DBRS Morningstar Confirms Ratings on Arrow CMBS 2018 DAC with Stable Trends

DBRS Ratings GmbH (DBRS Morningstar) confirmed its ratings on the following classes of commercial mortgage-backed floating-rate notes due May 2030 issued by Arrow CMBS 2018 DAC (the Issuer):

-- Class A1 at AAA (sf)
-- Class A2 at AAA (sf)
-- Class B at AA (sf)
-- Class C at A (low) (sf)
-- Class D at BBB (low) (sf)
-- Class E at BB (high) (sf)
-- Class F at BB (low) (sf)

The trends on all ratings remain Stable.

The transaction is a securitisation of an originally EUR 308.2 million (69.7% loan-to-value (LTV) ratio) floating-rate senior commercial real estate loan advanced jointly by Deutsche Bank AG, London Branch and Société Générale, London Branch, with the loan sellers jointly holding approximately 5.0% of the senior loan.

The transaction is secured by 73 assets (down from 89 at issuance), which are predominantly logistics and light industrial properties located in France, Germany, and the Netherlands. Savills Advisory Services Limited conducted a revaluation of the portfolio in March 2022 and estimated an aggregated value of the 73 assets at EUR 453.1 million. On the like-for-like basis, this is 22.4% higher than the original valuation at issuance (June 2018) or 5.4% higher than the previous valuation (January 2021).

As of the August 2022 interest payment date, the outstanding loan balance had reduced to EUR 247.7 million (80.4% of the original whole-loan balance) from EUR 267.6 million a year ago following the disposal of six properties over the past 12 months, with principal proceeds allocated to the notes on a pro-rata basis. As a result of the release premium for the sold assets, the loan’s LTV declined to 54.7% as of August 2022 from 59.1% a year ago.

The loan performed in line with expectations over the past 12 months. As of August 2022, net rental income stood at EUR 28.8 million, resulting in a debt yield (DY) of 11.6%. Both the LTV and DY are well in line with the cash trap covenants, which are set at 77.2% and 9.45%, respectively. Financial covenants are not applicable prior to a permitted change of control (CoC).

The senior loan carries a floating interest rate equal to three-month Euribor (subject to zero floor) plus a margin of 2.075%. There is no scheduled amortisation before a permitted CoC.

The senior loan had a term of two years with three one-year extension options. The borrower has submitted the third and final extension option notice in order to extend the loan to November 2023. As part of the extension requirements, the borrower entered into a hedging agreement with Société Générale, Paris Branch. In line with transaction documentation, the newly-signed cap agreement covers 100% of the outstanding senior loan balance, with a strike rate equal to 3.73% which allowed for a hedged ICR of 200% at the date on which the hedging transaction was contracted. After the expected note maturity date (22 November 2023), the Euribor rate payable at note level is capped at 5.0%.

DBRS Morningstar updated its net cash flow (NCF) assumption to EUR 19.2 million from EUR 20.2 million at last review to reflect the property sales. In addition, DBRS Morningstar maintained its cap rate assumption at 6.85%, as at issuance, which translates into a DBRS Morningstar value of EUR 280.4 million, representing a 38.1% haircut to the most recent appraised value. This did not result in any changes to the ratings on all classes of notes, which DBRS Morningstar confirmed with Stable trends.

The transaction benefits from a liquidity facility of EUR 10.8 million (EUR 13.5 million at origination), which equals to 7.6% of the total outstanding balance of the covered notes. The liquidity facility is provided by Deutsche Bank AG, London Branch and Société Générale, London Branch and can be used to cover interest shortfalls on the Class A1, Class A2, and Class B notes. According to DBRS Morningstar’s analysis, the commitment amount could provide interest payments on the covered notes of up to 17 months and 14 months based on the interest rate cap strike rate of 3.73% and the Euribor cap of 5.0% after loan maturity, respectively.

The final legal maturity of the notes is in May 2030, six and a half years after the fully extended senior loan maturity date. DBRS Morningstar believes that this provides sufficient time to enforce the loan collateral and repay the bondholders, given the security structure and jurisdiction of the underlying loan and properties.

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. (17 May 2022).

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 ratings 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/401817/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 quarterly data provided by Situs Asset Management 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 19 November 2021, when DBRS Morningstar confirmed its ratings on all classes of notes with Stable trends.

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 on www.dbrsmorningstar.com.

Sensitivity Analysis: 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 A1 Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating on Class A1 notes to AA (high) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating on Class A1 notes to A (high) (sf)

Class A2 Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating on Class A2 notes to AA (low) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating on Class A2 notes to A (sf)

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

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

Class D Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating on Class D notes to BB (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating on Class D notes to BB (low) (sf)

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

Class F Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating on Class D notes to B (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating on Class D notes to CCC (sf)

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: 23 October 2018

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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 (22 July 2022), https://www.dbrsmorningstar.com/research/400166/legal-criteria-for-european-structured-finance-transactions.
-- Interest Rate Stresses for European Structured Finance Transactions (22 September 2022), https://www.dbrsmorningstar.com/research/402943/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].