DBRS Morningstar Changes Trends on HAUS (European Loan Conduit No. 39) DAC to Negative from Stable, Confirms Ratings

DBRS Ratings GmbH (DBRS Morningstar) confirmed its ratings on the following classes of Commercial Mortgage-Backed Floating-Rate Notes Due July 2051 (the Notes) issued by HAUS (European Loan Conduit No. 39) DAC (the Issuer):

-- Class A1 at AAA (sf)
-- Class A2 at AAA (sf)
-- Class B at AA (low) (sf)
-- Class C at A (low) (sf)
-- Class D at BBB (low) (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, supported by the rental guarantee from the seller. The Negative trends reflect the delayed execution of the business plan and the consequent misalignment between the target rent and the projected net rental income (NRI), which resulted in a breach of the debt yield (DY) cash trap covenant since the April 2022 interest payment date (IPD).

The transaction is a securitisation of a EUR 318.75 million loan arranged by Morgan Stanley & Co. International plc in August 2021. The loan facility is secured by a portfolio of 6,284 multifamily residential units across 92 sites (equivalent to 59 properties) in Germany. The 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 (approximately 90%) with the seller of the properties (high-net worth individuals) and was retained as the asset/property manager and ultimate beneficial owner of the asset management entity, Belvona Asset Management Limited and Belvona Service GmbH.

According to the business plan, the portfolio had suffered from a period of underinvestment and the occupancy rate was reported at 67% at the cut-off date, on the 27 August 2021. However, the servicer has since reconciled the figures and the occupancy rate has been reported at around 60% over the last year. At the cut-off date, the seller funded a EUR 39.5 million capital expenditure (capex) to renovate the outdated units to achieve a modernisation rate of 75% across the portfolio in two years. Also, at the cut-off date, the seller deposited a EUR 23.3 million rental guarantee into the rent guarantee account to cover the shortfall between the expected EUR 35 million stabilised rent level (or annual target rent) and the actual rent level.

The outstanding whole-loan amount has remained unchanged at EUR 318.75 million since origination, as the loan is interest only until initial loan maturity in July 2026 when, if extended, a cash sweep trigger will be place. The loan may be extended on an annual basis until July 2046, provided that certain condition precedents are met.

There has been no new valuation of the portfolio since origination. The loan-to-value (LTV) ratio is 67.86%, unchanged from the Issuer’s LTV at the cut-off date. Knight Frank LLP provided the portfolio valuation as of 29 March 2021 with a market value of EUR 469.7 million. DBRS Morningstar understands from the servicer that a new valuation has been mandated and it will available during the next quarter.

The loan carries a floating rate of Euribor (floored at 0%) plus a 1.98% margin for the first two years since closing. Afterward, the margin will step down to 1.84% until the initial maturity date. Following the extension of the loan, the margin will step up to 3.25% per annum. Hedging is 100% on the notional outstanding loan amount, with a cap strike rate of 2.0% expiring in July 2023. Subsequently to the initial loan maturity, the hedging arrangement is expected to have a strike rate of 1.0%.

The transaction does not have financial default covenants; however, there are cash trap covenants that are set at an LTV of 77.9% while the DY covenant is set at 6.75% starting from April 2022 and increasing up to 9.0% from October 2024. Following the initial maturity date, DY and LTV covenants are set at 7.0% and 75%, respectively, and tested on an annual basis to extend the loan. The DY in April 2022 was 3.66% lower than the required 6.75% DY cash trap covenant. The servicer reported that there was no surplus cash to move to the cash trap account. Funds amounting EUR 7.01 million were released to cover payments due for agent fees, interest payments, general & administrative expenses, repairs and maintenance, asset and property management, as well as additional capex.

The tenancy profile is very granular, with the top 10 assets accounting for 40% of portfolio net cold rent and 38.2% of lettable area as of April 2022. According to the most recent servicer report, the annual contractual rent at April 2022 was EUR 19.02 million and the projected NRI is EUR 11.65 million. The rental guarantee has been utilised more rapidly than initially planned. At the April 2022 IPD, the outstanding amount was EUR 2.99 million, lower than the initial EUR 23.3 million. Under the acquisition agreement, the seller is required to top up the rental guarantee on a quarterly basis until December 2024 if the target rent is not reached. Furthermore, at the end of the first, second, and third year following the closing date, the amount of funds standing to the credit of the deposit account shall be adjusted to be equal to (1) the difference between the annual target rent and the projected annual NRI; and (2) a reasonable estimate of the void costs and leasing costs, in each case for the respective next four quarters. DBRS Morningstar understands from the servicer that the seller has already funded further the rental guarantee deposit account following last quarter’s IPD.

