DBRS Morningstar Confirms Ratings on Magenta 2020 PLC with Negative Trends

DBRS Ratings Limited (DBRS Morningstar) confirmed its ratings on the following classes of Commercial Mortgage-Backed Floating Rate Notes due December 2029 issued by Magenta 2020 PLC (the Issuer):

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

All trends remain Negative.

The rating confirmations follow the approval by extraordinary resolutions of the amendments and waivers agreed during the noteholders’ meeting held on 8 December 2021, and the transaction’s relatively stable performance over the last 12 months, with signs of recovery observed in the average daily rate (ADR) and occupancy rate driven by local leisure demand following the lifting of the Coronavirus Disease (COVID-19) containment measures.

The transaction is a securitisation of a GBP 270.9 million senior loan advanced to DTP Subholdco Limited (the Borrower) to provide acquisition financing to acquire a portfolio of hotels from Marathon Asset Management. The current securitised balance stands at GBP 265.4 million. The Borrower also acquired a 25% stake in the operating platform, Valor Hospitality Europe Limited (Valor Europe); however, the Borrower did not use the senior loan to fund the acquisition of this stake. The lender and lead arranger, Goldman Sachs Bank U.S.A, also provided a mezzanine loan of GBP 65.3 million to DTP Regional Hospitality Group Limited, part of the borrower group. The mezzanine loan is structurally and contractually subordinated to the senior loan and is not part of the transaction.

The senior loan is secured by 17 hotels located in the UK, concentrated mainly in North West England and the East Midlands. Valor Europe manages these hotels and operates them under various franchise agreements with InterContinental Hotels Group plc, Hilton Worldwide Holdings Inc., and Marriott International, Inc. The portfolio comprises three hotels operated under the Hilton DoubleTree brand, seven under Crowne Plaza, three under Hilton Garden Inn, two under AC Hotels by Marriott, one under Holiday Inn, and one under Hotel Indigo.

Due to the severe business disruption and forced hotel closures caused by the coronavirus pandemic, the servicer entered into an amendment and waiver letter with the Borrower and finance counterparties in June 2020 with a view to allowing the senior obligors to manage their liquidity and their business in the medium term without breaching their obligations, subject to certain conditions imposed to protect the Issuer’s position. In June 2020, the sponsor injected GBP 17.5 million of equity into the cure account for the Borrower to use to cover operating and financial shortfalls. Further equity injections occurred in December 2020 (GBP 0.7 million), March 2021 (GBP 5.8 million) and in May 2021 (GBP 1.5 million).

Due to the debt yield (DY) cash trap event continuing (DY lower than 11.3%), additional amortisation has been paid and the mezzanine amortisation has been trapped in the senior cash trap account. At the September 2021 interest payment date (IPD), GBP 3.7 million of surplus was also trapped, bringing the total balance of the senior cash trap account post-IPD to GBP 4.8 million. The total amount in blocked accounts (including furniture, fixtures, and equipment) stands at GBP 9.8 million.

As a consequence of the amendment and waiver letter, the DY breach below the financial covenant threshold has been waived. Accordingly, there was no Class X diversion trigger event occurring on the note payment date.

The coronavirus restrictions have continued to strain the portfolio’s performance since the last review, with hotels limited to accommodating essential workers only from November 2020 to May 2021. However, DBRS Morningstar noted signs of recovery in the portfolio’s performance since June 2021, buoyed by local leisure demand, resumed corporate travel, the G7 summit in Plymouth, and the UEFA European Championship. The ADR increased to above pre-coronavirus levels of GBP 95.7 reported in June 2021 versus GBP 94.4 in June 2019, which is 12% higher than the ADR of GBP 77.9 that DBRS Morningstar underwrote at the time of the initial rating. Meanwhile, occupancy also gradually increased, peaking at 79% in August 2021, albeit remaining below the pre-pandemic level of 88% in August 2019. As a result, the portfolio produced an EBITDA of GBP 3.6 million in August 2021, GBP 2.9 million above management’s expectations.

