DBRS Morningstar Confirms Ratings of Viridis (European Loan Conduit No. 38) DAC, Changes Trend to Negative from Stable

DBRS Ratings Limited (DBRS Morningstar) confirmed its ratings of the Commercial Mortgage-Backed Floating-Rate Notes Due July 2029 (the notes) issued by Viridis (European Loan Conduit No. 38) DAC (the Issuer), as follows:

-- 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)

DBRS Morningstar also changed the trends on all ratings to Negative from Stable.

The rating confirmations reflect the underlying property’s relatively stable performance over the past 12 months. The negative trends on all tranches of notes reflect the fact that a sizeable tenant, representing 12.9% of annual contracted rent, is in rent arrears and will be vacating the property in October 2022. Consequently, it is expected that the loan will be in debt yield (DY) cash trap at the July 2022 interest payment date (IPD), all else being the same. The negative trends on the notes also reflect the high vacancy level once the sizeable tenant vacates the property, as well as the loan no longer benefiting from a loan-level capital expenditure (capex) reserve or a loan-level interest reserve, as this was released to the borrower following temporary compliance with the relevant thresholds.

The transaction was originally backed by a GBP 192 million senior loan, which was split into two facilities: Facility A, which totalled GBP 150 million (which is the securitised loan), and Facility B (a syndicated loan, not forming part of the CMBS transaction), which totalled GBP 42 million. The senior loan refinanced the borrower’s existing debt. The senior loan was advanced by Morgan Stanley Bank, N.A. to Aldgate Tower S.A.R.L., which is controlled by Brookfield Property Partners L.P. (Brookfield) and China Life Insurance Company Limited (China Life). The senior loan is secured by the Aldgate Tower in the outskirts of the City of London.

In April 2021, Savills valued the Aldgate Tower building at GBP 330 million, representing a 58.2% day-one loan-to-value (LTV) ratio, which has since dipped slightly to 58.18%. This is because the LTV is the net debt as a percentage of the property’s market value. The net debt equates to principal minus cash held in the deposit, reserve, and cash trap accounts. The April 2022 investor report confirms that as there are no more funds held in the reserve account, compared with GBP 5,614,315.84 in the last quarter; as a result, the net debt increased to GBP 192 million (the current senior loan balance) from GBP 186,385,684. The current DY ratio is 6.8%.

The senior loan carries a floating rate of Sterling Overnight Index Average (Sonia; floored at 0%) plus a 2.85% margin for a three-year term. The interest rate risk is fully hedged with a prepaid cap provided by Standard Chartered Bank, with a strike rate of 1.0%, and a term expiring on the loan termination date.

The interest-only loan had a three-year term to 20 July 2024 with no extension options.

There are no DY or LTV financial covenants applicable either prior to a permitted transfer or following a permitted transfer. DBRS Morningstar’s view is that potential performance deteriorations can be captured and mitigated by the presence of the tightening cash trap covenants in the facility agreement. The loan is structured with increasingly stringent DY cash trap covenants requiring the sponsors to improve the asset performance in order to remain compliant with the loan terms. The covenants are tested quarterly on each IPD in years 2 and 3 at 7% and 8%, respectively. Additionally, the structure includes a senior LTV cash trap covenant set at 70% LTV for the three-year loan term.

The April 2022 investor report states that the DY was 6.8%, compared to 8.2% on the January 2022 IPD. The decrease in DY has been mainly driven by GBP 2 million rental arrears from an outgoing tenant (representing 12.9% of the annual contracted rent) being removed from the rental income. The outgoing tenant will be exercising its break option in October 2022. Currently, the adjusted net rental income (NRI) excludes the rent due from the outgoing tenant due to the arrears being more than 90 days past due, but includes a new incoming tenant (discussed below). The most recent investor report from April 2022 shows that the loan is currently performing. However, from DBRS Morningstar’s enquiries to the servicer, all things being the same, it is likely that the 7% DY cash trap will be breached on the July 2022 IPD, as it will now be year 2, so the DY cash trap threshold will now be 7% when, in year 1, there was no DY cash trap event. Therefore, after accounting for payments of interest, the remaining excess cash will likely be transferred to the cash trap account.

