DBRS Morningstar Finalises Provisional Ratings on Pearl Finance 2020 DAC

DBRS Ratings GmbH (DBRS Morningstar) finalised its provisional ratings on the notes issued by Pearl Finance 2020 DAC (the Issuer) as follows:

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

All trends are Stable.

RATING RATIONALE
Pearl Finance 2020 DAC is a securitisation of a EUR 335.4 million senior commercial real estate (CRE) loan backed by a pan-European portfolio of light industrial and logistics assets managed collectively by Mileway, M7 Real Estate, and Normandie Capital but owned by Blackstone Real Estate Partners (Blackstone, or the Sponsor). The senior loan is divided into two term facilities - term A and term B - with term facility A being advanced to non-French borrowers and term facility B only to French borrowers. At closing, Bank of America Europe DAC (BofA, or the loan seller) advanced the senior loan to the borrowers and then the issuer purchased the senior loan from BofA using the CMBS note issuance proceeds and an issuer loan provided by the loan seller. The issuer loan is sized to be 5% of the total senior loan amount to comply with the applicable regulatory requirements. BNP Paribas, Société Générale, and Merrill Lynch International were joint arrangers of the transaction. The senior loan matures on 15 November 2022 but can be extended three times for one year each up until 15 November 2025.

Similar to the recently closed Taurus 2020-2 UK DAC securitisation, the senior loan margin directly mirrors the weighted-average coupon on all the issued notes but will not exceed 3.95%; therefore, there will be no excess spread. The borrower will pay all the issuer costs as outlined in the ongoing financing costs letter. Apollo Global Management, Inc (Apollo) has provided an EUR 69.0 million mezzanine facility sized to the lower of 65.1% of the closing loan-to-cost ratio minus the senior loan amount . The mezzanine facility is contractually and structurally subordinated to the securitised senior loan.

The senior facility is denominated in euros (EUR) whereas the Danish assets and income, which amount to approximately one-tenth of the portfolio, are denominated in Danish kroner (DKK). In the absence of a currency swap, the Danish Holdco will make a monthly currency spot trade to convert DKK into euros, thus making sure that the Danish net rental income will be in euros when it reaches the relevant rental income account.

The senior loan is backed by 61 assets across six European countries and can be divided into three subportfolios. The sponsor acquired two of these subportfolios - Lotus and Cromwell - at the end of 2019: the Lotus portfolio comprises 22 assets in France and the Cromwell portfolio consists of 12 assets in the Netherlands, Denmark, and France. The sponsor purchased the remaining 27 assets in the Netherlands, the Republic of Ireland, Finland, Denmark, Germany, and France over time and formed the United subportfolio in this transaction. As such, the issuance proceeds will be mainly used to refinance both the existing debt and acquisition debts of the borrowers.

Cushman & Wakefield Debenham Tie Leung Limited (C&W) valued the portfolio on 31 July 2020 for a total market value (MV) of EUR 576.9 million including a 3% portfolio premium, or EUR 560.1 million based on aggregated MVs of each property. Most of the MV is concentrated in France (41.6% of aggregated MV) and Finland (28.0% of aggregated MV). In relation to the Lotus portfolio, 22 of the 31 French assets are part of the sale-and-lease-back operation agreed between Elis S.A. (rated BBB (low) with a Stable trend by DBRS Morningstar) and the prior owner of the portfolio. The 15-year leases on these premises are scheduled to expire in 2029. Compared with other Mileway transactions, DBRS Morningstar also noted the addition of Nordic logistic assets from Denmark and Finland, representing one-third of the portfolio's lettable area or 214,686 square metres.

As mentioned above, about 12.7% of the gross rental income (GRI) and 10.3% of the MV are from Danish assets and are denominated in DKK, whose exchange rate is pegged to the euro. As the Sponsor will not arrange any hedging between DKK and euro income, DBRS Morningstar has applied an exchange rate of 7.6282 DKK per euro, the highest exchange rate allowed by the Danish central bank, for all non-AAA (sf) rated investment grade stress scenarios and a higher exchange rate of 12.1086 DKK per euro in the AAA (sf) stress scenario. For the avoidance of doubt and unless specified, all the DKK income quoted below was converted to euros based on 1 DKK = 0.13 EUR (7.69 DKK per euro) as reported in the data tape.

As a result of the sale-lease-back transaction mentioned above, the portfolio has large exposure to Elis group, whose five subsidiaries contributed EUR 8.9 million, or 22.7%, to the portfolio's total EUR 39.1 million GRI as of the 23 July 2020 cut-off date. The leases of the investment grade-rated tenant will come to expiry only in 2029, thus providing good stability to the portfolio cash flow for the next 8.7 years. The remaining 355 tenants made up 77.3% of the GRI with DSV Solutions A/S contributing 8.4% to the total GRI. DBRS Morningstar concluded a total stressed net cash flow (NCF) of EUR 27.5 million, which is 26.7% lower than the reported net operating income (NOI) at the cut-off date. The DBRS Morningstar stressed value amounts to EUR 410.9 million, equating to a 28.8% haircut on the portfolio MV including a 3% portfolio premium or a 26.6% haircut on the aggregate MV of all assets.

