Morningstar DBRS Confirms Credit Ratings on Deco 2019 - Vivaldi S.R.L. with Negative Trends; Removes from Under Review with Positive Implications

DBRS Ratings GmbH (Morningstar DBRS) confirmed the credit ratings on the commercial mortgage-backed security notes, due August 2031, issued by Deco 2019 S.R.L. (the Issuer) as follows:

-- Class A Notes at A (high) (sf)
-- Class B Notes at BBB (sf)
-- Class C Notes at BB (high) (sf)
-- Class D Notes at B (high) (sf)

The trend on all credit ratings is Negative. Morningstar DBRS also removed the credit ratings on the notes from Under Review with Positive Implications (UR-Pos.), where they were initially placed on 13 October 2023 and maintained on 21 December 2023.

CREDIT RATING RATIONALE
The credit ratings confirmation of all classes of notes results from the stable performance of the securitised senior commercial real estate (CRE) loans over the last 12 months coupled with Morningstar DBRS’ removal of a stress scenario regime for sovereigns rated in the “A” category or below, as further detailed in the following press release: https://dbrs.morningstar.com/research/421863.

The transaction is a securitisation of an approximately 95% interest in two refinancing facilities, the Franciacorta loan and the Palmanova loan, each backed by a retail outlet village located in Northern Italy and managed by Multi Outlet Management Italy S.r.l. The borrowers are ultimately owned by the funds controlled by Blackstone LLP (the Sponsor) and are managed by Kryalos SGR S.p.a. The loans are interest only prior to a permitted change of control (P-CoC), hence their balances remain unchanged since closing at EUR 167,245,000 for the Franciacorta loan and EUR 66,690,000 for the Palmanova loan.

Both loans pay three-month Euribor (floored at zero) plus a margin, which is a function of the weighted-average (WA) margin payable on the notes capped at 3.04%. Accordingly, the Class D notes are subject to an available funds cap if the shortfall is attributable to an increase in the WA margin of the notes. Consequently, there is no excess spread in the structure, with the Issuer’s ongoing costs and expenses being covered by the borrowers.

The loans have a two-year term with three one-year extension options, subject to hedging being extended. The third extension option has been exercised, extending the loans’ maturity to the August 2024 interest payment date (IPD). There is a 0% strike rate hedging provided by HSBC plc until the August 2024 IPD.

There are no default covenants prior to the P-CoC. The cash trap covenants are set to 75% loan-to-value (LTV) for both loans, while the debt yield (DY) cash trap covenants are set at 7.6% for the Franciacorta loan and 9.6% for the Palmanova loan. Currently, the Franciacorta loan is in a breach of the LTV cash trap covenant.

CBRE Limited valued the Franciacorta property at EUR 257.3 million and the Palmanova property at EUR 102.6 million at origination. In December 2022 Cushman & Wakefield (C&W) revalued the two assets at EUR 215.4 million and EUR 87.1 million, respectively, resulting in a decline in value of 16.3% and 15.1%, respectively. As a result, as of November 2023 IPD, the LTV stands at 77.2% and 74.4% for the Franciacorta loan and the Palmanova loan, respectively.

An improvement in net rent income (NRI) was observed over the last year for both loans, driven by a decrease in arrears as well as by a number of new tenants and lease renewals. The Franciacorta portfolio’s NRI increased to EUR 15.6 million from EUR 15.0 million at last year’s review and EUR 14.7 million at cut off, while the vacancy rate decreased to 12.6% from 14.8% a year ago. There were no major changes among the top 10 tenants with the portfolio’s rental income stream remaining granular: the top 10 tenants accounted for 23.2% of the annual contracted rent. Quarterly arrears declined to EUR 506,528 in November 2023 from EUR 1,266,726 as of the November 2022 IPD. The Palmanova portfolio’s NRI increased to EUR 6.4 million from EUR 6.1 million at last year’s review, although it is still below the EUR 6.8 million NRI at cut off. The vacancy rate has fluctuated over the last year, reaching 13.9% as of the November 2023 IPD. The tenant profile is less granular than in Franciacorta as the top 10 tenants account for 40.3% of the total rental income. Quarterly arrears declined to EUR 648,047 in November 2023 from EUR 620,398 as of the November 2022 IPD.

The increase in income has positively affected the DY, which increased to 9.4% and 10.0% for Franciacorta and Palmanova loans, respectively, in November 2023 compared with 9.0% and 9.2 % at last year’s annual review. According to the latest available servicer report in November 2023, the loans’ WA lease terms were 4.1 and 3.3 years for the Franciacorta and Palmanova loan, respectively.

Morningstar DBRS conducted an in-depth analysis of both portfolios’ performances based on the latest available tenancy schedules dated September 2023 and updates from year-end as received from the servicer.

