Morningstar DBRS Places All Classes of Oranje (European Loan Conduit No. 32) DAC Under Review With Developing Implications

DBRS Ratings GmbH (Morningstar DBRS) placed its credit ratings on the following classes of the commercial mortgage-backed floating-rate notes (the notes) due November 2028 issued by Oranje (European Loan Conduit No. 32) (the Issuer) Under Review with Developing Implications (UR-Dev.).

-- Class A Notes rated AAA (sf)
-- Class B Notes rated AA (high) (sf)
-- Class C Notes rated A (sf)
-- Class D Notes rated BBB (high) (sf)
-- Class E Notes rated BBB (sf)

CREDIT RATING RATIONALE

The UR-Dev. status on the notes reflects the uncertainty as to whether the securitised loan will be refinanced or fully paid down by way of property disposals at its extended maturity on 15 August 2024.

Despite the strong loan performance metrics and the significant deleverage achieved both through asset disposals and the considerable equity injections made by the Sponsor since issuance, uncertainty remains mainly due to the persistent lack of liquidity and investor appetite for secondary office properties.

Consequently, Morningstar DBRS placed its credit ratings on all classes of notes UR-Dev. until it receives more clarity on the evolution of the refinancing options available to the borrower as well as on the progression of its property disposal strategy.

At issuance, the transaction comprised five Dutch commercial real estate loans (i.e., the Cygnet, Cheetah, Phoenix, Le Mirage, and Legion loans) advanced by Morgan Stanley Bank N.A., which cumulatively totalled EUR 207.4 million. The Cygnet, Cheetah, and Phoenix loans were advanced as refinancing facilities, whereas the Le Mirage and Legion loans were advanced as acquisition facilities. Currently, only the Phoenix loan remains in the transaction with the other loans repaid in full. Prepayment proceeds from the Cygnet, Cheetah, Le Mirage, and Legion loans were applied pro rata against the notes, whereas those from the Phoenix loan are allocated 70% pro rata and 30% sequential, with the pro rata payment applied first (the Phoenix Order of Priority).

The Phoenix loan is secured against a portfolio of 10 mainly secondary office properties (18 at issuance) spread across the Netherlands and it is sponsored by Marathon Asset Management (the Sponsor).

It was initially scheduled to mature on 15 August 2023, when the borrower obtained a further one-year extension to 15 August 2024 (the extended maturity date) after the servicer had agreed to various amendments, which Morningstar DBRS has already commented on in its press release available here https://dbrs.morningstar.com/research/423160/dbrs-morningstar-comments-on-oranje-european-loan-conduit-no-32-dac-loan-restructuring.

Six properties had been already been sold as of the May 2023 interest payment date (IPD), with the loan balance reducing by 24.2% to EUR 75.4 million in May 2023 from EUR 99.5 million at origination.

Following the maturity extension, the borrower intended to pay down the loan mainly through further property disposals by the extended maturity date. The Sponsor also made an equity injection of EUR 2.9 million to reduce the balance to EUR 72.5 million in August 2023.

On 28 December 2023 the borrower sold The Hague, De Bordewijk property, which resulted in a EUR 5.2 million net disposal proceeds applied as prepayment to the loan. The principal proceeds were then allocated 95% against the notes (according to the Phoenix Order of Priority) and 5% against the vertical risk retention (VRR) loan at the February 2024 IPD.

As part of the executed amendments, the borrower was required to reduce the loan balance down to EUR 45.0 million by 31 March 2024 as a condition subsequent of its extension. According to a notice from the issuer dated 4 April 2024, on 31 March 2024 the borrower had initially failed to meet this reduction requirement, resulting in a breach of the condition subsequent. According to the same notice, however, on 2 April 2024 the borrower made a total prepayment or EUR 22.3 million to reduce the loan balance down to EUR 45.0 million from EUR 72.5 million outstanding as of August 2023, thereby remedying the breach within the available cure period of five business days. In particular, the prepayment resulted from EUR 12.9 million of net disposal proceeds coming from the sale of the Europe Palace, Europaweg 45, Zoetermeer property on 28 March 2023, and a further Sponsor’s equity injection of EUR 9.4 million. Proceeds were applied towards the notes and the VRR loan at the May 2024 IPD.

