DBRS Morningstar Confirms Ratings on Scorpio (European Loan Conduit No.34) DAC

DBRS Ratings Limited (DBRS Morningstar) confirmed its ratings on the following classes of commercial mortgage-backed floating-rate notes due May 2029 issued by Scorpio (European Loan Conduit No.34) DAC:

-- Class RFN confirmed at AAA (sf)
-- Class A1 notes confirmed at AAA (sf)
-- Class A2 notes confirmed at AAA (sf)
-- Class B notes confirmed at AA (sf)
-- Class C notes confirmed at A (low) (sf)
-- Class D notes confirmed at BBB (low) (sf)
-- Class E notes confirmed at BB (sf)

All trends are Stable.

The confirmation reflects the collateral’s consistent performance and the transaction’s improving credit metrics since DBRS Morningstar’s last annual surveillance. Most notably, the collateral’s annualised net rental income (NRI) and market value both increased compared with values reported in the May 2022 servicer report.

The transaction is a securitisation of 82.5% (GBP 236.4 million) of an originally GBP 286.4 million floating-rate senior commercial real estate loan (the senior loan) advanced by Morgan Stanley Bank N.A. to borrowers sponsored by Blackstone Group L.P. (Blackstone). The remaining 17.5% of the senior loan was retained by the original senior lender and ranks pari passu with the securitised senior loan. The financing was also accompanied by a GBP 57.3 million (80% loan-to-value (LTV)) mezzanine loan at issuance, granted by BSRECP III Joint International S.à r.l. and Broad Street Credit Holdings S.à r.l. The mezzanine loan, which was structurally and contractually subordinated to the senior facility, was not part of the transaction and was fully repaid on 29 April 2022.

The senior loan (55.3% LTV) is backed by a portfolio of 105 multi-let, last-mile industrial properties located throughout the United Kingdom. A total of seven assets have been sold since issuance, resulting in a partial repayment of GBP 8.8 million on the loan. As of the May 2023 interest payment date (IPD), the current loan balance stood at GBP 277.5 million, GBP 229.1 million of which is securitised in this transaction. Blackstone acquired the assets through 16 subportfolio transactions between Q2 2018 and Q1 2019. Blackstone and M7 Real Estate Ltd. manage the portfolios, leveraging its asset and investment management platforms.

The initial maturity date of the loan was on 15 November 2020; however, the borrower had three extension options, all of which it has exercised to extend the maturity date to 15 May 2024.

Based on the metrics provided in the May 2023 servicer report, the portfolio’s performance improved considerably compared with those in May 2022 and at issuance. Debt yield (DY) increased to 13.25% as of the May 2023 IPD compared with 11.39% as of the May 2022 IPD and 10.1% at issuance. The increase in DY is primarily driven by an increase in annualised NRI and the loan’s deleveraging. Annualised NRI increased by 19.0% to GBP 37.8 million as of the May 2023 IPD from GBP 31.8 million as of May 2022 IPD and from GBP 29.1 million at issuance.

The transaction’s LTV ratio improved over the last 12 months and since issuance, owing to the portfolio’s increased valuation and the loan’s deleveraging. Savills’ most recent valuation of the portfolio dated October 2022 noted an increase of 17.14% to GBP 503.0 million on a like-by-like basis from its previous valuation of GBP 429.4 million dated September 2020. As of the May 2023 IPD, the portfolio’s value stood at GBP 502.3 million due to the sale of a single asset after the most recent valuation. As of May 2023, the resulting LTV was 55.26%, which is lower than the LTVs of 64.79% in May 2022 and 66.82% at issuance.

While the portfolio has generally exhibited a stable performance since issuance, the considerable improvement in LTV and DY metrics over the last 12 months has additional positive implications from a credit perspective. Given the collateral’s consistent performance, higher NRI, and current vacancy rate of 9.3%, DBRS Morningstar adjusted its vacancy assumption downward to 12.5% from 15.3% for this review. DBRS Morningstar also adjusted its net cash flow (NCF) assumption for the properties released from the portfolio since last year’s review. As a result of these two changes, DBRS Morningstar’s NCF increased to GBP 21.8 million from GBP 21.6 million. The capitalisation rate assumed remains at 7.2%. The resulting DBRS Morningstar value is GBP 302.1 million, representing a 40.0% haircut to the appraised value of GBP 502.3 million.

The loan structure does not include financial default covenants prior to a permitted change of control, but provides other standard events of default including: (1) any missing payment, including failure to repay the loan by the maturity date; (2) borrower insolvency; and (3) a loan default arising as a result of any creditor’s process or cross-default. Cash trap covenants are set at an LTV of 75% and at a DY of 9.24%. The current loan metrics, with an LTV of 55.26% and a DY of 13.25% as of May 2023 IPD, indicate a comfortable cushion from the listed cash trap covenants.

The loan bears interest at a floating rate equal to compounded daily Sonia (subject to a floor of zero) plus a margin of 2.15%. The transaction benefits from a prepaid cap agreement with Wells Fargo Bank N.A. The agreement matures in May 2024 and has an interest cap strike rate of 3.81%. The cap notional amount is 100% of the outstanding senior loan balance.

The transaction includes a reserve fund note (RFN), which funds 95% of the liquidity reserve (i.e., the note share portion). As of May 2023, the GBP 10.1 million RFN proceeds and the GBP 0.5 million vertical risk retention (VRR) loan contribution stood to the credit of the transaction’s liquidity reserve, which works similarly to a typical liquidity facility by providing liquidity to pay property protection advances, senior costs, and interest shortfalls (if any) in relation to the corresponding VRR loan, Class A1, Class A2, Class B, Class C, and Class D notes (for further details, please see the “Liquidity Support” section in DBRS Morningstar’s rating report for this transaction). According to DBRS Morningstar’s analysis, the liquidity reserve amount will be equivalent to approximately 11.5 months on the covered notes, based on the interest rate cap strike rate of 3.81% per year and 9.5 months based on the Sonia cap of 5.0% per year after loan maturity.

While there is some refinancing risk to consider due to the loan’s maturity in May 2024, DBRS Morningstar considered this risk to be fairly limited given the strong loan metrics in the May 2023 servicer report combined with the general resilience exhibited by logistic assets in the UK.

The final legal maturity of the notes is expected to be in May 2029, five years after the fully extended loan maturity date in May 2024. DBRS Morningstar believes that this provides sufficient time, given the security structure and jurisdiction of the underlying loan, to enforce on the loan collateral if required and repay bondholders.

Class E is subject to an available funds cap where the shortfall is attributable to an increase in the weighted-average margin 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 British pound sterling 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.

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 investor reports and asset status reports from Mount Street Mortgage Servicing Limited and investor reports from U.S. Bank Global Corporate Trust.

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 15 June 2022, when DBRS Morningstar confirmed its ratings on all classes of notes.

The lead analyst responsibilities for this transaction have been transferred to Deniz Gokce.

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

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

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

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

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

Class E Risk Sensitivity:
-- a 10% decline in DBRS Morningstar’s NCF would lead to an expected rating on the Class E notes at B (high) (sf)
-- a 20% decline in DBRS Morningstar’s NCF would lead to an expected rating on the Class E notes at 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. 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 GmbH for use in the European Union.

Lead Analyst: Deniz Gokce, Senior Analyst
Rating Committee Chair: David Lautier, Senior Vice President
Initial Rating Date: 17 May 2019

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 (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].