Morningstar DBRS Finalises Provisional Credit Ratings on Classes A to E notes of UK Logistics 2024-1 DAC

DBRS Ratings Limited (Morningstar DBRS) finalised its provisional credit ratings to the following classes of notes issued by UK Logistics 2024-1 DAC (the Issuer):

-- Class A notes at AAA (sf)
-- Class B notes at AA (low) (sf)
-- Class C notes at A (low) (sf)
-- Class D notes at BBB (low) (sf)
-- Class E notes at BB (sf)

Trends on all classes of notes are Stable

CREDIT RATING RATIONALE
The transaction is a securitisation of two senior commercial real estate (CRE) loans originated by Barclays Bank PLC. The St. Modwen Facility of GBP 328.0 million and the Mileway Facility of GBP 209.8 million were advanced by Barclays Bank PLC to borrowers ultimately owned by Blackstone Real Estate Partners (Blackstone or the Sponsor) in connection with refinancing the acquisition of two last-mile logistics portfolios comprising 6 million square feet (sf) of standing logistics assets and 3 million sf of industrial outdoor storage (IOS) located in England and largely concentrated in Greater Manchester.

St. Modwen

The St. Modwen Facility relates to a term loan facility which was advanced by the Issuer to four borrowers (the St. Modwen Borrowers) ultimately owned by Blackstone, for the purpose of refinancing existing indebtedness of the St. Modwen Borrowers (and other members of the group); refinancing the acquisition of the St. Modwen property portfolio (the acquisition of the St Modwen portfolio was a combination of property and unit acquisitions), for general corporate purposes and financing or refinancing financing costs. The Borrower group comprises one Jersey limited liability company and three Jersey property unit trusts. The collateral securing the loan comprises 49 logistics assets located in two prime urban logistics submarkets, Trafford Park and Heywood Industrial Park in Greater Manchester. Trafford Park has multi-modal transport links, including a freight terminal and direct connection to the M60 ring road and M62 arterial motorway; it also benefits from close proximity to Manchester Airport and a tram link to the city centre. Heywood (10 kilometres (km) from the central business district) is a key distribution hub, with excellent access to the M60 and M62. Valuations prepared for the properties by CBRE in April 2024 concluded an aggregate market value (MV) of the collateral at GBP 531.6 million. Based on the special assumption of a corporate portfolio sale representing 0% stamp duty land tax (SDLT), CBRE concluded a value of GBP 562.4 million. The loan-to-value ratio (LTV) based on these values equals 61.7% and 58.3%, respectively. The portfolio has an occupancy rate of 88%, with vacancy largely concentrated to three properties only; in economic terms, this translates to an economic vacancy of 8.82%. The portfolio income comprises rental payments from typical standing logistics assets and also from leased IOS, which forms 10% of in-place income. IOS generally comprises industrial-zoned land used to store bulky goods. Typical uses include third-party logistics (3PLs)/truck parking, container storage, equipment rental, building materials, waste and environmental services/green energy conversion, storage of chemicals, electric vehicle (EV) charging, and self-storage. The borrowers indicated a budget of GBP 25.0 million of refurbishment (refurb) capital expenditures (capex), which includes capex for identified environmental, social, and governance (ESG) measures to meet 15% carbon emission reduction targets and achieve at least an EPC B rating for all assets such as window upgrades, LED lighting upgrades, installation of solar photovoltaics (PVs), modernisation of building insulation, and roofing. The majority of the units within the portfolio (circa 80%) fall within the C–E rating category.

The portfolio has a weighted-average lease term to break (WALTb) and a weighted-average lease term to expiry (WALTe) of 3.1 years and 4.8 years, respectively. In aggregate, the portfolio tenant base is granular with the top 10 tenants accounting for 39% of the rental income. Included in the top 10 tenants are Great Bear (or Culina), which forms 10% of gross operating income (GRI); Martin Brower UK Limited, 6%; Iron Mountain (UK) PLC, 4%; and SIG Trading Limited, 4%. As at the Cut-Off Date 31January 2024, the properties generated GBP 23.9 million of GRI, which reflects a day-one debt yield (DY) of 7.4%. Morningstar DBRS’ long-term sustainable net cash flow (NCF) assumption for the portfolio is GBP 22.2 million, representing a haircut of 8.5% to in-place GRI. The corresponding Morningstar DBRS value of GBP 344.2 million represents a haircut of 35.3% to the CBRE valuation.

