DBRS Morningstar Assigns Provisional Ratings to HAUS (European Loan Conduit No. 39) DAC

DBRS Ratings Limited (DBRS Morningstar) assigned provisional ratings to the following classes of notes to be issued by HAUS (European Loan Conduit No. 39) DAC (the Issuer):

-- Class A1 notes at AAA (sf)
-- Class A2 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)

The trends on all ratings are Stable.

Haus (European Loan Conduit No. 39) DAC is the second ELOC transaction arranged by Morgan Stanley & Co. International plc (Morgan Stanley) in 2021. The EUR 318.8 million senior facility is secured by 6,281 multifamily residential housing units across 92 sites in Germany (the Portfolio). The senior loan refinanced the acquisition of the portfolio by eight German borrowers, ultimately controlled by the main sponsor Brookfield Property Group (Brookfield).

Brookfield acquired a majority interest in the portfolio (c. 90%) with the seller of the properties (high net worth individuals), retaining a minority share in the transaction in addition to being retained as the asset/property manager, as ultimate beneficial owner of the asset management entity Belvona. According to the business plan provided to DBRS Morningstar, the portfolio has suffered from a period of under-investment, under previous ownership. This would explain the current below average occupancy rate of 67% (2,024 vacant residential units), which is unusual for German multifamily, which normally benefits from occupancy levels above 90%. As a result, EUR 39.5 million of capex funded by the seller have been reserved at acquisition date to renovate approximately 2,250 unmodernised units in order to achieve a modernisation rate of 75% across the portfolio in the next two years.

Also, DBRS Morningstar notes that on the 27 June 2021 the Seller deposited into the rent guarantee account a EUR 23.3 million rental guarantee to cover (1) the shortfall between the expected EUR 35 million "stabilised" rent level and collection rate and the actual rent level and collection rate, and (2) recoverable void costs and leasing costs in relation to residential units, which were vacant as at 17 June 2021.

As at 29 March 2021, the residential portfolio was valued by Knight Frank Valuation & Advisory GmbH & Co. KG (Knight Frank or the Valuer) at EUR 469.7 million, which represents a day-one loan-to-value (LTV) ratio of 67.9%. DBRS Morningstar's stressed value is EUR 385 million, which implies a DBRS Morningstar LTV of 82.7% and represents a haircut of 18% to the market value.

As at the cut-off date, the portfolio generates EUR 19.9 million annual net cold rent and an estimated* EUR 15.4 million net operating income (NOI), which implies a day-one debt yield (DY) of 4.8%. The actual UW NOI amounts to EUR 35 million, including the rental guarantee. DBRS Morningstar stabilised net cash flow (NCF) is EUR 21 million, 14.7% higher than the current NOI, giving credit to the main sponsor’s capex investments in the portfolio as well as its ability to increase occupancy levels, and the units’ estimated rental values (ERVs).

Although the outbreak of the Coronavirus Disease (COVID-19) has negatively affected all commercial real estate sectors, the German multifamily sector has experienced a relatively limited impact compared with other asset types. Collection rates currently are over 90% and have steadily improved since the onset of the pandemic as asset management services were gradually transferred to Belvona from April 2022.

The loan carries a floating rate of Euribor (floored at 0%) plus a [-]% margin and is interest only until the initial maturity date on 28 July 2026. Following the initial five-year term, the loan may be extended on an annual basis until 28 July 2046, with a [-]% margin step-up and provided that the following conditions are met: (1) no material loan event of default, (2) adjusted DY equal to or higher than 7%, (3) LTV equal to or less than 75%, and (4) hedging in place up to the relevant extended termination date. However, the failure to repay the loan at the initial maturity date represents a cash sweep event, which triggers a minimum annual amortisation of 2.0% of the initial loan amount plus any surplus cash available following the payment of the interest and amortisation due plus the payment of certain senior costs including, inter alia: agent fees, corporate costs, asset management fees, and repair and maintenance costs.

Also, the missing repayment of the loan at the initial maturity date provides the servicer with the ability to sell the loan through an annual bidding process starting from the January 2027 note interest payment date, with a minimum redemption price higher than the outstanding amount of the Notes, including accrued and deferred interest and outstanding costs (including the VRR Loan).

The transaction does not have a financial default covenants, however, there are cash trap covenants, which are set at 77.9% LTV while the DY covenant is set up at 6.75% starting from April 2022 and increasing up to 9.0% from October 2024.

On the closing date, EUR [12.5] million of the proceeds from the issuance of the Class A1 notes and the VRR Loan proportion of such amount of the VRR Loan will be used to fund the Issuer Liquidity Reserve in an aggregate amount of EUR [13,157,894]. The Issuer Liquidity Reserve can be used to cover interest shortfalls on the Class A1, Class A2, and Class B 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 [15] months or [10] months based on the interest rate cap strike rate of [2.0%] or on the Euribor cap of [4%], respectively. The hedging agreements subsequent to the initial maturity date are expected to have a weighted-average strike rate of [1.0%].

The transaction includes a Class X interest diversion trigger event, meaning that if the loans’ DY is less than [3.0%], [5.5%], and [6.0%] prior to the end of years one, two, and three, respectively, and [6.5%] thereafter and/or if the LTV is equal to or greater than [85%], 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.

The legal final maturity of the notes is in [July 2051], [five] years after the final loan termination 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.

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

The ratings will be finalised upon receipt of execution versions of the governing transaction documents. To the extent that the documents and information provided to DBRS Morningstar as of this date differ from the executed version of the governing transaction documents, DBRS Morningstar may assign different final ratings to the notes.

The Coronavirus Disease (COVID-19) and the resulting isolation measures have caused an economic contraction, leading in some cases to 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, affecting refinancing prospects for maturing loans and expected recoveries for defaulted loans.

On 16 April 2020, DBRS Morningstar published 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 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.

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 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 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 mainly include the data tape and portfolio stratification tables as of March 2021 provided by the arrangers, a valuation report prepared by Knight & Frank, and additional reports and presentations prepared by the arrangers.

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 an expected-to-be-issued new financial instrument. These are the first DBRS Morningstar ratings on this financial instrument.

Information regarding DBRS Morningstar ratings, including definitions, policies, and methodologies, is available on www.dbrsmorningstar.com.

Sensitivity Analysis: To assess the impact of changing the transaction parameters on the ratings, DBRS Morningstar considered the following stress scenarios, as compared with the parameters used to determine the ratings (the Base Case):

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

Class A2 Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class A2 notes at AA (low) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class A2 notes at A (low) (sf)

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

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

Class D Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class D notes at BBB (low) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class D notes at BBB (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: 29 July 2021

DBRS Ratings Limited
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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.

-- 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 (29 July 2021), https://www.dbrsmorningstar.com/research/382171/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 (18 February 2021),
https://www.dbrsmorningstar.com/research/373856/currency-stresses-for-global-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: 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].

*Based on monthly void costs of EUR 2.5 per sqm per month.