DBRS Morningstar Confirms Ratings on Class RFN and Class A1 Notes of FROSN-2018 DAC; Places Class A2 through Class E Notes Under Review with Negative Implications

DBRS Ratings GmbH (DBRS Morningstar) confirmed its AAA (sf) ratings on both the Class RFN and the Class A1 of the commercial mortgage-backed floating-rate notes due May 2028 issued by FROSN-2018 DAC (the Issuer). The trend on the Class RFN notes remains Stable, while the trend on the Class A1 notes remains Negative.

DBRS Morningstar also placed its ratings on the following classes of notes Under Review with Negative Implications (UR-Neg.):

-- Class A2 rated AA (low) (sf)
-- Class B rated A (sf)
-- Class C rated BBB (high) (sf)
-- Class D rated BB (high) (sf)
-- Class E rated B (high) (sf)

DBRS Morningstar placed its ratings on Class A2 through Class E UR-Neg. following the loan’s failure to repay at maturity on the February 2023 interest payment date (IPD), and the loan’s subsequent transfer to special servicing.
The confirmations of ratings on Class RFN and Class A1 reflect the structural protection to the notes offered by, among others, the shift to sequential principal proceeds distribution following the occurrence of a loan event of default.

RATING RATIONALE
FROSN-2018 DAC is a securitisation of one floating-rate senior commercial real estate loan advanced by Morgan Stanley and Citibank, N.A., London Branch. The loan refinanced the existing indebtedness of the borrowers in addition to providing capex to the underlying collateral. At issuance, the collateral consisted of 63 predominantly secondary office and retail properties located across Finland. The assets are part of Sponda’s portfolio, previously one of the largest listed real estate firms in Finland, which was acquired and delisted by the Blackstone Group L.P. (Blackstone or the sponsor). As of the February 2023 IPD, 45 assets remain in the portfolio following the sale of 16 properties before the onset of the Coronavirus Disease (COVID-19) pandemic and the release of two properties from the security pool in Q1 2022 against an EUR 10.7 million voluntary repayment of the senior loan. As a result, the aggregate outstanding balance of the senior loan and senior capex loan has reduced almost by half to EUR 310.0 million (EUR 281.4 million for the securitised part) from EUR 590.9 million (EUR 533.9 million for the securitised part) at issuance, with all prepayment proceeds applied pro rata to the notes. In addition, there was also an EUR 103.8 million mezzanine facility at issuance, which was repaid on 30 November 2022.

The interest-only senior loan bears interest at a floating rate equal to three-month Euribor (subject to a zero floor) plus a 2.45% per annum margin.

Jones Lang LaSalle Limited (JLL) revalued the portfolio on 31 December 2021 and appraised the aggregate market value of the 45 properties at EUR 513.5 million, a 1.7% increase from the 2020 valuation, which was driven by tightening yields in the Finnish office market. This translates into a loan-to-value (LTV) ratio of 57.7% as of the February 2023 IPD, a slight decline from 58.2% LTV reported at last review, and in line with the transaction’s cash trap covenant of 60.0%.

The portfolio’s performance deteriorated following the onset of the pandemic, as occupiers began to reassess their office space needs, which hindered the demand for properties in secondary locations or without flexible amenities and strong environmental credentials. Indicative of the structural shifts in occupational demand, the portfolio’s vacancy has been persistently high, increasing to 46.2% in February 2023 from 44.2% a year prior. Gross rental income continued its downward trend, declining to EUR 41.5 million in Q1 2023 from EUR 42.4 million in Q1 2022.

The portfolio’s deteriorating performance caused the loan to breach its debt yield (DY) cash trap covenant of 10.0% in Q3 2020. The DY cash trap covenant stepped up to 11.0% from the fifth year onward and the loan remains in cash trap as of February 2023, with EUR 13.5 million trapped in the cash trap account, according to the February 2023 investor report.

The loan matured on 15 February 2023 after the sponsor had exercised the third and final extension option. Ongoing macroeconomic instability and market disruptions prompted Blackstone to put forward a restructuring proposal, which included a one year extension beyond the loan’s final maturity in return for the 125bps increase in loan/note margins and the use of all disposal proceeds to pay down the loan. However, the extraordinary resolution of noteholders to implement the proposal failed to pass. Mount Street Mortgage Servicing Limited (the servicer and special servicer) granted two one-week extensions while it explored other options, but no agreement was reached on the terms of any further loan maturity extension. As a result, the servicer has determined that a loan event of default has occurred on 1 March 2023 as the borrower failed to repay the loan, and the loan was consequently transferred to special servicing on 2 March 2023. The loan now accrues default interest of 1.0% p.a. on all overdue amounts.