There are no loan financial covenants applicable prior to a permitted change of control (PCOC), but cash trap covenants are applicable both prior to and post-PCOC. More precisely, the cash trap levels are set as follows: the LTV ratio is greater than 73.4% and the DY is less than 6.7%. After a PCOC, the financial default covenants on the LTV and the DY will be applicable; they are set, respectively, at the LTV ratio being greater than the PCOC LTV +15% and at 85% of the DY as at the PCOC date. The senior loan is interest-only prior to a PCOC and carries a floating rate, which is referenced to the sterling overnight index average (Sonia) (floored at 0%) plus a margin that is a function of the weighted average (WA) of the aggregate interest amounts payable on the notes. Morningstar DBRS understands that the borrowers will purchase an interest cap agreement to hedge against increases in the interest payable under the loan. This must be in place by the first interest payment date (IPD). The cap agreement will cover 95% of the outstanding loan balance with a strike rate of the higher of 3.5% and the rate that ensures that, as at the date on which the relevant hedging transaction is contracted, the hedged interest coverage ratio (ICR) is not less than 1.5 times (x). until the first hedging renewal date, being the first IPD falling after the second anniversary of the utilisation date, and, thereafter at each subsequent hedging renewal date until loan maturity, the higher of: (1) the lower of (A) 3.5%, and (B) in respect of any hedging transaction in the form of a swap, the market prevailing swap (fixed leg) rate on the date on which the relevant hedging transaction is contracted; and (2) the rate that ensures that, as at the date on which the relevant hedging transaction is contracted, the hedged interest coverage ratio (ICR) is not less than 1.5x. The maturity date of the loan is 15 May 2029. For the purpose of satisfying the applicable risk retention requirements, Barclays Bank PLC will advance a GBP 16.4 million loan (the Issuer Loan) to the Issuer, representing 5% of the total securitised balance.

Mileway

The Mileway Facility relates to a term loan facility which was advanced by the Issuer to three borrowers (the Mileway Borrowers) ultimately owned by Blackstone for the purpose of refinancing existing indebtedness of the Mileway Borrowers (and other members of the group), refinancing the acquisition of the Mileway property portfolio, for general corporate purposes, and financing or refinancing financing costs. Each borrower is a private limited liability company incorporated under the laws of Jersey. The collateral securing the loan comprises 17 prime UK logistics assets located within densely populated urban areas, with good highway connectivity. Of the portfolio value, 53% is located in London and the South East; the Midlands accounts for 23%; the North East, Yorkshire and Humberside, and North West account for 18%; and the remaining 6% is located in the South West. Valuations prepared for the properties by Jones Lang LaSalle (JLL) in March 2024 concluded an aggregate MV of the collateral at GBP 317.5 million including a portfolio premium of 2.5%. Based on the special assumption of a corporate portfolio sale representing 0% SDLT, JLL concluded a value of GBP 325.0 million. The LTV based on these values equals 66.2% and 64.3%, respectively.

The portfolio is well occupied and has an occupancy rate of 96%; in economic terms, this translates to an economic vacancy of 8.7%. The portfolio income comprises rental payments from typical standing logistics assets and also from leased IOS, which forms 17% of in-place income. The borrowers indicated a budget of GBP 22.0 million of refurb capex, which includes capex for identified ESG measures to meet 15% carbon emission reduction targets and achieve at least an EPC B rating for all assets such as LED lighting upgrades, installation of solar PVs, modernisation of building insulation, and roofing. The majority of the units within the portfolio (circa 80%) fall within the C–E rating category. The portfolio has a WALTb and a WALTe of 5.0 years and 7.3 years, respectively. In aggregate, the portfolio tenant base is granular with the top 10 tenants accounting for 29% of the rental income and no single tenant accounting for more than 5% of the total rent.

As at the Cut-Off Date 31January 2024, the properties generated GBP 16.4 million of GRI, which reflects a day-one DY of 8.0%. Morningstar DBRS’ long-term sustainable NCF assumption for the portfolio is GBP 16.0 million, representing a haircut of 5.0% to in-place GRI. The corresponding Morningstar DBRS value of GBP 237.6 million represents a haircut of 25.2% to the JLL valuation. There are no loan financial covenants applicable prior to a PCOC, but cash trap covenants are applicable both prior to and post-PCOC. More precisely, the cash trap levels are set as follows: the LTV ratio is greater than 74.5% and the DY is less than 6.8%. After a PCOC, the financial default covenants on the LTV and the DY will be applicable; they are set, respectively, at the LTV ratio being greater than the PCOC LTV +15% and at 85% of the DY as at the PCOC date.