Although the outbreak of the Coronavirus Disease (COVID-19) has negatively affected all CRE sectors, the portfolio has experienced a high rent collection ratio of 90% as of 4 September 2020 for the Q2 2020 invoiced amount. Except France, where only 80% of the rent is collected as a result of the rent deferrals, all other countries have a collection rate of 95% or above, and all Danish and German tenants have paid the invoiced amounts in full. Mileway also reported that the majority of tenants requested a rent deferral instead of a reduction.

The asset management duty of the portfolio is carried out by three different asset managers: M7 for Irish properties, Normandie Capital for Lotus properties, and Mileway for the remaining properties (after borrower group restructuring). Nevertheless, to ensure uniform management of all assets, the three asset managers share the same senior leadership team and investment committee, the same property management team, and the same IT system (Yardi).

The two-year senior loan (the initial loan term) has three one-year extension options, which can be exercised if certain conditions are met. During the loan term, the borrower purchased an interest cap agreement to hedge against increases in the interest payable under the loan. The initial cap agreement is provided by BNP Paribas and covers 95% of the outstanding loan balance with a strike rate of 1.25%. After the expected note maturity date (17 November 2025), the Euribor rate will be capped at 4%.

Similar to other Blackstone-sponsored loans, there are no financial covenants applicable prior to a permitted change of control (CoC) but cash trap covenants are applicable both prior and post a permitted CoC. The cash trap covenants are set at 68.42% LTV while the debt yield (DY) covenant is set at 9.53% during the entire loan term. Both cash trap covenants will tighten after the occurrence of a permitted CoC to 64.28% for LTV and 10.25% for DY. On and after a permitted CoC, the financial default covenants on the LTV and the DY will be applicable; they are set, respectively, at 68.42% and 9.04%. The senior loan also needs to have, among others, an LTV no higher than 68.42% and a DY no lower than 9.5% in order to be qualified as a permitted CoC. However, it should be noted that after a permitted change of control and should the initial mezzanine lender or other Apollo affiliates and/or managed funds enforce mezzanine security after remedying all the curable defaults, the financial covenants will be suspended for 18 months and amortisation requirements for 12 months. DBRS Morningstar considers that this could potentially negatively affect the transaction.

To cover any potential interest payment shortfalls, Société Générale has provided the issuer with a liquidity facility of EUR 21.3 million. The liquidity facility covers the Class A1 to Class D notes. DBRS Morningstar estimates that the commitment amount at closing is equivalent to approximately 21 months of coverage based on the hedging terms mentioned above or approximately 13 months of coverage based on the 4% Euribor cap. The liquidity facility will be reduced based on note amortisation, if any, and in the event of a substantial market value decline of the property portfolio.

The Class E Notes are subject to an available funds cap where the shortfall is attributable to a reduction in the interest-bearing balance of the senior loan as a result of prepayments. However, as the loan margin is based on the weighted-average coupon rate of the notes and senior costs are covered by the borrowers, it is unlikely to trigger an available funds cap except in the unlikely event that the weighted-average coupon exceeds the 3.95% loan margin cap.

The legal final maturity of the notes is in November 2032, seven years after the fully extended loan maturity date. DBRS Morningstar believes that this provides sufficient time to enforce the loan collateral and repay the bondholders, given the security structure and jurisdiction of the underlying loan.

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 increase for many CMBS borrowers, some meaningfully. In addition, CRE values will be negatively affected, at least in the short term, affecting refinancing prospects for maturing loans and expected recoveries for defaulted loans.

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/366542/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 principal methodology.

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 the data tape and various due diligence reports provided by BNP Paribas and a valuation report prepared by Cushman & Wakefield Debenham Tie Leung Limited.

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

DBRS Morningstar was 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.

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

This is the first rating action since the Initial Rating Date.

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 ratings, DBRS Morningstar considered the following stress scenarios, as compared to the parameters used to determine the ratings (the Base Case):

Class A1 Notes Risk Sensitivity:
--10% decline in DBRS Morningstar NCF, expected rating of Class A1 Notes to AAA (sf)
--20% decline in DBRS Morningstar NCF, expected rating of Class A1 Notes to AAA (sf)

Class A2 Notes Risk Sensitivity:
--10% decline in DBRS Morningstar NCF, expected rating of Class A2 Notes to AA (high) (sf)
--20% decline in DBRS Morningstar NCF, expected rating of Class A2 Notes to AA (low) (sf)

Class B Notes Risk Sensitivity:
--10% decline in DBRS Morningstar NCF, expected rating of Class B Notes to A (high) (sf)
--20% decline in DBRS Morningstar NCF, expected rating of Class B Notes to BBB (high) (sf)

Class C Notes Risk Sensitivity:
--10% decline in DBRS Morningstar NCF, expected rating of Class C Notes to BBB (sf)
--20% decline in DBRS Morningstar NCF, expected rating of Class C Notes to BBB (low) (sf)

Class D Notes Risk Sensitivity:
--10% decline in DBRS Morningstar NCF, expected rating of Class D Notes to BB (high) (sf)
--20% decline in DBRS Morningstar NCF, expected rating of Class D Notes to BB (sf)

Class E Notes Risk Sensitivity:
--10% decline in DBRS Morningstar NCF, expected rating of Class D Notes to BB (sf)
--20% decline in DBRS Morningstar NCF, expected rating of Class D Notes to B (sf)

For further information on DBRS Morningstar 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: 29 October 2020

DBRS Ratings GmbH
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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.
--Currency Stresses for Global Structured Finance Transactions (15 April 2020),
https://www.dbrsmorningstar.com/research/359639/currency-stresses-for-global-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].