DBRS Morningstar Confirms Credit Ratings on All Classes of Helios (European Loan Conduit No. 37) DAC, Changes Trends on Classes A to D to Stable from Negative

DBRS Ratings Limited (DBRS Morningstar) confirmed its credit ratings on the following classes of notes issued by Helios (European Loan Conduit No. 37) DAC (the Issuer):

-- Class RFN notes at AAA (sf)
-- Class A notes at AAA (sf)
-- Class B notes at A (high) (sf)
-- Class C notes at BBB (sf)
-- Class D notes at BB (high) (sf)
-- Class E notes at B (high) (sf)

DBRS Morningstar also changed the trends on Classes A, B, C, and D to Stable from Negative. The trend on Class RFN remains Stable and the trend on Class E remains Negative.

The credit rating confirmations and the trend change on the Class A to Class D notes reflect the transaction’s stable performance over the past 12 months and the improving credit metrics. DBRS Morningstar maintained its Negative trend on Class E because of the shortfall in interest distributed to Class E noteholders over the last year with the exception of the quarter ended in August 2023. Class E noteholders also did not receive the full accrued interest amount on the November 2023 Interest Payment Date (IPD). The shortfall in Class E interest payments does not accrue because of the Available Funds Cap.

Helios (European Loan Conduit No. 37) DAC is the securitisation of a single loan, which had a balance of GBP 350 million at issuance. The senior loan matures on 12 December 2024 and the final note maturity is on 2 May 2030. The loan is secured by a portfolio of 49 limited-service hotels located across the United Kingdom. With the exception of the Hampton by Hilton in Liverpool and the Park Inn hotel in York, the portfolio entirely comprises Holiday Inn Express hotels.

The ultimate beneficial owner of the portfolio is London & Regional Group (L&R), which acquired the hotels from Lone Star Funds in 2016. The hotels are managed by Atlas Hotels Group, which was also acquired as part of the transaction in 2016 and is now a wholly owned operating company of L&R. The Park Inn York and Holiday Inn Express Poole properties are subject to operating leases with rental income received from the tenants.

Debt yield and loan-to-value (LTV) metrics both showed improvement over the last year caused by an increase in the collateral’s net operating income and an increase in the market value of the portfolio, respectively. The annual 0.75% amortization of the senior loan also contributed to the improvement of these metrics. The loan amortizes each quarter by GBP 656,250. The loan balance is approximately GBP 310.8 million as of the August 2023 IPD.

According to Savills Advisory Services Limited’s (Savills) valuation dated 20 January 2023, the aggregated market value of the 49 properties in the securitised portfolio is GBP 490.0 million. The most recent valuation represents an increase of 3.8% in market value over the previous valuation of GBP 472.0 million, which was carried out by Cushman & Wakefield in January 2021. The increase in value, along with the amortisation of the loan, resulted in a decline in LTV to 63.43% as of the August 2023 IPD from 66.41% as of the August 2022 IPD.

Net operating income (NOI) for the trailing 12 months (T-12) similarly improved over the last year. T-12 NOI as of June 2023 was GBP 45.6 million, up from the reported T-12 NOI of GBP 41.4 million as of June 2022. The increase in NOI and the amortisation of the loan resulted in an increase in debt yield to 14.64% as of the August 2023 IPD from 13.17% as of the August 2022 IPD.

While the loan metrics improved over the last year, Class E distributed interest still shows a shortfall against the total accrued interest amount for Class E. The November 2023 cash manager’s report indicates a shortfall of approximately GBP 127,000 in interest distributed to Class E noteholders.

The shortfall is due to the GBP 30.0 million prepayment of the senior loan that took place in October 2021. which partially redeemed Class A notes and caused the spread between the loan margin and note margin to tighten. DBRS Morningstar calculates the weighted-average margin of the notes to be 3.19%, which reduces the excess spread between the note margin and the loan margin (3.25%) and, together with the presence of the senior ranking issuer costs, has started to eat into the interest amount payable in respect of the Class E notes since the February 2022 IPD. While the full accrued interest for Class E was distributed to the Class E noteholders on the August 2023 IPD, the November cash manager’s report once again indicates a shortfall in Class E interest paid out to noteholders for the November 2023 IPD. This shortfall does not accrue because of the Class E Available Funds provision.

According to the Class E Available Funds Cap provision, interest due and payable on the Class E notes, in the event that a shortfall attributable to partial prepayments of the senior loan occurs, is (on any note payment date prior to the service of a note acceleration notice) subject to a cap equal to the lesser of (1)
the note interest amount applicable to the Class E notes (Class E Interest Amount) and (2) the difference between the revenue receipts or the available funds, as the case may be, available on the relevant payment date and the sum of all amounts payable out of the revenue receipts or the available funds, as the case may be, on such payment date in priority to the payment of interest on the Class E notes (Class E Adjusted Interest Amount).