The senior loan is interest-only prior to a PCOC and carries a floating rate, which is referenced to Sonia (floored at 0%) plus a margin that is a function of the WA of the aggregate interest amounts payable on the notes. Morningstar DBRS understands that the borrowers will purchase an interest cap agreement to hedge against increases in the interest payable under the loan by the first IPD. The cap agreement will cover 95% of the outstanding loan balance with a strike rate of the higher of 3.5% and the rate that ensures that, as at the date on which the relevant hedging transaction is contracted, the hedged interest coverage ratio (ICR) is not less than 1.5x times until the first hedging renewal date, being the first IPD falling after the second anniversary of the utilisation date, and, thereafter at each subsequent hedging renewal date until loan maturity, the higher of: (1) the lower of (A) 3.5%, and (B) in respect of any hedging transaction in the form of a swap, the market prevailing swap (fixed leg) rate on the date on which the relevant hedging transaction is contracted; and (2) the rate that ensures that, as at the date on which the relevant hedging transaction is contracted, the hedged ICR is not less than 1.5x. The maturity date of the loan is 15 May 2029.

For the purpose of satisfying the applicable risk retention requirements, Barclays Bank PLC will advance a GBP 10.5 million loan (the Issuer Loan) to the Issuer, representing 5% of the total securitised balance.

In aggregate, Morningstar DBRS' NCF and valuation for the St. Modwen and Mileway portfolios are GBP 38.3 million and GBP 661.6 million, respectively, implying a WA capitalisation rate of approximately 6.6%. The transaction is expected to repay in full by 15 May 2029. If the loans are not repaid by then, the transaction will have five years' tail to allow the special servicer to work out the loan(s) by May 2034, or where the final note maturity date is automatically extended pursuant to an extension of the final loan maturity date, the date falling 5 years after the final loan maturity date, which in each case is the final note maturity date.

The Issuer has established a reserve that has been credited with the initial Issuer liquidity reserve required amount. Part of the noteholders’ subscription for the Class A notes was used to provide 95% of the liquidity support for the transaction, which will be set at GBP 27 million or 5% of the total outstanding balance of the notes. The remaining 5% was funded by the Issuer Loan. Morningstar DBRS understands that the liquidity reserve will cover the interest payments to the Class A to Class C notes. No liquidity withdrawal can be made to cover shortfalls in funds available to the Issuer to pay any amounts in respect of the interest due on the Class D and Class E notes. The Class D and Class E notes are subject to an available funds cap where the shortfall is attributable to an increase in the WA margin of the notes.

Based on a cap strike rate of 3.5% and a Sonia cap of 5.0% for the two loans, Morningstar DBRS estimated that the liquidity reserve will cover approximately 15 months of interest payments and 12 months of interest payments, respectively, assuming the Issuer does not receive any revenue.

Morningstar DBRS’ credit rating on the notes addresses the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents. The associated financial obligations are for each of the rated notes are the related interest payment amounts and related class balance.

Morningstar DBRS’ credit rating does not address nonpayment risk associated with contractual payment obligations contemplated in the applicable transaction document(s) that are not financial obligations. For example, credit ratings on the notes listed above do not address payments of the SONIA excess amounts, exit payment amounts, and pro rata default interest.

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

Notes:
All figures are in GBP unless otherwise noted.

The principal methodology applicable to the credit rating 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.

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 this credit rating include a data tape with a cut-off date of 31 January 2024, valuation reports prepared by CBRE (St Modwen) and JLL (Mileway) with valuation date of 21 February 2024 and 01 March 2024, respectively, technical due diligence reports prepared by CBRE and Arcadis with various issue dates throughout 2023, transaction documentation and related legal opinions, all provided by Barclays Bank PLC.

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

At the time of the initial credit rating 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 this credit rating 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.

This is the first credit rating action since the Initial Rating Date.

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 Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating on the Class A Notes of AA (high) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating on the Class A Notes of A (high) (sf)

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

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

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

Class E Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating on the Class D Notes of B (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating on the Class D Notes of NR

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.

This credit rating is endorsed by DBRS Ratings GmbH for use in the European Union.

Lead Analyst: Dinesh Thapar, Vice President
Rating Committee Chair: David Lautier, Senior Vice President
Initial Rating Date: 26 April 2024

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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/european-cmbs-rating-and-surveillance-methodology.
-- Legal Criteria for European Structured Finance Transactions (30 June 2023),
https://dbrs.morningstar.com/research/416730/legal-criteria-for-european-structured-finance-transactions.
-- Interest Rate Stresses for European Structured Finance Transactions (15 September 2023),
https://dbrs.morningstar.com/research/420602/interest-rate-stresses-for-european-structured-finance-transactions.
-- Derivative Criteria for European Structured Finance Transactions (18 September 2023),
https://dbrs.morningstar.com/research/420754/derivative-criteria-for-european-structured-finance-transactions.
-- Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024),
https://dbrs.morningstar.com/research/427030/morningstar-dbrs-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

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].