DBRS Morningstar Downgrades and Confirms Ratings on HAUS (European Loan Conduit No. 39) DAC

DBRS Ratings GmbH (DBRS Morningstar) took the following rating actions on the commercial mortgage-backed floating-rate notes due July 2051 (the Notes) issued by HAUS (European Loan Conduit No. 39) DAC (the Issuer):

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

The trends remain Negative.

The rating actions reflect DBRS Morningstar’s revised underwriting assumptions, including a higher capitalisation rate (cap rate) resulting in a lower DBRS Morningstar value of EUR 366.4 million compared with EUR 385.0 million at the last review of the transaction. DBRS Morningstar increased the cap rate because of the deteriorated quality of the collateral buildings and higher construction costs, accounted for in Knight Frank Limited’s (Knight Frank) latest valuation of the properties at EUR 423.7 million as of October 2022, compared with EUR 469.7 million in March 2021(-9.8%). The deterioration of the portfolio’s performance and valuation are also reflected in weaker loan-to-value (LTV) and debt yield (DY) ratios. Given the deteriorated loan key credit metrics, the rating trends remain Negative.

The transaction is a securitisation of a EUR 318.75 million loan arranged by Morgan Stanley & Co. International plc in August 2021. The loan facility is secured by a portfolio of 6,284 multifamily residential units across 92 sites (equivalent to 59 properties) in Germany. The loan refinanced the acquisition of the portfolio by eight German borrowers, ultimately controlled by the main sponsor, Brookfield Property Group L.P. (Brookfield).

At issuance, Brookfield had a majority interest in the portfolio (approximately 90%) with the seller (a group of high-net-worth individuals) retaining a minority stake. The seller was retained as the asset/property manager under Belvona Asset Management Limited. Following the seller’s exit in March 2023, the sponsor gained full control and appointed a new asset manager, MVGM Property Management Germany GmbH, to speed up the delivery of the initial business plan.

According to the initial business plan, the portfolio had suffered a period of underinvestment and the occupancy rate was around 60% at issuance. The business plan provided for a refurbishment program aimed at creating significant revisionary upside in the first two years. The plan was to achieve a modernisation rate of 75% of certain unmodernised units across the portfolio. At the cut-off date, the seller funded a capital expenditure (capex) guarantee of EUR 39.5 million and a rent guarantee of EUR 23.3 million to cover the shortfall between the expected EUR 35 million stabilised rent level and the actual rent level. The rent reserve was depleted during 2022 and topped up by the sponsor since. The rental guarantee implies top-up commitment, now endorsed by the sponsor under the equity commitment agreement, until December 2024. As for the capex account, in March 2023, the sponsor benefitted from a balance of EUR 22.7 million in the escrow account and agreed to contribute additional amounts toward increased construction and backlog capex costs.

The outstanding whole-loan amount has remained unchanged at EUR 318.75 million since origination because the loan is interest only until the initial loan maturity in July 2026 when, if extended, a cash sweep trigger will be place. The loan may be extended on an annual basis until July 2046, provided that certain condition precedents are met.

The loan carries a floating rate of Euribor plus a 1.98% margin for the first two years since closing, after which the margin will step down to 1.84% until the initial maturity date. Following the extension of the loan in July 2026, the margin will step up to 3.25% . Hedging is 100% on the notional outstanding loan amount, with a cap strike rate of 2.0% expiring in July 2024. The subsequent hedging arrangement until initial loan maturity in July 2026 is expected to have a strike rate of 2.0%, necessitating sponsor support considering current market interest rates.

As of the April 2023 interest payment date, the LTV ratio was 75.2%, up from 67.9% at the last review and at the cut-off date.

The loan does not have financial default covenants; however, there are cash trap covenants set at 77.9% for the LTV and 8.5% for the DY starting from the third year and increasing up to 9.0% from October 2024. Following the initial maturity date, DY and LTV covenants are set at 7.0% and 75%, respectively, and will be tested on an annual basis to extend the loan. The DY in April 2023 was 3.44%. A DY cash trap event is continuing since April 2022, but there is no surplus cash to move to the cash trap account.

The property and tenancy profiles are granular, with the top 10 assets accounting for 40% of portfolio net cold rent and 40% of the lettable area as of April 2023. According to the most recent servicer report available, the annual contractual rent as at April 2023 was EUR 18.43 million and the projected net rental income was EUR 10.96 million. According to the sponsor, the unit renovation program has averaged 100+ units per month since March 2023 and a total of 1,090 units have been refurbished since the acquisition. Also, the leasing of refurbished units has occurred at market rates with an average of EUR 7.9 per square metre (sqm) per month, 34% higher than current average in-place rents of EUR 5.9 per sqm per month. External leasing agents have been engaged to improve performance and implement rental uplift on in-place rents in line with government regulations.

