DBRS Morningstar Finalises Provisional Ratings on Viridis (European Loan Conduit No. 38) DAC

DBRS Ratings Limited (DBRS Morningstar) finalised its provisional ratings on the following classes of notes issued by Viridis (European Loan Conduit No. 38) DAC (the Issuer):

-- Class A notes at AAA (sf)
-- Class B notes at AA (low) (sf)
-- Class C notes at A (low) (sf)
-- Class D notes at BBB (low) (sf)
-- Class E notes at BB (high) (sf)

Viridis (European Loan Conduit No. 38) DAC is the first ELOC transaction arranged by Morgan Stanley & Co. International plc (Morgan Stanley) in 2021. The transaction is backed by a GBP 192 million senior loan, which is split into two facilities: Facility A, which totals GBP 150 million, and Facility B (syndicated loan, not part of the CMBS transaction), which totals GBP 42 million. The senior loan refinanced the borrower’s existing debt. The senior loan is advanced by Morgan Stanley Bank, N.A. to Aldgate Tower S.A.R.L., which is controlled by Brookfield Property Partners L.P. (Brookfield; 10%) and China Life Insurance Company Limited (China Life; 90%).

The senior loan was utilised on 18 June 2021 and is secured by the Aldgate Tower in the City of London.

Aldgate Tower is a modern Grade A office tower designed by WilkinsonEyre Architects, and was completed in November 2014 without any prelets. The property was fully let up and sold to the current joint venture in 2016 for GBP 346 million. With WeWork recently vacating the property, it was 72% occupied as at the cut-off date of 20 April 2021. The recent valuation by Savills, dated April 2021, shows a valuation of GBP 330 million.

The Aldgate Tower is located on 2 Leman Street, London E1 8FA by the Aldgate East tube station. The 16-storey office tower features mezzanine and basement levels, each containing three storage rooms let separately to tenants. The property offers a large floor plan office space of 323,934 sf and has a BREEAM rating of excellent. Apart from a small retail (coffee shop) on the ground floor, the storage space at the mezzanine and basement levels, and circa 4,000 sf of reception, the remaining circa 316,000 sf is let as office space.

Savills valued the Aldgate Tower building at GBP 330 million in April 2021, representing a 58.2% day-one loan-to-value (LTV) ratio. The appraiser also estimated the current market rent of the building to be GBP 18.8 million (fully occupied) whereas the current contracted rent at the 20 April 2021 cut-off date was only GBP 12.8 million (72% occupied). The property was fully occupied until recently. Of the circa 102,435 sf of vacant space (including Maersk, which has notified that it will exercise its break option), 61,194 sf is due to the lease surrender of the entirety of floors 4, 5, and 6 from WeWork at the end of March 2021. The surrender was on favourable terms to the landlord (undisclosed surrender premium was received from WeWork and it handed back the space in a fully fitted specification to include good quality furniture commensurate with a WeWork serviced office/coworking centre).

The 30,533 sf of vacant space is in the process of undergoing a light refurbishment, with a GBP 2.7 million capital expenditure budget dedicated to the refurbishment works. DBRS Morningstar understands that circa GBP 1 million of this amount has already been spent and the remaining GBP 1.7 million is held in the capex/TI reserve.

According to the business plan provided to DBRS Morningstar, the sponsor has plans in place to manage the current vacancy and the upcoming lease rollover. DBRS Morningstar gave credit to the sponsor’s business plan, recognising Brookfield’s experience as a commercial real estate manager and the high historical occupancy of the building until recently.

It should be noted that DBRS Morningstar’s ratings are based on (1) the sponsor’s successful execution of the planned relet programme, (2) ongoing attractiveness of reasonably priced high quality building in the London office market to tenants, and (3) the analysis and reports provided by the appraiser and legal counsel to the Issuer to date. Given the asset requires active asset management, the replacement of Brookfield with a less experienced asset manager or changes in London office market may cause rating volatility.

