DBRS Morningstar Takes Rating Actions on FROSN-2018 DAC

DBRS Ratings GmbH (DBRS Morningstar) downgraded its ratings on the Class A2 and Class B notes of FROSN-2018 DAC (the Issuer) as follows:

-- Class A2 to AA (low) (sf) from AA (high) (sf)
-- Class B to A (sf) from A (high) (sf)

DBRS Morningstar confirmed the ratings on the remaining classes as follows:

-- Class RFN at AAA (sf)
-- Class A1 at AAA (sf)
-- Class C at BBB (high) (sf)
-- Class D at BB (high) (sf)
-- Class E at B (high) (sf)

DBRS Morningstar changed the trends on the Class A1 through E notes to Negative from Stable. The trend on Class RFN remains Stable.

The rating downgrades are to align DBRS Morningstar’s ratings following the increased drawdown of the capex facility. In its last review, DBRS Morningstar considered the possibility of the capex loan being prepaid at the first loan maturity given the limited usage of the capex facility then. As such, only part of the capex facility was considered when analysing the senior loan at the last review. However, the sponsor has extended the senior loan as well as stepped up capex spending since then; thus, DBRS Morningstar has now included the full capex facility in its analysis hence the downgrade on the Class A2 and B notes.

The Negative trend changes were driven by the continuous performance deterioration since the last review. This is mainly evidenced by the increasing of vacancy to 42.8% from 37.9% at the last review. However, given the October 2020 valuation has concluded a slightly higher market value (MV) and the increased capex spending from the sponsor, DBRS Morningstar considers that a performance pick-up is still possible thus did not revise its underwriting assumption at this review. Nevertheless, should the portfolio’s performance continue its downward trajectory in the next 12 months, DBRS Morningstar will revise its underwriting, which could result in further downgrades.

The Issuer is a securitisation of one floating-rate EUR 590.9 million senior commercial real estate loan, which was advanced by Morgan Stanley and Citibank, N.A., London Branch. The loan refinanced the existing indebtedness of the borrowers as well as providing capex to the underlying collateral. The collateral consisted of 63 mixed office and retail properties located throughout Finland. As of the Q1 2021 interest payment date, only 47 assets remained, with a total EUR 320.8 million senior loan balance.

As mentioned above, the performance of the remaining portfolio continues to trend down. Based on the Q1 2021 servicer report, the gross rental income (GRI) amounts to EUR 43.4 million with a high vacancy rate of 42.8%. The same assets generated a total EUR 56.4 million at issuance and EUR 48.8 million at the last review. The increasing vacancy level is particularly concerning. In DBRS Morningstar’s view, to lease up these empty office spaces in a post-Coronavirus Disease (COVID-19) era in a market continuously seeing new supplies would be particularly difficult, hence the Negative trends. Should the vacancy remain high in the next 12 months, DBRS Morningstar would likely revise its vacancy underwriting assumption, which was already increased to 24.5% from 4.5% during the last review.

Also at last review, DBRS Morningstar took into consideration the disposals of 15 properties which had been announced by then. However, besides these 15 properties, the Hiukkavaara asset was also sold in Q2 2020. As such, DBRS Morningstar has removed the disposed asset’s cash flow and value and arrived at a new net cash flow of EUR 28.1 million and DBRS Morningstar value of EUR 339.4 million. The DBRS Morningstar value represents a value hair-cut of 36.2% to the latest CBRE valuation.

The capex spending has picked up, evidenced by further drawn down of the senior capex facility. A further EUR 4.4 million capex facility has been utilised since the last review. Based on a 65% loan-to-cost covenant, DBRS Morningstar estimated an additional EUR 6.8 million has been spent since the last review, when only EUR 4.5 million capex work was taken out. This is, however, still a distance away from the EUR 21.3 million budget at issuance.

The senior loan’s cash trap covenants provide some protections for the noteholders. Currently, the senior loan is in cash trap and DBRS Morningstar expects that the loan will remain in cash trap in the coming months. The cash trapped proceeds will be deducted from net debt calculation and be held in a cash trap account. DBRS Morningstar has queried the servicer on the possible usage of these cash trapped proceeds.

As commented in its “European CMBS Transactions’ Risk Exposure to Coronavirus (COVID-19) Effect” commentary, DBRS Morningstar thinks the short-term impact of the coronavirus on office properties is relatively more limited. This is evidenced by a high collection rate (90%+ since April 2020, when a 81% collection rate was recorded) reported by the borrower. As the current haircut on the portfolio MV largely exceeds DBRS Morningstar’s coronavirus-linked office sector medium-term value decline assumption, which is based on DBRS Morningstar’s moderate macroeconomic scenarios, DBRS Morningstar did not make any coronavirus-related value adjustment in its analysis.

The senior loan has been extended to February 2022 and can be further extended for another year provided the borrowers have procured the hedging for the extended period. The final maturity of the notes is on 21 May 2028, approximately five years after the date of the fully extended senior loan maturity.

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.

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 updated on 17 March 2021. For details, see the following commentaries: https://www.dbrsmorningstar.com/research/375376/global-macroeconomic-scenarios-march-2021-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 can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

Notes:
All figures are in euros unless otherwise noted.

The principal methodology applicable to the ratings is: “European CMBS Rating and Surveillance Methodology” (26 February 2021).

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

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.

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/350410/global-methodology-for-rating-sovereign-governments.

The sources of data and information used for these ratings include investor reports from Mount Street Asset Management, valuation report for CBRE, and cash manager reports from U.S. Bank Global Corporate Trust.

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 this rating 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 24 April 2020, when DBRS Morningstar downgraded the ratings on the Class A2, B, C, D, and E notes of the Issuer and confirmed the ratings on the Class RFN and A1 notes. The trends on all classes were Stable.

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 RFN Risk Sensitivity:
-- 10% decline in DBRS Morningstar net cash flow (NCF), expected rating of Class RFN at AAA (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class RFN at AAA (sf)

Class A1 Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class A1 at AA (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class A1 at A (sf)

Class A2 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 Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class B at BBB (high) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class B at BBB (sf)

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

Class D 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 B (low) (sf)

Class E Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class E at CCC (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class E at CCC (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. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Rick Shi, Assistant Vice President
Rating Committee Chair: Christian Aufsatz, Managing Director
Initial Rating Date: 22 March 2018

DBRS Ratings GmbH
Neue Mainzer Straße 75
60311 Frankfurt am Main Deutschland
Tel. +49 (69) 8088 3500
Geschäftsführer: Detlef Scholz
Amtsgericht Frankfurt am Main, HRB 110259

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 (26 February 2021), https://www.dbrsmorningstar.com/research/374399/european-cmbs-rating-and-surveillance-methodology.
-- Legal Criteria for European Structured Finance Transactions (6 April 2021), https://www.dbrsmorningstar.com/research/376314/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.
-- DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (3 February 2021), https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

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].