DBRS Morningstar maintained its net cash flow (NCF) assumption at GBP 33.0 million and the capitalisation rate at 8.9%, which translates into a DBRS Morningstar value of GBP 367.2 million, a 25.1% haircut to the latest market value provided by Savills, as of January 2023. DBRS Morningstar maintained its underwritten 73% portfolio-wide occupancy rate.

The transaction includes a reserve fund note (RFN), which funds 95% of the liquidity reserve (i.e., the note share portion). As of November 2023, the GBP 13.4 million RFN proceeds and the GBP 0.7 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 and the Class A, 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 9.5 months on the covered notes, based on the interest rate cap strike rate of 5% per year.

Because of prevailing market conditions, in November 2022 the senior borrower requested that, in respect of the hedging agreement to be entered into on a date not later than the date falling three business days prior to the third anniversary of the utilisation date (in December 2022), the strike rate be set at 5% per annum as opposed to 3% per annum as required by the Senior Facility Agreement. The borrower agreed to deposit approximately GBP 6.2 million into the debt service account to mitigate any potential cash flow shortfall that could result from the higher strike rate. This request from the borrower was agreed to by the servicer with an amendment letter dated 17 November 2022. The current hedging agreement, which has an interest rate cap strike rate of 5%, will expire in December 2023. The above-mentioned GBP 6.2 million was drawn upon at each IPD in accordance with the Hedging Reserve Amount schedule provided in the amendment letter. The schedule indicates the amount allocated to each IPD starting on the January 2023 IPD up to and including the January 2024 IPD to cover the term of the current hedging agreement. Unused funds left over from debt service are remitted to the borrower at each IPD. The amount on deposit will be zero once the January 2024 IPD transfers are complete.

The final legal maturity of the notes is expected to be in May 2030, five-and-a-half years after the fully extended loan term. Given the security structure and jurisdiction of the underlying loan, DBRS Morningstar believes the final legal maturity date provides sufficient time to enforce, if necessary, on the loan collateral and repay the bondholders.

DBRS Morningstar’s credit ratings on the notes issued by the Issuer address the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents. The associated financial obligations are principal amounts and interest amounts.

DBRS Morningstar’s credit ratings do not address non-payment risk associated with contractual payment obligations contemplated in the applicable transaction document(s) that are not financial obligations. For example, Default Interest Amounts, Note Prepayment Fees, and the excess of the Class E Interest Amount over the Class E Adjusted Interest Amount in cases where the Available Funds Cap applies.

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. The DBRS Morningstar short-term debt rating scale provides an opinion on the risk that an issuer will not meet its short-term financial obligations in a timely manner.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a relevant or significant 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 (4 July 2023).

Notes:
All figures are in British pound sterling unless otherwise noted.

The principal methodology applicable to the credit ratings is: European CMBS Rating and Surveillance Methodology (19 October 2023), https://www.dbrsmorningstar.com/research/422173/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/421590.

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 valuation reports by Savills, servicer reports by Mount Street Mortgage Servicing Limited, and cash management 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 credit rating, 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 18 November 2022, when DBRS Morningstar removed its credit rating on the Class E notes from Under Review with Negative Implications and confirmed the credit rating at B (high) (sf) with a Negative trend.

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

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 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 credit rating of the Class A notes at AAA (sf)
-- 20% decline in DBRS Morningstar NCF, expected credit rating of the Class A notes at AA (high) (sf)

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

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

Class D Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected credit rating of the Class D notes at BB (high) (sf)
-- 20% decline in DBRS Morningstar NCF, expected credit rating of the Class D notes at BB (sf)

Class E Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected credit rating of the Class E notes at B (high) (sf)
-- 20% decline in DBRS Morningstar NCF, expected credit rating of 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://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 GmbH for use in the European Union.

Lead Analyst: Deniz Gokce, Senior Analyst
Rating Committee Chair: David Lautier, Senior Vice President
Initial Rating Date: 16 December 2019

DBRS Ratings Limited
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London EC1Y 1HQ United Kingdom
Tel. +44 (0) 20 7855 6600
Registered and incorporated under the laws of England and Wales: Company No. 7139960

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 (19 October 2023),
https://www.dbrsmorningstar.com/research/422173/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 (15 September 2023),
https://www.dbrsmorningstar.com/research/420602/interest-rate-stresses-for-european-structured-finance-transactions.
-- Derivative Criteria for European Structured Finance Transactions (18 September 2023),
https://www.dbrsmorningstar.com/research/420754/derivative-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/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].