Morningstar DBRS Comments on ERNA S.r.l. Restructuring Proposal

DBRS Ratings GmbH (Morningstar DBRS) reviewed the most recently proposed amendments as set out in the Notice of Noteholders' Meetings dated 22 April 2024 sent by ERNA S.R.L. (the Issuer), and concluded that the proposed amendments are credit neutral and, as such, would not translate either into a downgrade or withdrawal of its credit ratings to the notes, or into a trend change.

ERNA S.r.l. is the securitisation of four Italian senior commercial real estate loans: the Aries loan, the Ermete loan, the Nucleus loan, and the Raissa loan. The loans are secured predominantly by telephone exchange properties spread across Italy, but the Nucleus loan portfolio also includes some office, warehouse, garage, and residential spaces. The loans were granted as refinancing facilities to four borrowers all ultimately owned and controlled by TPG Sixth Street Partners (the Sponsor).

Each loan bears interest at a floating rate equal to three-month Euribor, plus a margin that is a function of the weighted average (WA) of the aggregate interest amounts payable on the notes. The loans are fully hedged with cap strike rate at 2.0% provided by Bank of America Merrill Lynch International and a termination date on 20 July 2024. The originators, Zodiac Holdings LLC and Nucleus Investments LLC, are ultimately controlled by the Sponsor. To comply with the applicable regulatory requirements, the originators retained an ongoing material economic interest of no less than 5.0% by subscribing to the unrated and junior-ranking EUR 15.8 million Class Z notes. This retained class of notes is fully subordinate within the structure as it will not receive any principal payment until the Class A, B, and C notes are repaid in full.

The aggregate principal amount of the four facilities was equal to EUR 315.8 million at issuance. At the time, the business plan from each borrower envisaged to dispose of the assets that were considered noncore over the course of the underlying loans’ term, before looking for a block exit. As of the January 2024 interest payment date (IPD), the borrowers have successfully completed the disposal of 306 assets for a total consideration of EUR 238.6 million, and each borrower has partially repaid its loan for an aggregate overall amount of EUR 160.8 million as of the January 2024 IPD, which is equal to 50.9% of the original aggregate loan amount. While the calculation agent quarterly report for the most recent April 2024 IPD is already available to the public, the servicer report for the same IPD has not been published yet.

On 31 December 2023, Colliers Valuation Italy Srl (Colliers) and CBRE Valuation & Advisory Services (CBRE) revalued the underlying portfolios and appraised the aggregate market value of the 322 properties remaining in the transaction as of the January 2024 IPD at EUR 474.9 million. On a like-for-like basis, thus excluding the sold properties, the new valuation reflects only a modest decline of 3.2% from EUR 490.8 million as of 31 December 2022 and it is 3.8% lower than the original valuation of EUR 493.5 million at issuance. However, for the purpose of the loans’ covenants calculation, the 2022 valuation was applied at the January 2024 IPD. As a result, the transaction’s WA loan-to-value ratio (LTV) stood at 32.9% as at the January 2024 IPD, down from 42.6% at issuance.

Physical occupancy has remained on a stable trajectory since issuance, with the Ermete, Raissa, and Aries portfolios being fully occupied by Telecom Italia as of January 2024, and the Nucleus portfolio hovering around the 75% figure since issuance. The WA unexpired lease term remains strong, ranging between 12.8 years and 16.1 years across the four loans, with the majority of rent expiring after the notes’ maturity.

According to the servicer report as of January 2024 IPD, contracted rent and net rental income for the aggregate portfolio stood at EUR 38.7 million and EUR 31.1 million, respectively. Moreover, the transaction’s WA debt yield (DY) increased to 19.0% as of January 2024 from 13.0% as at issuance. The underlying loans were expected to mature on 20 July 2024, with the final legal maturity of the notes being on 25 July 2031, seven years after the expected loan maturity date.

However, despite the resilience of the underlying portfolios and the strong performance metrics of the securitised loans as of date, the borrowers were unable to execute their exit plan through a block sale of the whole remaining perimeter, mainly due to the increase in interest rates and broader macroeconomic uncertainty.

As a result, according to the Notice of Noteholders' Meetings dated 22 April 2024, noteholders are asked to vote on a Sponsor’s restructuring proposal to push back the loans’ maturity date two years to 20 July 2026 from 20 July 2024, and to extend accordingly the final legal maturity of the notes by two years to 25 July 2033 from 25 July 2031. Noteholder meetings of each class of notes will be held on 7 May 2024.

This will be the third noteholders’ meeting on the restructuring proposal. In particular, based on the relevant notices sent by the Issuer, the first noteholders’ vote was cancelled to allow for changes to be made to the initial proposal following noteholders feedback, and the second vote on a revised proposal failed after the Class A meeting was inquorate, and the Class B vote was 44.34% against. The Class C and Class D votes were unanimously in favor of the proposal.

As part of the latest proposal, on 20 July 2024 (the effective date) the borrowers will prepay the EUR 6.2 million outstanding Ermete Loan in full, and will make further voluntary prepayments across the four loans as follows: EUR 5.5 million for the Raissa loan, EUR 4.0 million for the Aries loan, and EUR 7.0 million for the Nucleus loan. The resulting principal proceeds will be first applied reverse sequentially to the notes to prepay in full the outstanding amount of the Class C notes, and then to repay the Class A and Class B notes on a pro rata basis. As of the April 2024 IPD, the Class C notes had EUR 7.8 million outstanding.

As part of the proposed amendments, on the effective date the Class A notes margin will increase from 225 basis points (bps) to 275 bps, while the Class B notes margin will increase from 360 bps to 500 bps. The Class Z notes margin will remain at 550 bps. On the effective date, the new loan margins will reflect the WA of the new margins due on the notes.

All excess cash flow will be used to pay down the loans, and all net disposal proceeds above the release price will be used to prepay the loans. New hedging, coterminous with the new maturities, will be put in place at a maximum strike rate of 3.25% and on a notional amount equal to 90% of the outstanding loan balances on the effective date. At note level, disposal proceeds up to the allocated loan amount will be applied sequentially, while release premiums and disposal proceeds above the release price will be applied pro rata to the notes (except for the Class Z notes), as will principal payments from excess cash flow, subject to the sequential payment trigger.

Morningstar DBRS conducted a new underwriting of the outstanding property portfolio as at the January 2024 IPD, based on the latest tenancy schedule and the latest valuation reports received from the servicer. In particular, the updated Morningstar DBRS NCFs resulted in EUR 2.2 million, EUR 6.7 million, EUR 5.1 million, and EUR 8.1 million for the Ermete, Raissa, Aries, and Nucleus loans, respectively. Based on the same cap rate assumptions of 8.0% at issuance for the Ermete, Raissa, and Aries loans and 8.5% for the Nucleus loan, the Morningstar DBRS values resulted into EUR 27.1 million, EUR 83.4 million, EUR 64.4 million, and EUR 95.5 million, respectively. Furthermore, the aggregate Morningstar DBRS value of EUR 270.5 million represents a haircut of 43.0% to the latest aggregate market value of EUR 474.9 million for the four portfolios.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the “DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings” at https://dbrs.morningstar.com/research/427030, (23 January 2024).

Notes:
All figures are in euros unless otherwise noted.

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

DBRS Ratings GmbH
Neue Mainzer Straße 75
60311 Frankfurt am Main Deutschland
Tel. +49 (69) 8088 3500
Geschäftsführer: Detlef Scholz
Amtsgericht Frankfurt am Main, HRB 110259