Morningstar DBRS Confirms Credit Ratings and Removes the Under Review With Developing Implications Status on the Secured Notes Issued by Portman Ridge Funding 2018-2 Ltd

DBRS, Inc. (Morningstar DBRS) confirmed its AAA (sf) credit ratings and removed the Under Review with Developing Implications status on the Class A-1R-R Senior-Secured Revolving Floating-Rate Notes (the Class A-1R-R Notes) and the Class A-1T-R Senior-Secured Floating-Rate Notes (the Class A-1T-R Notes; together with the Class A-1R-R Notes, the Class A-1 Notes) issued by Portman Ridge Funding 2018-2 Ltd. (the Issuer or Portman Ridge CLO) pursuant to the Indenture dated as of October 18, 2018, as amended from time to time, among the Issuer; Portman Ridge Funding 2018-2 LLC as Co-Issuer; and Deutsche Bank Trust Company Americas as Trustee.

The credit rating on the Class A-1R-R Notes addresses the timely payment of interest up to the Interest Rate Cap (as defined in the Indenture) and the ultimate payment of principal on or before the Stated Maturity (as defined in the Indenture). The credit rating on the Class A-1R-R Notes does not address the payment of any Class A-1R Note Additional Amount (as defined in the Indenture). The credit rating on the Class A-1T-R Notes addresses the timely payment of interest and the ultimate payment of principal on or before the Stated Maturity (as defined in the Indenture).

CREDIT RATING RATIONALE/DESCRIPTION
The credit rating actions are a result of Morningstar DBRS’ review of the transaction performance and application of the “Global Methodology for Rating CLOs and Corporate CDOs” (the CLO Methodology), including the Morningstar DBRS CLO Insight Model, initially released on October 22, 2023. On November 9, 2023, the credit ratings were placed Under Review with Developing Implications to allow Morningstar DBRS to review the credit ratings using the CLO Methodology. The Reinvestment Period ended on November 20, 2022. The Stated Maturity Date is November 20, 2029.

The Class A-1 Notes issued by Portman Ridge CLO are collateralized primarily by a portfolio of U.S. senior-secured middle-market corporate loans (the Assets) and are managed by Portman Ridge Finance Corporation as Collateral Manager and Sierra Crest Investment Management LLC as Sub-Collateral Manager.

In its analysis, Morningstar DBRS considered the following aspects of the transaction:
(1) The transaction’s capital structure and the form and sufficiency of available credit enhancement.
(2) Relevant credit enhancement in the form of subordination and excess spread.
(3) The ability of the Class A-1 Notes to withstand projected collateral loss rates under various cash flow stress scenarios.
(4) The credit quality of the underlying collateral.
(5) Morningstar DBRS’ assessment of the origination, servicing, and collateralized loan obligation (CLO) management capabilities of Portman Ridge Finance Corporation, Sierra Crest Investment Management LLC, and BC Partners as Affiliate. Morningstar DBRS considers BC Partners an acceptable CLO manager.
(6) The legal structure as well as legal opinions addressing certain matters of the Issuer and the consistency with the Morningstar DBRS “Legal Criteria for U.S. Structured Finance” methodology.

Some particular strengths of the transaction are (1) significant overcollateralization (OC) cushion levels above the trigger levels, showing substantial subordination for the Class A-1 Notes, and (2) the collateral quality, which consists entirely of senior-secured middle-market loans. Some challenges are (1) failures in some of the Collateral Quality Tests and (2) some Collateral Loans in the portfolio have experienced a default.

The transaction entered its amortization period on November 20, 2022, which assumes limited reinvestment abilities. To account for the static pool, Morningstar DBRS analyzed the actual obligations in the pool as reported in the trustee report on February 7, 2024, which took into account several failing Collateral Quality Tests as well as Concentration Limitations.

