DBRS Morningstar Downgrades Ratings on River Green Finance 2020 DAC, Maintains Stable Trends

DBRS Ratings GmbH (DBRS Morningstar) downgraded its ratings on the commercial mortgage-backed floating-rate notes due January 2032 issued by River Green Finance 2020 DAC (the Issuer) as follows:

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

All trends are Stable.

River Green Finance 2020 DAC is the securitisation of a EUR 196.2 million floating-rate commercial real estate loan split into two different facilities (Facility A and Facility B) both advanced by Goldman Sachs International Bank (GS). The EUR 35.8 million Facility A was advanced to four ring-fenced compartments of LRC RE-2, a Luxemburg investment company with variable share capital - reserved alternative investment fund (the Facility A Borrower), while the EUR 160.4 million Facility B was advanced to a French Organisme de Placement Collectif Immobilier (the Facility B Borrower). The Issuer purchased the loan using the proceeds from the notes’ issuance (95.0% of the purchase price) and from an issuer loan advanced by GS (5.0% of the purchase price). The debt facilitated the acquisition of the River Ouest building by a group of investors led by LRC Real Estate Limited (the Sponsors).

River Ouest is a campus-style office with amenities including restaurants, terraces, an auditorium, a fitness club, and concierge services located in the Bezons municipality in Paris’ western suburbs. A major business district, La Défense, is approximately five kilometres southeast of the asset. Built in 2009, it was awarded a sustainability rating of "Very Good" under the Building Research Establishment Environmental Assessment Method scheme on 25 January 2017.

CREDIT RATING RATIONALE

The downgrade across all classes of notes reflects greater refinance risk due to a property value decline and weakening of the tenant profile. Although the asset is currently performing with respect to its loan metrics, 83.0% of total rental income comes from a lease to Atos, a French multinational IT and consulting company whose credit outlook is now deemed to be weaker than it was at issuance. The next largest tenant is Dell Technologies, contributing 15.1% of total rent; its lease is due to expire in September 2023, and DBRS Morningstar understands that negotiations about a lease extension or renewal are ongoing. The remaining 1.9% of the rent comes from Sophos Group plc, which is currently occupying under a rolling month-to-month contract, and similarly, lease negotiations are still ongoing.

According to the latest valuation conducted by CBRE Limited (CBRE) in January 2023, the value of the asset decreased to EUR 307.0 million from EUR 337.4 million, representing a fall of 9.0%. As a result of the revaluation, the loan-to-value (LTV) increased to 61.8% as at April 2023 from 56.4% in the previous quarter. The loan was initially scheduled to mature on 15 January 2023, with two one-year conditional extension options available to the borrowers. The borrowers exercised the first extension option, thus extending the loan’s maturity to 15 January 2024 (the first extended termination date) following satisfaction of the required conditions. According to a notice from the Issuer in January 2023, some amendments were agreed, including increasing the maximum strike rate for the new interest rate cap agreement to 5.0% from 2.5%, which also equals the Euribor cap after the expected loan maturity.

According to the latest servicer report, as of the July 2023 interest payment date, the outstanding whole loan balance stands at EUR 189.3 million, which is 3.5% lower than the original loan amount. The loan amortises at a rate of 1.0% per annum (p.a.) of the original loan amount, with a step-up to 2.0% in the fifth year, should the loan still be outstanding at that time.

The property’s occupancy rate of 98.4% has not changed since issuance, although annual gross rental income has increased through indexation to EUR 25.2 million from EUR 23.7 million and the weighted-average lease term is currently 5.9 years. Since closing, there have been no arrears, with 100% of scheduled rent always collected.

