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 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 continued stable performance of the transaction over the last year and the improving debt yield metric of the Big Six loan, which is the only loan remaining in the transaction as of February 2023. DBRS Morningstar maintained Negative trends on all classes to reflect the refinancing risk stemming from the maturity of the Big Six loan in August 2023 and the continued uncertainty in the Dutch retail property market.

The transaction was originally a securitisation of two Dutch senior commercial real estate loans, the Maxima loan and the Big Six loan, both advanced by Goldman Sachs Bank U.S.A. The Maxima loan was repaid in full in February 2023, leaving Big Six as the only remaining loan in the transaction.

The Big Six loan (EUR 140.3 million at origination) financed the acquisition of six predominantly retail properties located in the Netherlands. Five of the six assets are retail-only assets comprising galleries, shopping centres, and high-street retail units while Deventer is a mixed-use asset with retail and office elements. The loan structure includes amortisation of 2.0% per annum (p.a.) in years two and three and 3.0% p.a. in years four and five. As a result of amortisation and partial releases from the portfolio, the outstanding balance of the Big Six loan has reduced by 17.5% since origination to EUR 115.8 million as of the February 2023 interest payment date (IPD).

In spite of the decline in loan balance, the Big Six loan-to-value (LTV) ratio stood at 60.1% as of the February 2023 IPD, up from the LTV of 56.5% at issuance. The increase in LTV is primarily driven by the decline in value with each revaluation since issuance. According to the latest available valuation conducted by CBRE Limited (CBRE) in June 2022, the portfolio value declined to EUR 192.7 million (adjusted for the Spijkenisse Office unit, which was disposed of for EUR 850,000 in the second half of 2022), down by 22.4% since loan origination in 2018 and 5.2% from the previous valuation dated January 2021 (excluding the value of partial releases from the portfolio). The downward trajectory of the Big Six loan in terms of market value resulted from the higher uncertainty affecting retail assets.

While the portfolio had exhibited a similar trajectory in terms of cash flow since issuance, gross rental income (GRI) and debt yield (DY) metrics began to improve in 2022. GRI climbed by 3.4% to EUR 16.8 million as of the February 2023 IPD from EUR 16.2 million as of the February 2022 IPD while DY increased to 12.3% from 11.0.% over the same period. Additionally, vacancy declined to 17.0% as of the February 2023 IPD from 22.5% as of DBRS Morningstar’s last annual surveillance.

Notwithstanding the recent improvement in cash flow, the transaction still faces considerable refinancing risk with the maturity of the Big Six loan in August 2023 drawing near. According to the February 2023 IPD servicer report, the sponsor is actively pursuing refinancing options for its repayment strategy at maturity. DBRS Morningstar will continue to monitor the transaction, especially with regard to any developments in refinancing.

DBRS Morningstar has not revised its net cash flow (NCF) assumption of EUR 12.6 million for the Big Six loan since the last annual surveillance; however, DBRS Morningstar revised its cap rate assumption upward to 8.5% from 8.0% in light of the latest appraisal report dated June 2022 and the comparable properties provided therein. The resulting DBRS Morningstar value was approximately EUR 148.0 million, which represents a haircut of 23.2% over the appraised value of EUR 192.7 million.

The Big Six loan bears interest at a floating rate equal to three-month Euribor (subject to zero floor) plus
a margin of 3.38%. The transaction is fully hedged with an interest rate cap strike of 2.0% provided by BNP Paribas. The hedging agreement will expire on 15 August 2023, which is the fully extended loan maturity date.

The transaction is supported by a EUR 5.4 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. According to DBRS Morningstar’s analysis, the commitment amount could provide coverage for 15 months of interest payments on the covered notes based on the 2% interest rate cap and the note margin.

The expected note maturity will be 22 August 2023, seven days after the fully extended maturity of the Big Six loan. If the notes are not repaid by then, the transaction will have five years to allow the special servicer to work out the loan by August 2028 at the latest, which is the legal final maturity of the notes. DBRS Morningstar considers this period of time to be sufficient, given the security structure and jurisdiction of the underlying loan, to enforce on the loan collateral, if necessary, and repay bondholders.

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 (14 December 2022), https://www.dbrsmorningstar.com/research/407379/european-cmbs-rating-and-surveillance-methodology.

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/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 quarterly investor reports provided by CBRE, the latest available tenancy schedules, and valuation reports by CBRE.

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 24 March 2022, when DBRS Morningstar confirmed its ratings on the notes with Negative trends.

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

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

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

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

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

DBRS Ratings GmbH
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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 (14 December 2022), https://www.dbrsmorningstar.com/research/407379/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.
-- 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.
-- 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].