As of February 7, 2024, the transaction is failing its Weighted Average Life Test, Morningstar DBRS Diversity Score Test, and Morningstar DBRS Risk Score Test, as well as the Largest Obligor (5.3% vs the 4.0% maximum), Fourth Largest Obligor (3.7% vs the 3.0% maximum), and CCC Collateral Obligation (31.9% vs the 30.0% maximum) Concentration Limitations. Failures of this nature are expected to be observed in static transactions well into the amortization period. Morningstar DBRS considered these failures while analyzing the transaction performance to account for the static pool. Further, Morningstar DBRS analyzed each loan in the pool separately by inputting its credit rating, seniority, country of origin, and industry, among others, into the Morningstar DBRS CLO Insight Model. The Coverage Tests and Collateral Quality Tests that that Morningstar DBRS modeled in its analysis are presented below:

Coverage Tests:
OC Ratio: Threshold 128.00%; Current 185.23%
Interest Coverage Ratio: Threshold 135.00%; Current 273.39 %

Collateral Quality Tests:
Maximum Weighted Average Life Test: Threshold 2.70 years; Current 2.93 years
Minimum Weighted Average Coupon Test: Threshold 8.00%; Current 13.00%
Minimum Weighted Average Spread Test: Threshold 6.00%; Current 6.20%
Minimum Diversity Score Test: Threshold 34; Current 22
Minimum Weighted Average Recovery Rate Test: Threshold 47.80%; Current 50.20%
Maximum Risk Score Test: Threshold 35.50%; Current 37.73%

Morningstar DBRS analyzed the transaction using the Morningstar DBRS CLO Insight Model and its proprietary cash flow engine, which incorporated assumptions regarding principal amortization, principal prepayment, amount of interest generated, principal prepayments, default timings, and recovery rates, among other credit considerations referenced in Morningstar DBRS’ “Global Methodology for Rating CLOs and Corporate CDOs” (February 24, 2024; https://dbrs.morningstar.com/research/428544).

Model-based analysis, which had incorporated the above-mentioned Collateral Quality Test and Concentration Limitation failures, produced satisfactory results. Considering the transaction performance, as well as its legal aspects and structure, Morningstar DBRS confirmed its credit ratings on the above-mentioned Class A-1 Notes.

The transaction assumptions consider Morningstar DBRS’ baseline macroeconomic scenarios for rated sovereign economies, available in its commentary “Baseline Macroeconomic Scenarios for Rated Sovereigns: December 2023 Update,” published on December 19, 2023 (https://dbrs.morningstar.com/research/425506). These baseline macroeconomic scenarios replace Morningstar DBRS’ moderate and adverse coronavirus pandemic scenarios, which were first published in April 2020.

For more information regarding Morningstar DBRS’ additional adjustment for select industries related to the coronavirus, please see its May 18, 2020, commentary “CLO Risk Exposure to the Coronavirus Disease (COVID-19)” at https://dbrs.morningstar.com/research/361112.

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 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 (January 23, 2024) https://dbrs.morningstar.com/research/427030.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal methodology applicable to the credit ratings is Global Methodology for Rating CLOs and Corporate CDOs and the CLO Insight Model version 1.0.1.0 (February 23, 2024) https://dbrs.morningstar.com/research/428544/global-methodology-for-rating-clos-and-corporate-cdos

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

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

Please see the related appendix for additional information regarding the sensitivity of assumptions used in the credit rating process.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom, and by DBRS Ratings GmbH for use in the European Union, respectively. The following additional regulatory disclosures apply to endorsed credit ratings:

The last credit rating action on this issuer took place on November 9, 2023, when Morningstar DBRS placed the credit ratings on the Class A-1 Notes Under Review with Developing Implications.

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.

Lead Analyst: Oxana Rhybak, Vice President, Sector Lead
Rating Committee Chair: Jerry van Koolbergen, Managing Director
Initial Rating Date: September 21, 2018

DBRS, Inc.
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New York, NY 10005 USA
Tel. +1 212 806-3277

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

Operational Risk Assessment for CLOs and CDOs (September 14, 2023)
https://dbrs.morningstar.com/research/420608

Legal Criteria for U.S. Structured Finance (December 7, 2023)
https://dbrs.morningstar.com/research/425081

Interest Rate Stresses for U.S. Structured Finance Transactions (February 26, 2024)
https://dbrs.morningstar.com/research/428623

For more information on this credit or on this industry, visit dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.