Recent hybrid working trends continue to weigh on office occupiers’ leasing plans, and, coupled with an increase in office supply in Bezons and the surrounding regions, there is now more direct competition from nearby assets; consequently, vacancy rates in the submarket have risen. Although the property benefits from being a high-quality asset in a good state of repair, the asset is slightly compromised in respect to location when compared with other currently available space in the area. Consequently, DBRS Morningstar revised its stabilised vacancy assumptions to 15.0% from 11.9%. This also reflects in part the long-term nature of lease negotiations with respect to Dell Technologies and Sophos Group plc. Additionally, DBRS Morningstar has increased its tenant improvements (TIs) and leasing commissions (LCs) deductions from the cash flow, reflecting the weakening credit profile of the largest tenant, Atos. The resulting DBRS Morningstar net cash flow (NCF) assumption slightly decreased to EUR 18.1 million from EUR 18.3 million at issuance. In addition, DBRS Morningstar revised its capitalisation rate assumption to 7.25% from 6.8%, largely reflecting continued increases in interest rates that have led to further uncertainty in the property investment market. These changes translate to a DBRS Morningstar value of EUR 249.3 million, representing an 18.8% haircut to CBRE’s most recent valuation. The decline in the DBRS Morningstar value has resulted in DBRS Morningstar downgrading its credit ratings on all classes of notes.

The loan accrues interest at the aggregate of three-month Euribor (floored at zero) plus a margin of 2.4% and it is fully hedged with a prepaid interest rate cap provided by Wells Fargo Bank, N.A. (rated AA with a Stable trend by DBRS Morningstar) with a strike rate of 5.0%. The cap agreement terminates on 24 January 2024.

There are three sets of cash trap covenants based on performance ratios, withholding tax (WHT) liability, and technical and environmental (T&E) items. The performance ratio cash trap covenants are set at 10.27% for debt yield (DY) calculated based on 12-month forward-looking adjusted net rental income and a 62.15% LTV based on the latest valuation. The WHT cash trap is triggered by any action, claim, investigation, or proceeding commenced or announced by the French tax administration or any other person, without limitation, to levy WHT at a rate greater than the rate then currently provided for by the French Tax Code (currently 15%) on the dividend distribution by the Facility B Borrower. Under the WHT cash trap, an amount corresponding to the increased tax exposure will be trapped after paying senior costs and interest but before the performance ratio and T&E cash trap amounts. The T&E items cash trap is meant to incentivise the Sponsor to carry out the immediate remedial works identified in the T&E reports at issuance. According to a notice from the Issuer dated 30 January 2023, the servicer has agreed to further extend the deadline for the Facility B Borrower to remedy T&E defects under the T&E items cash trap trigger to 30 September 2023. In particular, the borrower provided the servicer with satisfactory evidence that it had undertaken its best endeavours to remedy each of the T&E defects, a condition for the deadline to be extended under limb (b) of the definition of a T&E items cash trap event.

The loan includes financial default covenants which are based on 67.15% LTV and 9.39% DY ratios. A non-cured financial covenant breach will trigger a loan event of default and, subsequently, the acceleration of the loan.

The transaction is supported by a EUR 10.9 million liquidity facility (EUR 11.3 million at origination). The liquidity facility was provided by Crédit Agricole Corporate and Investment Bank at issuance and can be used to cover interest shortfalls on the Class A to the Class C notes (the covered notes), as well as the issuer loan. Following the increase in the cap strike rate to 5.0%, the estimated coverage amounts to approximately 14 months.

DBRS Morningstar’s credit ratings on Classes A, B, C, and D of the commercial mortgage-backed floating-rate notes issued by River Green Finance 2020 DAC address the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents.

DBRS Morningstar’s credit ratings do not address non-payment risk associated with contractual payment obligations contemplated in the applicable transaction documents that are not financial obligations. For example, pro rata default interest, Euribor excess amount, and 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/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 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 credit 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/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 credit ratings include data from the servicer reports published by Mount Street Mortgage Servicing Limited, as well as a valuation report prepared by CBRE and dated 7 March 2023.

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 9 February 2023, when DBRS Morningstar confirmed its AAA (sf), AA (low) (sf), A (low) (sf), and BBB (sf) credit ratings on the Class A, Class B, Class C, and Class D notes, respectively, with Stable trends.

The lead analyst responsibilities for this transaction have been transferred to Andrea Selvarolo.

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

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

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

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

Class D Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating on Class D notes to BB (high) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating on Class D notes to BB (low) (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://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: Andrea Selvarolo, Senior Analyst
Rating Committee Chair: Christian Aufsatz, Managing Director
Initial Rating Date: 8 January 2020

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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.
-- 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
-- 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 (4 July 2023), https://www.dbrsmorningstar.com/research/416784/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].