Given the sponsor’s equity commitment to fund interest shortfall and capex needs for the refurbishment program, DBRS Morningstar maintained the initial assumptions in its net cash flow (NCF) analysis, resulting in a DBRS Morningstar net cold rent of EUR 28.3 million and DBRS Morningstar NCF of EUR 21.07 million. DBRS Morningstar increased its cap rate assumption to 5.75% from 5.47%, resulting in a DBRS Morningstar value of EUR 366.4 million, a 18% haircut to the appraiser’s valuation.

The Class X interest diversion trigger event followed the loan’s DY breach of 5.5% during the second year and Class X interests were not distributed since. The Class X interest amount and the vertical risk retention (VRR) loan proportion of that amount have been diverted to the Issuer’s transaction account and credited to the Class X diversion ledger. The amount credited to the ledger was EUR 3.6 million at the August 2023 payment date.

On the closing date, the Issuer used EUR 12.5 million of the proceeds from the issuance of the Class A1 notes and the proportionate VRR loan amount to fund its liquidity reserve in an aggregate amount of EUR 13.157 million. The Issuer can use its liquidity reserve to cover interest shortfalls on the Class A1, Class A2, and Class B notes. As of August 2023, the liquidity facility balance reduced slightly to EUR 13.154 million. The liquidity reserve amount can provide interest payments on the covered notes for up to 15 months or 10 months based on the interest rate cap strike rate of 2.0% or on the Euribor cap of 4.0%, respectively.

The transaction is structured with a five-year tail period to allow the special servicer to work out the loan at maturity by July 2051, which is the Notes’ final legal maturity.

DBRS Morningstar’s credit rating on HAUS (European Loan Conduit No. 39) DAC addresses the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents.

DBRS Morningstar’s credit rating does not address non-payment risk associated with contractual payment obligations contemplated in the applicable transaction documents that are not financial obligations. For example, Euribor excess amounts, pro rata default interest amounts, and note prepayment fees.

DBRS Morningstar’s long-term credit ratings provide opinions on risk of default. DBRS Morningstar considers risk of default to be the risk that an issuer will fail to satisfy the financial obligations in accordance with the terms under which a long-term obligation has been issued.

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/416784.

Notes:
All figures are in euros unless otherwise noted.

The principal methodology applicable to the credit 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 credit 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.

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.

The sources of data and information used for these credit ratings include Regulatory Information Service notice, quarterly servicer reports and the latest available tenancy schedules provided by Mount Street Mortgage Servicing Limited, quarterly cash manager reports prepared by U.S. Bank Global Corporate Trust Limited, and valuation reports prepared by Knight Frank.

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

At the time of the initial credit ratings, DBRS Morningstar was not supplied with third-party assessments. However, this did not impact the credit rating analysis.

DBRS Morningstar considers the data and information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

DBRS Morningstar does not audit or independently verify the data or information it receives in connection with the credit rating process.

The last credit rating action on this transaction took place on 16 August 2022, when DBRS Morningstar confirmed its ratings on the Class A1, Class A2, Class B, Class C, and Class D notes at AAA (sf), AAA (sf), AA (low) (sf), A (low) (sf), and BBB (low) (sf), respectively, and changed the trends to Negative from Stable.

Information regarding DBRS Morningstar credit 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 credit rating, DBRS Morningstar considered the following stress scenarios as compared with the parameters used to determine the credit 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 A notes at AA (high) (sf)
-- A 20% decline in DBRS Morningstar’s NCF would lead to an expected rating on the Class A notes at A (low) (sf)

Class A2 Risk Sensitivity:
-- A 10% decline in DBRS Morningstar’s NCF would lead to an expected rating on the Class A notes at A (low) (sf)
-- A 20% decline in DBRS Morningstar’s NCF would lead to an expected rating on the Class A notes at BBB (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 BBB (high) (sf)
-- A 20% decline in DBRS Morningstar’s NCF would lead to an expected rating on the Class B notes at BB (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 (low) (sf)
-- A 20% decline in DBRS Morningstar’s NCF would lead to an expected rating on the Class C notes at BB (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 B (high) (sf)
-- A 20% decline in DBRS Morningstar’s NCF would lead to an expected rating on the Class D notes at below B (low) (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 credit 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://registers.esma.europa.eu/cerep-publication/. 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 credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Patrizia Catanese, Assistant Vice President
Rating Committee Chair: Christian Aufsatz, Managing Director
Initial Rating Date: 29 July 2021

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 credit 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.
-- 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.
-- Legal Criteria for European Structured Finance Transactions (30 June 2023), https://www.dbrsmorningstar.com/research/416730/legal-criteria-for-european-structured-finance-transactions.
-- DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (4 July 2023), https://www.dbrsmorningstar.com/research/416784.

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].