DBRS Morningstar Confirms Ratings on Kanaal CMBS Finance 2019 DAC with Negative Trends

DBRS Ratings GmbH (DBRS Morningstar) confirmed its ratings on all classes of Commercial Mortgage-Backed Floating-Rate Notes due August 2028 issued by Kanaal CMBS Finance 2019 DAC (the Issuer) as follows:

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

The trends on all ratings remain Negative.

The rating confirmations reflect the partial repayment of the Maxima loan and the subsequent deleveraging of the notes despite the weak performance of the retail-backed Big Six loan, whose rental income and market value have continued to decline since the last annual review. The Negative trends reflect the ongoing uncertainty in the retail sector, as well as the risks surrounding the Big Six loan’s refinancing prospects if its performance does not improve.

The transaction is a securitisation of two Dutch senior commercial real estate loans, the Maxima loan and the Big Six loan, advanced by Goldman Sachs Bank U.S.A. The two loans have demonstrated different performance trajectory, with the office-backed Maxima loan’s performance improving marginally since origination, while the retail-backed Big Six loan has faced pandemic-induced difficulties.

The performance of the Maxima loan has been positive since origination, with its gross rental income (GRI) increasing gradually and its market value being adjusted upwards at each annual re-valuation. In Q3 and Q4 2021, four assets (Dillenburgstraat, Schiphol, Den Haag, and Utrecht) were sold, bringing the outstanding loan balance down to EUR 31.2 million from EUR 138.0 million at origination. The repayment amounts were allocated on a pro rata basis to the notes and triggered the breach of the minimum loan amount, with all surplus from the debt service account now being applied towards prepayment at each loan interest payment date. Based on the valuation conducted by JLL in April 2021, the aggregate market value of the remaining assets totals EUR 94.5 million, resulting in a LTV of 33.0% as of Q4 2021, down from 54.1% before the disposals. The substantial deleveraging from release pricing and surplus prepayment also resulted in debt yield increasing to 18.3% in February 2022 from 10.3% in August 2021.

The servicer has confirmed that the borrower is in negotiations for the sale of two assets, with the sale anticipated to conclude in July 2022. Four more assets are expected to be brought to the market in the coming months. By DBRS Morningstar’s estimates, the aggregate release price of the properties would be enough to fully repay the loan whose maturity is in February 2023.

Meanwhile, the Big Six loan’s performance has been on a downtrend over the past year despite the improvement in collection rates and occupancy remaining unchanged. The GRI reduced to EUR 16.2 million in Q4 2021 from EUR 17.2 million in Q4 2020, driven by contract renewals in a competitive environment, according to the servicer. The latest available valuation conducted by Savills in January 2021 saw the portfolio’s value decline to EUR 203.2 million, down 12.9% since loan origination in 2018 and 6.0% from the previous valuation in July 2019 (excluding the sale of several units). The next valuation is scheduled in June 2022 and, in DBRS Morningstar’s opinion, is expected to result in further decline in the collateral’s value amid downward pressure on rental income in the retail sector. This could affect the loan’s refinancing prospects, as the decline in value is not fully mitigated by the scheduled amortisation, with the LTV standing at 59.6% in February 2022, compared with 56.5% at origination.

As of February 2022, the LTV together with the debt yield (11.0%) and the projected interest coverage ratio (3.3x) were still in line with the financial covenants set at 82.5%, 9.6%, and 1.78x, respectively. Based on the current performance, the loan is likely to continue to meet the covenants, allowing the sponsor to exercise the second extension option, provided a hedging agreement is obtained. DBRS Morningstar expects the final maturity of the Big Six loan to be in August 2023, which would provide the sponsor with an opportunity to proceed with its refurbishment plans, potentially recovering some of the portfolio’s lost value.

DBRS Morningstar did not revise its assumptions since the last annual surveillance as the loans are still performing in line with DBRS Morningstar’s underwriting. However, following the disposal of the four Maxima properties, DBRS Morningstar’s value for the Maxima loan declined to EUR 69.4 million, representing a haircut of 26.6% to the latest valuation. For the Big Six loan, DBRS Morningstar’s value continues to stand at EUR 157.2 million, a haircut of 22.6% to the latest portfolio valuation.

As the sponsor intends to sell several assets in the Maxima portfolio over the course of 2022, there is a strong possibility that the Maxima loan will be repaid in full, with the prepayment proceeds allocated pro rata to the notes. This would leave only the Big Six loan in the transaction. DBRS Morningstar has tested this scenario against its underwriting assumptions, and concluded that, all else equal, it would not trigger any changes to the current ratings. As a result, DBRS Morningstar confirmed its ratings on all classes with Negative trends, reflecting the continued uncertainty in the retail market and increasing risks surrounding the Big Six portfolio’s refinancing. For DBRS Morningstar’s underwriting assumptions at issuance, please refer to the transaction’s rating report.

The transaction is supported by a EUR 7.1 million liquidity facility (EUR 13.0 million at origination), which equals 4.7% of the total outstanding balance of the covered notes. The liquidity facility is provided by Goldman Sachs Bank U.S.A., and can be used to cover interest shortfalls on the Class A to Class D notes.

The expected note maturity will be on 22 August 2023, seven days after the fully extended maturity of the Big Six loan. Should the notes fail to be repaid by then, the transaction will have five years to allow the special servicer to work out the loan(s) by August 2028 at the latest, which is the legal final maturity of the notes.

The Coronavirus Disease (COVID-19) and the resulting isolation measures had caused an immediate economic contraction, leading in some cases to increases in unemployment rates and income reductions for many tenants and borrowers.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. These scenarios were last updated on 24 March 2022. 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/394150/baseline-macroeconomic-scenarios-for-rated-sovereigns-march-2022-update and https://www.dbrsmorningstar.com/research/384482/baseline-macroeconomic-scenarios-application-to-credit-ratings.

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” (17 December 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.

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 mainly include quarterly investor reports provided by CBRE, as well as EIRP files and latest available tenancy schedules.

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 25 March 2021, when DBRS Morningstar confirmed its ratings on the Class A, Class B, Class C, and Class D notes at AAA (sf), AA (low) (sf), A (low) (sf), and BBB (low) (sf), respectively, and changed the trends on the Class A and Class B notes to Negative from Stable, with trends remaining Negative for the Class C and Class D notes.

The lead analyst responsibilities for this transaction have been transferred to Violetta Volovich.

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 to AAA (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of the Class A notes to AA (sf)

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

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

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

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 Limited for use in the United Kingdom.

Lead Analyst: Violetta Volovich, Senior Analyst
Rating Committee Chair: Christian Aufsatz, Managing Director
Initial Rating Date: 19 March 2019

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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 (17 December 2021),
https://www.dbrsmorningstar.com/research/389947/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].