DBRS Morningstar Downgrades All Classes of Emerald Italy 2019 Srl; Assigns Negative Trends

DBRS Ratings GmbH (DBRS Morningstar) downgraded its ratings on the Class A, Class B, Class C, and Class D notes of the Commercial Mortgage-Backed Floating Rate Notes due September 2030 issued by Emerald Italy 2019 Srl (the Issuer) as follows:

-- Class A Notes to A (low) (sf) from AA (low) (sf)
-- Class B Notes to BBB (low) (sf) from A (low) (sf)
-- Class C Notes to B (high) (sf) from BBB (low) (sf)
-- Class D Notes to B (low) (sf) from BB (high) (sf)

DBRS Morningstar also assigned a Negative trend to all classes of notes. The Class C notes have an interest in arrears designation.

The downgrades are a the result of a steady deterioration in the transaction’s performance since the outbreak of the Coronavirus Disease (COVID-19) pandemic. This, compounded with the reluctance of the sponsor to inject further equity in the transaction in order to fulfill its debt obligations, is expected to severely affect the collateral’s value.

As a consequence, the following changes have been made to DBRS Morningstar’s underwriting assumptions at issuance: (1) the assumed vacancy has been increased to 20% from 15% to capture the expected pressure on the rental income as well as potential rent-free/reduced rents periods negotiated by the tenants and (2) the cap rate has been increased to 9% from 8% to reflect the increased risk associated with the collateral securing the loan. These changes resulted in a decrease in DBRS Morningstar’s net cash flow (NCF) and stressed value to EUR 8.6 million from EUR 9.4 million and to EUR 95.7 million (i.e., 40.7% haircut to market value at closing) from EUR 118.1 million, respectively. Additionally, the equity credit together with the amortisation credit add-on the DBRS Morningstar loan-to-value (LTV) hurdles have been removed to reflect the unwillingness of the sponsor to support the borrower so far and the missed principal payment on the last two interest payment dates (IPDs).

Emerald Italy 2019 Srl is the securitisation of 100% of an Italian commercial real estate loan advanced by J.P. Morgan Chase Bank, N.A., Milan Branch (the loan seller) and arranged by J.P. Morgan Securities PLC (the arranger; together with the loan seller, JPM). The securitised loan comprises a EUR 99.1 million term facility (EUR 100.4 million at inception) and a EUR 5.4 million capital expenditure (capex) facility. The capex facility was fully drawn at closing, but it has not been used so far; it is currently held in the blocked capex account and is subject to a commitment fee of 2.025%. The loan is secured against a portfolio of two retail malls and one shopping centre located in the Lombardy region of Northern Italy. The borrower is Investire Società Di Gestione Del Risparmio S.P.A., acting on behalf of an Italian real estate alternative closed-end fund (fondo comune di investimento immobiliare alternative di tipo chiuso riservato) named Everest, which is ultimately owned by Kildare Partners (the sponsor).

Following a payment default on the 16 June 2020 IPD and the subsequent transfer of the securitised loan into special servicing on the 19 June 2020, the borrower was once again unable to meet its entire debt obligations on the latest IPD (15 September 2020). As a result, the Class C and Class D notes have currently accumulated deferred interest of EUR 33,167,60 and EUR 332,632,54, respectively. Under the terms of the Facility Agreement, the special servicer (acting on behalf of the loan facility agent) may obtain a valuation at any time when an event of default is continuing and payable by the borrower. As a result of the current market conditions and ongoing negotiations with the tenants, the special servicer is deferring the requirement to call a valuation for up to six months. Consequently, the 61.4% LTV (or 64.7% including the capex facility) currently reported is still based on the EUR 161.4 million initial valuation provided by Cushman & Wakefield Debenham Tie Leung Limited in March 2019.