For the Franciacorta loan, Morningstar DBRS increased its net cash flow (NCF) assumption to EUR 11.7 million from EUR 11.1 million at its last review, representing a haircut of 27.2% from the issuer’s NCF. In addition, Morningstar DBRS increased its cap rate assumption by 50 basis points (bps) to 7.1% from 6.6% to reflect the prolonged uncertainty in the Italian retail property market. This resulted in a Morningstar DBRS value of EUR 165.8 million, which represents a 23.0% haircut to the most recent C&W valuation.

For the Palmanova loan, Morningstar DBRS decreased its NCF assumption to EUR 4.7 million from EUR 5.1 million at its last review, representing a haircut of 22.4% from the issuer’s NCF. In addition, Morningstar DBRS increased its cap rate assumption by 50 bps to 7.0% from 6.5%, resulting in a Morningstar DBRS value of EUR 63.3 million, which represents a 27.3% haircut to the most recent C&W valuation.

The loans mature on 15 August 2024, with the notes’ final maturity date scheduled in August 2031, seven years after the fully extended loan maturity date.

The transaction benefits from a liquidity reserve facility that totals EUR 10.5 million and is provided by Deutsche Bank AG, London Branch. The liquidity reserve facility can be used to cover interest shortfalls on the Class A and Class B Notes. Morningstar DBRS estimates that the liquidity facility support is equivalent to approximately 31 months of coverage based on the hedging terms mentioned above and approximately 10 months of coverage based on the Euribor capped at 5.0% after notes’ maturity

Morningstar DBRS’ credit ratings on the Issuer address the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents. The associated financial obligations are the related Interest Payment Amounts and the related Class Balances.

Morningstar DBRS’ credit ratings do not address nonpayment risk associated with contractual payment obligations contemplated in the applicable transaction document(s) that are not financial obligations. For example, the credit ratings on the notes do not address Euribor Excess Amounts, Default Interest Amounts and Prepayment Fees.

Morningstar DBRS’ long-term credit ratings provide opinions on risk of default. Morningstar DBRS 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, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the “Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings” at https://dbrs.morningstar.com/research/427030.

Notes:
All figures are in euros unless otherwise noted.

The principal methodology applicable to the credit ratings is European CMBS Rating and Surveillance Methodology (17 January 2024), https://dbrs.morningstar.com/research/426818.

Other methodologies referenced in this transaction are listed at the end of this press release.

Morningstar DBRS 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://dbrs.morningstar.com/research/421590.

The sources of data and information used for these credit ratings include the quarterly servicer reports and quarterly cash management reports provided by CBRE Services Limited and Zenit S.p.A., respectively, from issuance to the November 2023 IPD. Morningstar DBRS also received C&W’s valuation report dated 22 December 2022 and the latest tenancy schedules provided by the servicer dated 30 September 2023.

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

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

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

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

The last credit rating actions on this transaction took place on 21 December 2023, when Morningstar DBRS maintained the UR-Pos. status on all classes of notes where they were initially placed on 13 October 2023.

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on dbrs.morningstar.com.

Sensitivity Analysis: To assess the impact of changing the transaction parameters on the credit rating, Morningstar DBRS considered the following stress scenarios as compared with the parameters used to determine the credit rating (the base case):

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

Class B Notes Risk Sensitivity:
-- 10% decline in Morningstar DBRS NCF, expected credit rating on Class B Notes at BB (high) (sf)
-- 20% decline in Morningstar DBRS NCF, expected credit rating on Class B Notes at BB (sf)

Class C Notes Risk Sensitivity:
-- 10% decline in Morningstar DBRS NCF, expected credit rating on Class C Notes at B (sf)
-- 20% decline in Morningstar DBRS NCF, expected credit rating on Class C Notes at Below B (low) (sf)

Class D Notes Risk Sensitivity:
-- 10% decline in Morningstar DBRS NCF, expected credit rating on Class D Notes at Below B (low) (sf)
-- 20% decline in Morningstar DBRS NCF, expected credit rating on 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. Morningstar DBRS’ outlooks and credit ratings are monitored.

For further information on Morningstar DBRS 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 Morningstar DBRS 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: 2 February 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 credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

-- European CMBS Rating and Surveillance Methodology (17 January 2024),
https://dbrs.morningstar.com/research/426818
-- Legal Criteria for European Structured Finance Transactions (30 June 2023),
https://dbrs.morningstar.com/research/416730
-- Interest Rate Stresses for European Structured Finance Transactions (15 September 2023),
https://dbrs.morningstar.com/research/420602
-- Derivative Criteria for European Structured Finance Transactions (18 September 2023),
https://dbrs.morningstar.com/research/420754
-- Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024),
https://dbrs.morningstar.com/research/427030

A description of how Morningstar DBRS analyses structured finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/278375.

For more information on this credit or on this industry, visit dbrs.morningstar.com or contact us at [email protected].