In August 2021, the valuer, Savills plc, estimated the portfolio’s total market value to be GBP 384.4 million, nearly 12% lower than the initial valuation of GBP 435.6 million. This resulted in a loan-to-value ratio of 69.4%, under the required covenant (72.2%) but above the cash trap covenant (67.2%). The DBRS Morningstar value remains unchanged since the last review and stands at GBP 270.7 million, representing a haircut of 29.6% to the updated appraised value. DBRS Morningstar also maintained its net cash flow (NCF) assumption at GBP 20.9 million as at the last review, reflecting continued uncertainty in the hospitality industry.

The waivers, extraordinary cash controls, and forecasting obligations were agreed to expire on 20 December 2021. This was in line with the initial loan termination date, however the new restructuring agreement, approved via extraordinary resolutions, entails the extension of the loan maturity date until 18 December 2024. The sponsor will inject GBP 15 million of equity by 12 January 2022 in order to apply GBP 12.05 million towards the repayment of the senior loan on the March 2022 IPD. The remaining of equity injection, GBP 2.95 million, will be applied towards the repayment of the mezzanine loan. The financial parties agreed to waive the DY covenant for one year until 20 December 2022 from 20 December 2021 earlier. This will be followed by a two-tier amendments at six monthly intervals for the following year: first at 5.53% and then at 5.75%. Thus, the DY default covenant will revert to the previously agreed covenant level, i.e., 8.75%, in the facility agreement for the last year of the loan until December 2024, from December 2023. The amendment and restated agreement provides with a waiver of the prepayment fee on the prepayment of the senior loan due in March 2022 and from December 2022. Furthermore, the restructuring agreement includes a continued obligation to fund via equity injection projected operating and debt service shortfalls on a quarterly basis (instead of monthly as previously agreed), and to maintain an amount not less of than EUR 7.5 million on the Cash Trap Account, which will not be used unless an event of default has occurred.

As part of the restructuring proposal, the noteholders were asked to give consent to the replacement of the reference rate currently used to calculate senior loan interest (Libor). The reference rate will be transitioned to cumulative compounded Sonia (floored at zero), plus a credit adjustment spread of 4 basis points.

The transaction benefits from a liquidity reserve facility of GBP 8.65 million available to Class A through Class C notes, which was funded by the proceeds of the Class A notes and a proportionate amount of the issuer loan. Based on a cap strike rate of 1.5%, DBRS Morningstar estimated that the liquidity reserve will cover 17 months of notes’ interest payments.

The notes issued by the Issuer bear a final maturity date falling in December 2029, thereby providing a tail period of five years.

The Coronavirus Disease (COVID-19) and the resulting isolation measures have caused an immediate 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. In addition, commercial real estate values could be negatively affected, at least in the short term, affecting refinancing prospects for maturing loans and expected recoveries for defaulted loans. The ratings are based on additional analysis to expected performance as a result of the global efforts to contain the spread of the coronavirus.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. These scenarios were last updated on 9 December 2021. DBRS Morningstar analysis considered impacts consistent with the baseline scenario in the below referenced report. For details, see the following commentaries: https://www.dbrsmorningstar.com/research/389454/baseline-macroeconomic-scenarios-for-rated-sovereigns-december-2021-update and https://www.dbrsmorningstar.com/research/384482/baseline-macroeconomic-scenarios-application-to-credit-ratings.

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.

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

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. DBRS Morningstar analysis considered impacts consistent with the baseline scenarios as set forth in the following report: https://www.dbrsmorningstar.com/research/384482/baseline-macroeconomic-scenarios-application-to-credit-ratings.

The sources of data and information used for these ratings include servicer reports and valuation reports provided by CBRE Loan Services Limited 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 4 November 2020, when DBRS Morningstar removed the ratings from Under Review with Negative Implications, downgraded the ratings on all classes of notes and assigned Negative trends.

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

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

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

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

Class E Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of the Class E notes at CCC (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of the Class E notes at CC (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: 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: Dinesh Thapar, Vice President
Rating Committee Chair: Mirco Iacobucci, Senior Vice President
Initial Rating Date: 13 February 2020

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.

-- 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 (24 September 2021), https://www.dbrsmorningstar.com/research/384920/interest-rate-stresses-for-european-structured-finance-transactions.
-- Derivative Criteria for European Structured Finance Transactions (20 September 2021), https://www.dbrsmorningstar.com/research/384624/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: 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].