DBRS Morningstar Comments on Oranje (European Loan Conduit No. 32) DAC Loan Restructuring

DBRS Ratings GmbH (DBRS Morningstar) commented on the recent amendments to the Phoenix loan securitised in Oranje (European Loan Conduit No. 32) DAC.

In August 2023 the Phoenix loan’s maturity (the only remaining facility of the initial five facilities included in the transaction) was extended to 15 August 2024 from 15 August 2023.

In connection with the loan extension;
a) The loan margin was agreed to be amended to 3.872% from 1.90%;
b) The definition of “Disposal Proceeds” was agreed to be amended to “the net disposal proceeds as defined in paragraph (e) of Clause 24.4 (Disposals) (after sales costs) to be applied to reducing loan amount”;
c) The hedging provisions under Clause 12.1 (Terms of Hedge Documents) of the Phoenix Facility Agreement will continue to apply until the new termination date;
d) All hedging transactions must provide for an interest rate cap with a weighted-average strike rate on any day of no more than 3.5%;
e) A condition subsequent was added to the Phoenix Facility Agreement whereby the Phoenix borrower will ensure that on 31 March 2024 the outstanding balance of the loan does not exceed EUR 45 million. A breach of this condition subsequent requires the exercise of a cure right in accordance with Clause 23.3 (Cure Rights) of the Phoenix Facility Agreement;
f) As a result of the increased margin on the loan, additional amounts will be received by the Issuer, therefore the definition of relevant margin in respect of the notes was amended to take into account such additional amounts, such that they form part of the applicable interest amount to be paid to noteholders.

The CMBS notes’ maturity remains unchanged at 15 November 2028, resulting in a shorter tail period of four years instead of the initial five years at issuance.

The extension of the Phoenix termination date did not constitute a basic terms modification as the date of maturity was extended to a date that is no more than 12 months after the initial maturity date of the loan. The servicer concluded that granting its consent to the loan extension amongst the other loan amendments was consistent with the servicing standard and therefore did not require the consent of the noteholders.

As a part of the loan extension, a further partial repayment of EUR 2.9 million was made at the August 2023 interest payment date, which reduced the net debt to EUR 72.5 million, resulting in a loan-to-value (LTV) of 49.8%. Going forward, net disposal proceeds received by the Issuer will be allocated in line with the “prior to note acceleration” waterfall, which is 70% pro rata and 30% sequential, with the pro rata payment applied first.

An interest rate cap agreement was entered into between the Phoenix Borrower and Bank of America Europe Designated Activity Company (as cap provider) on 15 August 2023. The cap strike rate is 3.5% against the full notional amount of EUR 72.5 million and the cap will terminate on the extended loan maturity date of 15 August 2024. As a result of the increase in loan margin, the relevant margin paid to the noteholders was also amended.

The loan amendments did not constitute a basic terms modification on the basis that they do not result in a reduction in the amount of principal or the rate of interest payable in respect of any class of notes and do not constitute a modification of the method of calculating the amount payable in respect of any interest or principal. While the note amendments would constitute a Class X entrenched right, a written extraordinary resolution of the sole Class X noteholder has been duly passed whereby the sole Class X noteholder directed the note trustee and Issuer security trustee who concurred with the Issuer and entered into the deed of amendment effecting the note amendments as of 15 August 2023.

The transaction still benefits from a EUR 3.1 million liquidity facility (EUR 9.0 million at closing) provided by Wells Fargo Bank, N.A., London branch, which can be used to cover interest payments on the Class A, Class B, Class C, and Class D notes. The facility was extended until 15 August 2024 and amortises in line with the amortisation of the covered notes. According to DBRS Morningstar’s analysis, the commitment amount could provide interest payments on the covered notes of up to 8.2 and 6.8 months based on the interest rate cap strike rate of 3.5% and the Euribor cap of 5.0% after loan maturity, respectively. This is a significant reduction from pre-loan extension, where coverage of interest on the covered notes was in excess of 12 months, (based on the cap strike rate of 2.5% and a Euribor cap of 5.0%). Although the higher cap strike rate and the step up in margin have shortened the length of time that liquidity support is available, DBRS Morningstar notes that if the loan had not been extended and a loan failure event had occurred, the loan would have accrued default interest of an additional 2.0%, which would not have been covered by the liquidity support. DBRS Morningstar believes that in the short term, specifically before March 2024, the likelihood of any drawings under the liquidity facility will be extremely low.

The Phoenix loan is secured against a portfolio of 12 office properties (18 at issuance) across ten cities in the Netherlands. The latest revaluation was carried out by Jones Lang Lasalle (JLL) in April 2023 and resulted in a market value of EUR 145.7 million, which marks a 14% decrease from the EUR 169.3 million Savills valuation in February 2022. The underlying portfolio cash flow metrics continue to perform in line with that of issuance with annual contracted rent of EUR 12.8 million and vacancy of 21.1% as of August 2023. As such, the DBRS Morningstar net cash flow and value assumptions remain unchanged at EUR 7.8 million and EUR 108.2 million, respectively. Of the top five assets by market value, three carry most of the portfolio vacancy: Zuidtoren, 50%; Porta Mosae, 14%, and Zen Building, 17%. DBRS Morningstar understands that there is an active lease up plan with respect to the Zuidtoren asset after its repositioning, but will continue to monitor the transaction with respect to actual sales.

In DBRS Morningstar’s opinion the loan amendments offer a slightly weaker position than if a loan event of default had been triggered and if the loan had been transferred into special servicing because (i) it allows for equity to be released back to the sponsor after property disposals; (ii) the extension increases the likelihood of cherry picking as it incentivises the sponsor to sell the stronger assets in order to meet the repayment obligation in March next year. As a result, DBRS Morningstar expects that at the extended loan maturity, the portfolio would comprise weaker assets, leading to a more complex and lengthier workout; (iii) excess spread is neither credited to the Class X diversion ledger nor subordinated to the principal due on the notes, which would have been the case had the loan not been extended and; (iv) the application of proceeds remain unchanged whereas proceeds following a loan failure event would have been applied sequentially to the notes, repaying the most senior class of notes first. However, the condition subsequent that the Phoenix borrower is obligated to prepay the loan by March 2024 so that the outstanding loan balance does not exceed EUR 45 million represents a significant milestone and until then, the executed loan amendments remain credit neutral for the transaction. As such, DBRS Morningstar did not take any further credit rating action as a result of the amendments. The trend on all classes of Notes remains Negative.

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-rating (4 July 2023).

Notes:
All figures are in euros unless otherwise noted.

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.

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