The loan previously benefited from a GBP 2.7 million capex/tenant improvement reserve and a GBP 5 million interest reserve. The property had been fully let until shortly before issuance; however as at the 20 April 2021 cut-off date, due to the loss of a key tenant, the property was only 68.4% occupied. This was mitigated by: (1) the loan-level interest reserve of GBP 5 million, which could be released to the borrower on the latter of occupancy being greater than 90%, or the interest coverage ratio equalling or exceeding 1.8x; and (2) a loan-level capex reserve of GBP 2.7 million (amortised to GBP 1.7 million at issuance, with the loan-level capex reserve being available to fund deficits in interest shortfall reserve amounts). On the January 2022 IPD, the conditions to release the loan-level interest reserve of GBP 5 million were met, and it was consequently released to the borrower at its request. Hence, once the outgoing tenant vacates the property in October 2022, the loan-level interest reserve as well as the loan-level capex reserve (which the servicer has confirmed is no longer available) will not serve as mitigants as they did at issuance.

The transaction also benefits from an issuer liquidity reserve in an aggregate amount of GBP 5.8 million. 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, provided 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, expected to repay on or before July 2024, 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.

As of the April 2022 IPD, the servicer reported an adjusted NRI of GBP 13.1 million. Rent shall be deemed to have been received for any rent-free period that falls during the calculation period.

The vacancy as of the April 2022 IPD has decreased to 9.7%, from 28.5% last quarter and 31.6% on the April 2021 cut-off date. This is due to the completion of a new lease representing 20.6% of the annual contracted rent. However, as mentioned above, the outgoing tenant (representing 12.9% of the annual contracted rent) will be vacating the property in October 2022, and according to the servicer, once that outgoing tenant vacates the property, the vacancy rate will increase to 21.9%.

The weighted-average unexpired lease term (WAULT) and the weighted-average unexpired lease term to break option (WAULB) have also remained relatively long (i.e., longer than the maturity of the loan) at 8.8 years and 6.5 years, respectively. The WAULT and WAULB include the outgoing tenant (representing 12.9% of the annual contractual rent) that is expected to vacate the property in October 2022.

The tenant profile is concentrated and currently includes the outgoing tenant (representing 12.9% of the annual contractual rent) that is expected to vacate the property in October 2022. There is significant tenant concentration and exposure to a single firm (a consultancy). In DBRS Morningstar’s view, the risk is mitigated by the high credit quality of the tenant. The largest tenant represents 31.2% of the annual contractual rent in the portfolio and the second largest tenant represents 20.6% of the annual contractual rent (i.e., the two largest tenants represent 51.8% of the annual contractual rent), while the top 5 tenants provide in total 87 % of the GRI of the portfolio, and the top 10 tenants provide in total 99.5% of the annual contractual rent.

DBRS Morningstar updated its underwriting by updating the issuer net cash flow (NCF) to GBP 13,077,161 (which is the adjusted NRI according to the April 2022 investor report) and maintained its other assumptions. The resulting DBRS Morningstar value of EUR 232.88 million reflects a 29.4% haircut to the initial valuation.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

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” (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 include reports provided by Mount Street Mortgage Servicing Limited, as well as EIRP files, latest available tenancy schedules, and transaction notices.

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 20 July 2021, when DBRS Morningstar finalised its provisional ratings of AAA (sf), AA (low) (sf), A (low) (sf), BBB (low) (sf), and BB (high) (sf) on the Class A, Class B, Class C, Class D, and Class E notes, respectively, with Stable trends.

The lead analyst responsibilities for this transaction have been transferred to Sioban Sugrue.

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 with 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)

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: Sioban Sugrue, Assistant Vice President
Rating Committee Chair: Christian Aufsatz, 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.

-- 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 (17 May 2022),
https://www.dbrsmorningstar.com/research/396929/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].