DBRS Morningstar Confirms Ratings on Salus (European Loan Conduit No. 33) DAC and Changes Trends on Classes B to D to Negative from Stable; Trend on Class A Remains Stable

DBRS Ratings Limited (DBRS Morningstar) confirmed the ratings on the following classes of notes due May 2030 issued by Salus (European Loan Conduit No. 33) DAC (the Issuer):

-- Class A at AAA (sf)
-- Class B at AA (sf)
-- Class C at A (low) (sf)
-- Class D at BBB (sf)

DBRS Morningstar also changed the trends on the Class B through D notes to Negative from Stable. The trend on the Class A notes remains Stable.

The rating confirmations follow the transaction’s relatively stable performance over the last 12 months, although the prolonged level of vacancy during last year has exceeded the anticipated letting time, precipitating the trend change on Classes B through D to Negative from Stable.

The transaction is a securitisation of a GBP 367.5 million floating-rate senior commercial real estate (CRE) loan advanced by Morgan Stanley & Co. International plc (Morgan Stanley), which was originated in November 2018. The loan is secured by a single asset known as the CityPoint office building in London. The asset is a 35-storey office tower with a total lettable area of 704,657 square feet (sf). The senior loan is split between two facilities: Facility A, which totals GBP 354.0 million, and Facility B—the capital expenditure (capex) facility—which totals GBP 13.5 million, equating to a loan-to-value (LTV) ratio of 57.9% based on the GBP 635.0 million January 2020 valuation prepared by Jones Lang Lasalle. Additionally, there is a nonsecuritised mezzanine facility totalling GBP 91.9 million (72.34% LTV) that is contractually and structurally subordinated to the senior facilities. The January 2020 valuation of GBP 635.0 million represented a 6% increase on the GBP 600.0 million valuation provided at issuance; subsequently, the LTV decreased to 57.9% from 61.3% at issuance, below the cash trap covenant of 75%. A new valuation is currently conducted and the servicer expects to include the new valuation in the first reporting in January 2022.

The initial loan maturity is in January 2022, but the borrower intends to exercise the first one-year extension to January 2023. The request letter has been provided and confirmation is subject to condition precedents being met. Considering the two one-year extension options that are conditional upon the loan being fully hedged, the latest loan maturity date is in January 2024. The legal final maturity of the notes is in January 2029, five years after the latest possible loan maturity. Given the security structure and jurisdiction of the underlying loan, DBRS Morningstar believes that this provides sufficient time to enforce on the loan collateral, if necessary, and repay the bondholders.

The loan interest rate three-month Libor plus a margin of 2.15%; however, the servicer confirmed that the current reference rate (Libor) will be replaced with Sonia at the next interest payment date (IPD) in January 2022. DBRS Morningstar understands that notes’ interest rate and cap agreement floating rate will also reference to Sonia. In terms of hedging, the cap notional is 100% of the outstanding amount of the loan and the interest rate cap strike is set at a maximum of 2% per annum (p.a).

The CityPoint building is located on 1 Ropemaker Street by Finsbury Circus and Moorgate tube station. The 35-storey office tower has four basement floors and ground-floor retail space with shops and restaurants. The majority of the 704,657-sf lettable area in the building is office space, which totals 662,962 sf. The building is owned and operated by Brookfield Asset Management Inc. (Brookfield), which is a large and experienced CRE operator (currently rated A (low) with a Stable trend by DBRS Morningstar). The sponsor’s business plan at issuance was to use the capex facility to refurbish three floors, the sixth to eighth floors. To date, the Issuer has expended an aggregate amount of GBP 32.2 million, GBP 20.7 million of which on the levels 5 to 8 refurbishment project and GBP 11.5 million on other capex projects, including: the levels 12 and 14 refurbishment project, the Core 6 reception refurbishment project, the base-build plant replacement, and lift upgrades. DBRS Morningstar understands that the marketing for letting these floors is still ongoing. Part of floor 5 and the entirety of floors 6, 7, 8, 12, and 14 are still vacant.

The reported debt yield (DY) for the transaction was 6.34% as of the October IPD, which is below the cash trap DY covenant of 6.75%. The cash trap DY covenant has been breached since January 2021. Following the permitted release of funds mainly related to the refurbishment works, there is currently no surplus remaining for cash sweep. Until a permitted change of control, there are no financial default covenants in place. On or after the permitted change of control date, the financial default covenants on DY (5.75%) and LTV (80%) will apply and the cash-trapped amount will be released to pay down the loan should the cash trap continue for two consecutive interest periods. Furthermore, in the pre-enforcement principal allocation scenario, the cash trapped will be applied sequentially to the notes.

At the October 2021 IPD, the portfolio was let to 30 tenants for a total annual contractual rent of GBP 29.14 million p.a. and a passing rent of GBP 23.68 million p.a.. The five main tenants (Simons & Simons, Simpson Thacher, SquarePoint Capital LLP, and London CityPoint Centre Limited) account for 69% of the total contracted rent across the portfolio. Over the past year, there has been a slight improvement in the level of contractual rent and a significant improvement in the passing rent, the latter due to the end of rental incentives that were granted to stimulate the take-up, especially during the Coronavirus Disease (COVID-19) restrictions. Furthermore, the weighted-average lease term has increased since the cut-off (7.5 years versus 6.5 years), indicating that longer leases have been agreed. 94% of rental income originates from office space with the remaining 6% from retail, including restaurants, coffee shops, bars, and a gym. As of October 2021, the contracted annual rent generated by the office sector stands at GBP 27.5 million while the retail sector contributed GBP 1.5 million.

The portfolio vacancy rate was 22.3% as of October 2021 IPD, higher than last year’s rate of 19.4%. Specifically, the vacancy rate per sector was 24% for the office area and 8% for the retail space.

DBRS Morningstar’s underwriting assumptions remain unchanged from the initial analysis, with DBRS Morningstar’s Net Cash Flow (NCF) at GBP 25.3 million and DBRS Morningstar’s stabilised cap rate at 5.2%. This results in a DBRS Morningstar value of GBP 486.5 million, which represents a 23.4% discount to the updated valuation.

The liquidity facility support stands at GBP 20 million, unchanged since issuance, and covers the Class A through Class D notes. Based on the cap strike rate of 2%, DBRS Morningstar estimated that the liquidity reserve will cover 16 months of notes’ interest payments.

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, CRE 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 Mount Street Mortgage Servicing 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 these transactions took place on 16 December 2020, when DBRS Morningstar confirmed its ratings on the Class A to Class D notes with Stable trend.

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

A decrease of 10% and 20% in the DBRS Morningstar NCF, derived by looking at comparable market rents, market occupancies in addition to expense ratios, and capex, would lead to a downgrade in the transaction, as noted below for each class, respectively.

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

Class B Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class B Notes to BBB (high) (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 (low) (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 (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, Credit Ratings
Rating Committee Chair: Christian Aufsatz, Managing Director, head of European Structure Finance
Initial Rating Date: 11 December 2018

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].