The senior loan carries a floating rate of Sterling Overnight Index Average (Sonia; floored at 0%) plus 2.85% margin for a three-year term. The interest rate risk is fully hedged by a prepaid cap with a maximum strike rate of 1.0% provided by Standard and Chartered Bank, a hedge provider with a rating plus relevant triggers, as at the date of this report, commensurate with DBRS Morningstar’s rating criteria. The transaction does not have a financial default covenant. There are cash trap covenants, which are set at 7.00% debt yield (DY) in year 2, 8.00% DY in year 3, and a 70.0% LTV for the three-year loan term.. The loan benefits from a GBP 2.7 million capex reserve (amortised to GBP 1.7 million at the date of this report) and a GBP 5 million interest reserve.

On the closing date, GBP 5.5 million of the proceeds from the issuance of the Class A notes and the VRR Loan proportion of such amount of the VRR Loan were used to fund the Issuer Liquidity Reserve in an aggregate amount of GBP 5,789,473.68. The Issuer Liquidity Reserve can be used to cover interest shortfalls on the Class A, Class B, Class C, and Class D notes.

According to DBRS Morningstar’s analysis, the Issuer Liquidity Reserve amount, as at closing, could provide interest payment on the covered notes up to 16.7 months or 11.5 months based on the interest rate cap strike rate of 1% or on the Sonia cap of 4%, respectively.

The transaction is expected to repay on or before July 2024. Should there be non-payment on the due date of any amount payable pursuant to a Finance Document, non-compliance with documents, misrepresentation, a senior obligor becomes subject to insolvency, or a default arises out of a creditor’s process or cross default, a special servicing transfer event will occur in respect of the defaulted loan and the proceeds from the defaulted loan will be applied sequentially to the notes. Should the notes fail to be fully redeemed by the expected note maturity, the Issuer will make principal payments on a sequential basis. The transaction is structured with a five-year tail period to allow the special servicer to work out the loan at maturity by July 2029 at the latest, which is the final legal maturity of the notes.

The transaction includes a Class X interest diversion trigger event, meaning that if the loans’ DY is less than 4.8%, 5.6%, and 6.4% prior to the end of years one, two, and three, respectively, and/or the LTV is equal to or greater than 80%, the payment of Class X interest amount and the VRR Loan proportion of that amount will instead be diverted into the Issuer transaction account and credited to the Class X diversion ledger. However, once the trigger is cured, the held amount will be released back to the Class X noteholders and only following the sequential payment trigger event and enforcement of note security can such funds be applied as available funds.

Morgan Stanley will retain a 5% material economic interest in the securitisation through the VRR 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 continue to 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.

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 18 June 2021. For details, see the following commentaries: https://www.dbrsmorningstar.com/research/380281/global-macroeconomic-scenarios-june-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 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.

For more information regarding the structured finance rating approach and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/359905.

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 British pound sterling 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 principal methodology.

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/381451/global-methodology-for-rating-sovereign-governments.

The sources of data and information used for these ratings include Morgan Stanley and its delegates.

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

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

Class C 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 BB (high) (sf)

Class D 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 (low) (sf)

Class E 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 (low) (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. 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.

These ratings are endorsed by DBRS Ratings GmbH for use in the European Union.

Lead Analyst: Mirco Iacobucci, Senior Vice President
Rating Committee Chair: Erin Stafford, Managing Director
Initial Rating Date: 28 June 2021

DBRS Ratings Limited
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London EC3M 3BY United Kingdom
Tel. +44 (0) 20 7855 6600
Registered and incorporated under the laws of England and Wales: Company No. 7139960

The rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

-- Legal Criteria for European Structured Finance Transactions (6 April 2021), https://www.dbrsmorningstar.com/research/376314/legal-criteria-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.
-- 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.
-- European CMBS Rating and Surveillance Methodology (26 February 2021), https://www.dbrsmorningstar.com/research/374399/european-cmbs-rating-and-surveillance-methodology.
-- 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: 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].