DBRS Morningstar Takes Rating Actions on FROSN-2018 DAC

DBRS Ratings GmbH (DBRS Morningstar) removed the Under Review with Negative Implication status on its ratings on Classes A2, B, C, D, and E of the commercial mortgage-backed floating-rate notes due May 2028 issued by FROSN-2018 DAC; confirmed its AAA (sf) ratings on Class RFN; and downgraded Classes A1, A2, B, C, D, and E as follows:

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

DBRS Morningstar confirmed the Stable trend on the Class RFN notes and Negative trend on the Class A1 notes, and assigned a Negative Trend on the Classes A2, B, C, D, and E notes.

RATING RATIONALE
The downgrade rationale is based on the deteriorated value of the underlying collateral and the uncertainty around the timing of the workout strategy pursued by the special servicer. Given the volatility of the cash flow, the absence of amortisation, and the macroeconomics, further deterioration of the key credit metrics cannot be discarded in the future.

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 capital expenditure (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 Ltd.’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 May 2023 interest payment date (IPD), 45 assets remain in the portfolio. The aggregate outstanding balance of the senior loan and senior capex loan has reduced 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. In addition, there was also an EUR 103.8 million mezzanine facility at issuance, which was repaid on 30 November 2022.

Following the borrower’s failure to repay the loan at maturity on 15 February 2023, and the noteholders’ rejection to pass the restructuring proposal brought forward by the sponsor, Mount Street Mortgage Servicing Limited (the servicer and special servicer) transferred the loan to special servicing on 2 March 2023. The special servicer, at this stage, is providing short-term standstill agreements since pursuing a consensual workout strategy.

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 (p.a.) margin, and a default interest of 1.0% p.a., the latter being compounded since the occurrence of the loan failure event. Past maturity, the loan remained unhedged.

Jones Lang LaSalle Limited (JLL) revalued the portfolio on 31 March 2023 and appraised the aggregate market value of the 45 properties at EUR 345.8 million, a 32.7% drop from the 2021 valuation. This results into a loan-to-value (LTV) ratio of 86.3% as of the May 2023 IPD, a sharp increase from 57.7% LTV reported last quarter, and a breach of the transaction’s cash trap covenant of 60.0%.

The portfolio’s performance deteriorated following the onset of the Coronavirus Disease (COVID-19) pandemic with a sharp increase of the portfolio’s vacancy up to 47.5% as of May 2023 from 29.2% at issuance. Also, DBRS Morningstar observes an increase of operating costs, which translates into a drop of adjusted net rental income to EUR 24.5 million as of May 2023. The debt yield (DY) cash trap covenant has been breached since mid-2020. As of May 2023 IPD, the DY stands at 8.2%, less than the cash trap threshold of 11.0%. The DY for this period is 8.2%, still below the cash trap threshold. The DY has decreased primarily due the drawing of the cash trap account, increasing net debt. The balance of the cash trap account stands at EUR 11.7 million as of May 2023 IPD. The funds are used toward capex works to maintain the portfolio value in view of the sales program.

The special servicer communicated that two assets have been approved for sale, which combined would provide approximately EUR 5.7 million of gross sales proceeds versus a combined allocated loan amount of EUR 3.3 million. The release price will be applied toward the repayment of the notes in sequential order, while the difference of the disposal proceeds will be kept into the cash trap account.

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 May 2023 IPD, EUR 953,537 of the Euribor excess amount have been applied toward repayment of the Class RFN (EUR 47,778) and the Class A1 (EUR 905,759) notes.

DBRS Morningstar underwrote a new analysis with the following assumptions: capitalisation rate at 9% and net class flow (NCF) of EUR 24.8 million. The analysis resulted in a DBRS Morningstar value of EUR 276.1 million, representing a 20.2% haircut to appraised value. This is a decline of 14.3% from DBRS Morningstar value at last review, which led to DBRS Morningstar downgrading its ratings on classes A1 to E notes.

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 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’ interest coverage on the covered notes, based on the 4.25% Euribor cap after loan maturity.

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 factor(s) 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.

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.

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 the quarterly investor reports as well as the latest available tenancy schedule provided by Mount Street Mortgage Servicing Limited, the valuation reports produced by CBRE Limited and JLL, and the cash manager reports by U.S. Bank Trustees Limited.

DBRS Morningstar did not rely upon third-party due diligence in order to conduct its analysis.

At the time of the initial rating, 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 4 April 2023, when DBRS Morningstar confirmed its ratings on Class RFN and Class A1 notes, placed Class A2 through Class E notes UR-Neg., while maintaining a Stable trend on the Class RFN notes, and a Negative trend on the Class A1 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 rating, DBRS Morningstar considered the following stress scenarios as compared with the parameters used to determine the rating (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.

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: Mark Wilder, Senior Vice President
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 (30 June 2023),
https://www.dbrsmorningstar.com/research/416730/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 (16 June 2023), https://www.dbrsmorningstar.com/research/415976/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].