As the refurbishment program has not progressed in line with the business plan, the reletting program has also progressed at a slower pace than anticipated. The capex reserve has been only partially utilised since closing. From the initial EUR 39.5 million deposited, EUR 38.0 million was still outstanding as of April 2022 as only 142 residential units out of the 2,264 scheduled for refurbishment were completed. The delay in the refurbishment works is due mainly to past Coronavirus Disease (COVID-19) restrictions underpinning construction supply and labour shortages. At the same time, costs for materials and labour have increased significantly, which makes it more challenging to find suppliers for various workstreams in the refurbishment process.

DBRS Morningstar’s underwriting assumptions remain unchanged. DBRS Morningstar gave credit to the rental and capex reserves in its net cash flow (NCF) analysis, which resulted in a DBRS Morningstar net cold rent of EUR 28.3 million and NCF of EUR 21.07 million. DBRS Morningstar maintained its cap rate assumption of 5.5%, resulting in a DBRS Morningstar value of EUR 385.04 million, an 18% haircut from the appraiser’s valuation. DBRS Morningstar will wait for the new valuation to reassess its ratings.

Finally, the Class X interest diversion trigger event followed the loan’s DY breach of 5.5% deemed during the second year. Class X interests were not distributed on the August 2022 note payment date (NPD). The Class X interest amount and the VRR loan proportion of that amount have been diverted to the Issuer transaction account and credited to the Class X diversion ledger. The amount credited to the ledger was EUR 692,569 at the August 2022 NPD.

On the closing date, EUR 12.5 million of the proceeds from the issuance of the Class A1 notes and the proportionate VRR loan amount was 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. The current liquidity facility balance is EUR 13,154,102. The liquidity reserve amount can provide interest payments on the covered notes up to 15 months or 10 months based on the interest rate cap strike rate of 2% p.a. or on the Euribor cap of 4.0% p.a., respectively.

The transaction is structured with a five-year tail period to allow the special servicer to work out the loan at maturity by July 2051, which is the final legal maturity of the Notes.

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 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 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 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 quarterly servicer reports prepared by Mount Street Mortgage Servicing Limited, U.S. Bank Global Corporate Trust Limited and the 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 27 August 2021, when DBRS Morningstar finalised its provisional ratings on the Class A1, Class A2, Class B, Class C, and Class D notes with Stable trends.

The lead analyst responsibilities for this transaction have been transferred to Patrizia Catanese.

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

Class A1 Risk Sensitivity:
-- a 10% decline in DBRS Morningstar’s NCF would lead to an expected rating of the Class A notes at AAA (sf)
-- a 20% decline in DBRS Morningstar’s NCF would lead to an expected rating of the Class A notes at A (high) (sf)

Class A2 Risk Sensitivity:
-- a 10% decline in DBRS Morningstar’s NCF would lead to an expected rating of the Class A notes at AA (low) (sf)
-- a 20% decline in DBRS Morningstar’s NCF would lead to an expected rating of the Class A notes at A (low) (sf)

Class B Risk Sensitivity:
-- a 10% decline in DBRS Morningstar’s NCF would lead to an expected rating of the Class B notes at A (low) (sf)
-- a 20% decline in DBRS Morningstar’s NCF would lead to an expected rating of the Class B notes at BBB (sf)

Class C Risk Sensitivity:
-- a 10% decline in DBRS Morningstar’s NCF would lead to an expected rating of the Class C notes at BBB (sf)
-- a 20% decline in DBRS Morningstar’s NCF would lead to an expected rating of the Class C notes at BB (high) (sf)

Class D Risk Sensitivity:
-- a 10% decline in DBRS Morningstar’s NCF would lead to an expected rating of the Class D notes at BB (sf)
-- a 20% decline in DBRS Morningstar’s NCF would lead to an expected rating of the Class D notes at B (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: Patrizia Catanese, Assistant Vice President
Rating Committee Chair: David Lautier, Senior Vice President
Initial Rating Date: 29 July 2021

DBRS Ratings GmbH
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60311 Frankfurt am Main Deutschland
Tel. +49 (69) 8088 3500
Geschäftsführer: Detlef Scholz
Amtsgericht Frankfurt am Main, HRB 110259

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.
-- Derivative Criteria for European Structured Finance Transactions (20 September 2021), https://www.dbrsmorningstar.com/research/384624/derivative-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.
-- Legal Criteria for European Structured Finance Transactions (22 July 2022), https://www.dbrsmorningstar.com/research/400166/legal-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].