Additionally, as a result of the financial burden caused by the coronavirus, tenants have been demanding rent waivers and refusing to pay any rent until they agree to revised lease terms. To address likely breaches and ensure that the shopping centres remain operational and value is preserved, in August 2020, the special servicer agreed to implement the following borrower requests: (1) amendments to tenant lease terms (suspensions/postponements or abatements of rental income on all leases for the period from 1 March 2020 to 31 December 2020); (2) moratoriums or rent deferrals for overdue amounts; (3) refraining from legal action against tenants till 31 December 2020; and (4) switching from quarterly in advance to monthly in arrears payments until 31 December 2020.

The legal final maturity of the notes is in September 2030, seven years after the latest possible loan maturity. Considering that the one-year extension option that is conditional upon the loan being fully hedged is exercised and there are no continuing events of default, the latest loan maturity date is 15 September 2023. Assuming the loan remains in default, the first loan maturity is on 15 September 2022, which, in DBRS Morningstar’s view, provides the special servicer with sufficient time to work on a recovery of the collateral value and mitigates the refinancing risk of the transaction.

The transaction benefits from a liquidity facility of EUR 5,223,875.56 (commitment at closing: EUR 5,290,000.00) to cover any potential interest payment shortfalls on the Class A and Class B notes, including the corresponding retention tranches. The liquidity facility has not been drawn to date. According to DBRS Morningstar’s analysis, the commitment amount at closing was equivalent to approximately 23 months of coverage based on the hedging term or approximately 10 months’ coverage and the 5% Euribor cap. DBRS Morningstar does not rate the liquidity provider but maintains public ratings on JPMorgan Chase Bank, N.A. at AA/R-1 (high) with Stable trends.

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. For this transaction, DBRS Morningstar adjusted its NCF and cap rate assumptions as outlined above.

On 16 April 2020, the DBRS Morningstar Sovereign group released a set of macroeconomic scenarios for the 2020-22 period in select economies. These scenarios were last updated on 10 September 2020. For details, see the following commentaries: https://www.dbrsmorningstar.com/research/366543/dbrs-morningstar-global-macroeconomic-scenarios-september-update and https://www.dbrsmorningstar.com/research/359903/global-macroeconomic-scenarios-application-to-credit-ratings. The 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 transactions 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 euros 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 at: https://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 Morningstar Credit Ratings” of the “Global Methodology for Rating Sovereign Governments” at: https://www.dbrsmorningstar.com/research/364527/global-methodology-for-rating-sovereign-governments.

The sources of data and information used for these ratings include servicer reports provided by CBRE Loan Services Ltd and Securitisation Services S.p.A. since issuance.

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 this transaction took place on 2 July 2020 when DBRS Morningstar placed all classes of Emerald Italy 2019 Srl Under Review with Negative implications.

Information regarding DBRS Morningstar ratings, including definitions, policies, and methodologies, is available at www.dbrsmorningstar.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 ratings (the Base Case):

Class A Notes Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class A at A (low) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class A at BBB (high) (sf)
Class B Notes Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class B at BBB (low) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class B at BB (high) (sf)
Class C Notes Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class C at BB (high) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class C at BB (low) (sf)
Class D Notes Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class D at BB (low) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class D at below B (low) (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’s historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings GmbH are subject to EU and U.S. regulations only.

Lead Analyst: Rick Shi, Assistant Vice President
Rating Committee Chair: Christian Aufsatz, Managing Director
Initial Rating Date: 9 October 2019

DBRS Ratings GmbH
Neue Mainzer Straße 75
60311 Frankfurt am Main Deutschland
Geschäftsführer: Detlef Scholz
Amtsgericht Frankfurt am Main, HRB 110259

The rating methodologies used in the analysis of this transaction can be found at: https://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 (28 September 2020), https://www.dbrsmorningstar.com/research/367292/interest-rate-stresses-for-european-structured-finance-transactions.
-- Derivative Criteria for European Structured Finance Transactions (24 September 2020),
https://www.dbrsmorningstar.com/research/367092/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: https://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].