The loan’s hedging agreement expired on 15 February 2023, however, the note Euribor cap is set at 4.25% following the loan final maturity date, which limits the potential of interest shortfalls on the notes to a certain extent.

Additionally, the loan failure priority of payments waterfall will be applied going forward, shifting to the sequential application of principal receipts. On the February 2023 IPD, EUR 608,403 of the Euribor excess amount have been applied towards repayment of the Class RFN (EUR 30,484) and the Class A1 (EUR 577,919) notes.

According to the special servicer, they would prefer a consensual workout strategy with an agreed business plan. The special servicer has meanwhile instructed JLL to conduct a new valuation. The special servicer is also putting in place a short-term standstill arrangement with the borrower whilst the business plan and cash flow are reviewed, and the updated valuation is awaited.

DBRS Morningstar notes that rising interest rates and increased financing costs have caused office valuation yields to widen. Together with the slowdown in the investment activity observed in the Finish market in the second half of 2022, this exposes the portfolio to a potential market value decline compared with the December 2021 valuation, especially as the portfolio’s rental growth prospective might be limited by occupier flight to quality.

In DBRS Morningstar’s view, the note Euribor cap, the shift to sequential-pay, the EUR 9.1 million liquidity facility, and a five-year tail period offer structural protection to the senior notes. Hence, DBRS Morningstar confirmed its ratings on Class RFN and Class A1 notes, and placed its ratings on Class A2 through Class E notes UR-Neg. until the new valuation is available and DBRS Morningstar receives more information regarding the disposal strategy. Currently, DBRS Morningstar’s value of the portfolio stands at EUR 322.0 million. This translates into a haircut of 37.3% to the 2021 valuation and a DBRS Morningstar LTV of 92.3%.

The reserve fund notes (RFN) included in the transaction fund the note share part (95%) of the liquidity reserve. At issuance, the EUR 16.7 million RFN proceeds and the EUR 878,947.37 VRR Loan Interest contribution were deposited into the transaction’s liquidity reserve account, which can be used to pay property protection advances, senior costs, and interest shortfalls (if any) in relation to the corresponding VRR Loan Interest, RFN, Class A1, Class A2, and Class B notes. The liquidity reserve currently amounts to EUR 9.1 million and, according to DBRS Morningstar’s analysis, is equivalent to approximately 12 months’ coverage on the covered notes, based on the 4.25% Euribor cap after loan maturity.

The senior loan is structured with tightening cash trap covenants, which are set at 11.0% for DY and 60% for LTV from the fifth year onwards. Financial default covenants are set at 8.89% for DY and 80% for LTV and are applicable only after a permitted change of control.

The loan matured on 1 March 2023, with the final maturity of the notes scheduled on 21 May 2028.

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.

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.

DBRS Morningstar is undertaking a review and will remove the rating from this status as soon as it is appropriate.

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, EIRP files and tenancy schedule dated 1 March 2023, all provided by Mount Street Mortgage Servicing Limited, as well as cash manager reports prepared by U.S. Bank Global Corporate Trust Limited.

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 7 April 2022, when DBRS Morningstar confirmed its ratings on all classes of notes, while maintaining the Stable trend on Class RFN notes and the Negative trends on Class A1 through Class E notes.

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 RFN Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class RFN at AAA (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class RFN at AAA (sf)

Class A1 Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class A1 at AA (high) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class A1 at A (high) (sf)

Class A2 Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class A2 at A (low) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class A2 at BBB (sf)

Class B Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class B at BBB (high) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class B at BBB (low) (sf)

Class C Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class C at BBB (low) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class C at BB (high) (sf)

Class D Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class D at BB (low) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class D at B (sf)

Class E Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class E at B (low) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class E at CC (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.

The ratings on Class A2 through Class E notes are Under Review with Negative Implications. Generally, the conditions that lead to the assignment of reviews are resolved within a 90-day period.

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. For further information on DBRS Morningstar historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

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: 22 March 2018

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