On 1 April 2023 Jones Lang LaSalle (JLL) last revalued the collateral portfolio at EUR 145.7 million, which also included the two properties just mentioned, representing a 14.0% decrease from the previous valuation of EUR 169.3 million conducted by Savills Advisory Services Limited (Savills) on 1 February 2022. Excluding the two properties, the market value (MV) of the remaining 10 properties in the portfolio stood at EUR 128.5 million. As a result, based on the EUR 45.0 million loan balance outstanding as of May 2024, the Phoenix loan’s loan-to-value ratio (LTV) decreased to 35.0% in May 2024 from 44.5% in May 2023 and from 56.1% at issuance. Based on the latest available servicer report dated February 2024, the loan’s debt yield (DY) stood at 15.5% compared with 12.7% in May 2023 and 13.2% at origination. Hence, the loan’s LTV and DY were in line with the transaction’s cash trap and financial covenants, which are set at 61.15% and 68.85% for LTV, respectively, and at 11.0% and 10.0% for DY, respectively.

Overall, the loan’s performance continues to be in line with Morningstar DBRS’ expectations at issuance, with an annual contracted rent of EUR 12.7 million, a vacancy rate of 21.9%, and a weighted-average lease term of 5.4 years reported in February 2024. As such, Morningstar DBRS did not change any of its underwriting assumptions, but updated its net cash flow (NCF) to EUR 6.8 million from EUR 7.8 million as at its last annual review to account for the two properties sold since then. Moreover, Morningstar DBRS has kept its cap rate assumption constant at 7.25% since issuance, which translates into a Morningstar DBRS value of EUR 93.7 million, thus representing a haircut of 27.1% to the most recent JLL valuation.

The Phoenix loan is interest-only and accrues interest at 3-month Euribor (floored at zero) plus a 3.872% margin. It is fully hedged via cap agreement with Bank of America Europe DAC. The hedging agreement provides with a strike rate of 3.5% and will be terminated on 15 August 2024.

The transaction still benefits from a EUR 1.6 million liquidity facility outstanding as of May 2024 IPD (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 covered notes). According to Morningstar DBRS’ analysis, the outstanding commitment amount could provide interest payments on the covered notes of up to 6.8 and 5.9 months based on the interest rate cap strike rate of 3.5% and the Euribor cap of 5.0% after loan maturity, respectively.

The transaction includes a Class X diversion trigger event over two levels, which depend on the percentage of the defaulted outstanding loan amount in the transaction. If between 25% and 50% of the outstanding loan balance is in default, 25% of the excess spread will be diverted into the Issuer transaction account and credited to the Class X diversion ledger. If the defaulted loan amount increases to over 50% of the then-total outstanding loan amount, all excess spread will be diverted and credited to the Class X diversion ledger.

Morningstar DBRS' credit ratings on the notes address 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 the related interest payment amounts and related class balance.

Morningstar DBRS' credit ratings do not address non-payment risk associated with contractual payment obligations contemplated in the applicable transaction documents that are not financial obligations. For example, credit ratings on the notes do not address payments of the Euribor excess amounts, pro rata default interest amounts and note 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 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” (23 January 2024) https://dbrs.morningstar.com/research/427030/morningstar-dbrs-criteria:-approach-to-environmental,-social,-and-governance-risk-factors-in-credit-ratings .

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/european-cmbs-rating-and-surveillance-methodology

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.

Morningstar DBRS is undertaking a review and will remove the credit ratings from this status as soon as it is appropriate.

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 Morningstar DBRSCredit 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 servicer reports provided by Mount Street Mortgage Servicing Limited, as well as investor and cash management reports provided by U.S. Bank Global Corporate Trust Limited.

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 issuer took place on 26 May 2023, when Morningstar DBRS confirmed its credit rating on the Class E notes and changed the trends on all classes of notes to Negative from Stable.

The lead analyst responsibilities for this transaction have been transferred to Andrea Selvarolo.

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 Morningstar DBRS NCF, expected rating on Class A notes to AA (high) (sf)
-- 20% decline in Morningstar DBRS NCF, expected rating on Class A notes to AA (sf)

Class B Risk Sensitivity:
-- 10% decline in Morningstar DBRS NCF, expected rating on Class B notes to AA (low) (sf)
-- 20% decline in Morningstar DBRS NCF, expected rating on Class B notes to A (low) (sf)

Class C Risk Sensitivity:
-- 10% decline in Morningstar DBRS NCF, expected rating on Class C notes to BBB (high) (sf)
-- 20% decline in Morningstar DBRS NCF, expected rating on Class C notes to BBB (sf)

Class D Risk Sensitivity:
-- 10% decline in Morningstar DBRS NCF, expected rating on Class D notes to BBB (sf)
-- 20% decline in Morningstar DBRS NCF, expected rating on Class D notes to BB (high) (sf)

Class E Risk Sensitivity:
-- 10% decline in Morningstar DBRS NCF, expected rating on Class E notes to BB (high) (sf)
-- 20% decline in Morningstar DBRS NCF, expected rating on Class E notes to BB (sf)

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: Mark Wilder, Senior Vice President
Initial Rating Date: 6 November 2018

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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.

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 info-DBRS@morningstar.com.