Morningstar DBRS Downgrades Credit Ratings on FROSN-2018 DAC

DBRS Ratings GmbH (Morningstar DBRS) took the following credit rating actions on the commercial mortgage-backed floating-rate notes due May 2031 issued by FROSN-2018 DAC (the Issuer):

Morningstar DBRS confirmed its credit rating on the Class RFN notes at AAA (sf).

Morningstar DBRS downgraded its credit ratings on the Class A1 through Class E notes as follows:

-- Class A1 to A (sf) from AA (sf)
-- Class A2 to BBB (sf) from A (sf)
-- Class B to BBB (low) (sf) from BBB (high) (sf)
-- Class C to BB (sf) from BBB (low) (sf)
-- Class D to B (low) (sf) from BB (low) (sf)
-- Class E to CCC (sf) from B (low) (sf)

The trend on the Class RFN notes is Stable, while the trends on the Class A1 through Class E notes are Negative.

CREDIT RATING RATIONALE
FROSN-2018 DAC is a securitisation of one floating-rate senior commercial real estate loan jointly advanced by Citibank, N.A., London Branch; Morgan Stanley Bank, N.A.; and Morgan Stanley Principal Funding, Inc. At issuance, the collateral securing the loan consisted of 63 predominantly secondary office and retail properties across Finland. The assets constituted a noncore part of Sponda Ltd's (Sponda) portfolio. Sponda was one of the largest listed real estate firms in Finland before The Blackstone Group L.P. acquired and delisted it in 2017. The quality of the portfolio securing the loan had deteriorated after Sponda sold some of the stronger properties, and changing office demand fundamentals have led to persistently high vacancy rates (over 40% portfolio vacancy rates have been observed over the past three years).

The senior loan failed to repay at maturity on 15 February 2023 and was subsequently transferred into special servicing. The special servicer provided short-term standstill agreements in order to pursue a consensual workout strategy until December 2023, when noteholders passed a series of extraordinary resolutions modifying certain basic terms of the facility agreement, including an extension of the original senior loan maturity date by an initial three years to 15 February 2026, with an option to extend the loan to 15 February 2027 subject to certain conditions being met, including hedging in place and no event of default. The final note maturity date was also extended by three years to 21 May 2031 from 21 May 2028. After the amendments were adopted, the loan became a corrected loan.

Sponda is undertaking a portfolio disposal process. It has disposed of three properties since the loan restructuring, with 40 properties currently remaining in the portfolio. However, the sale of the Kuusiniementie 2 property completed in May 2024 was not reflected in the latest available reporting for the May 2024 Interest Payment Date. Therefore, the portfolio valuation figure of EUR 340.4 million from the May 2024 servicer report reflects 41 properties. The portfolio value is based on aggregate market values of individual properties as appraised by Jones Lang LaSalle Limited (JLL) in March 2023.

Following loan restructuring, the servicer is no longer obligated to call for annual revaluation. Instead, any individual noteholder has the right to require the servicer/special servicer to instruct a valuation subject to there being no less than 12 months between each valuation. As of June 2024, revaluation was not instructed.

Despite property disposals, the loan balance remained unchanged since restructuring and stands at EUR 303.4 million as of May 2024. This is because disposal cash proceeds are allocated to the credit of the cash trap account until the account's balance reaches EUR 10.0 million, after which disposal proceeds will be applied towards repayment of the loan. As of May 2024, EUR 6.8 million was trapped in the cash trap account. This translated into a reported loan-to-value ratio which gives credit to cash held in the cash trap account of 87.1% in May 2024, a slight increase from 86.2% the year before.

The portfolio performance has continued to deteriorate over the past 12 months. Annual contracted rent declined to EUR 39.4 million in May 2024 from EUR 42.0 million in May 2023. The reduction is only partially attributable to property disposals, as the vacancy rate increased by four percentage points over the past 12 months to 51.5% in May 2024. Subsequently, reported debt yield fell to 7.3% in May 2024 from 8.2% a year before, with an interest coverage ratio reported at 100.5% in the latest quarter. As structural headwinds continue to weigh on the secondary office space, Morningstar DBRS cannot discard potential further deterioration of the portfolio's performance.

Morningstar DBRS revised its net cash flow (NCF) assumption to account for the properties disposed of after the loan restructuring took place in December 2023. Morningstar DBRS also increased its portfolio vacancy assumption to 51.5% from 47.1% and adjusted its nonrecoverable expenses assumptions to reflect the increased vacant space. Subsequently, Morningstar DBRS' NCF declined to EUR 20.4 million from EUR 24.2 million. In addition, Morningstar DBRS revised its capitalisation rate assumption to 9.5% from 9.0%, largely reflecting continued uncertainty in the office investment market. These changes translate to a Morningstar DBRS value of EUR 214.6 million, representing a 37.0% haircut to JLL's most recent valuation. The decline in the Morningstar DBRS value has resulted in Morningstar DBRS downgrading its credit ratings on the Class A1 through E notes. The trends on Classes A1 through E notes are Negative, reflecting potential further deterioration of the underlying loan's key credit metrics. Additionally, Morningstar DBRS is closely monitoring the transaction with respect to the sales process, and delays in the disposal process could negatively affect the credit ratings.

The loan carries a floating interest rate equal to three-month Euribor (subject to a zero floor) plus a 3.95% margin. It is hedged with a prepaid interest rate cap provided by HSBC Bank Plc with a strike rate of 4.25%. The cap agreement terminates on 15 February 2026.

The transaction includes the reserve fund notes (RFN), which fund the note share part (95%) of the liquidity reserve. At issuance, the EUR 16.7 million RFN proceeds and the EUR 878,947 vertical risk retention (VRR) loan interest contribution were deposited into the transaction's liquidity reserve, which can be used to pay property protection advances, senior costs, and interest shortfalls (if any) in relation to the corresponding VRR Loan Interest, RFN, Class A1, Class A2, and Class B notes. The liquidity reserve currently amounts to EUR 8.6 million and, according to Morningstar DBRS' analysis, is equivalent to approximately 12 months' coverage on the covered notes based on the interest rate cap strike rate of 4.25%.

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 for each of the rated notes 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 documents that are not financial obligations. For example, Pro-Rata Default Interest Amounts and Euribor Excess Amounts.

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 (23 January 2024) 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.

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 quarterly investor reports prepared by Mount Street Mortgage Servicing Limited, and cash manager reports prepared by U.S. Bank Trustees 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 transaction took place on 4 July 2023, when Morningstar DBRS removed Classes A2, B, C, D, and E from Under Review with Negative Implications, where they were placed on 4 April 2023; confirmed its AAA (sf) rating on Class RFN with a Stable trend; and downgraded its credit ratings on Class A1 to AA (sf) from AAA (sf), Class A2 to A (sf) from AA (low) (sf), Class B to BBB (high) (sf) from A (sf), Class C to BBB (low) (sf) from BBB (high) (sf), Class D to BB (low) (sf) from BB (high) (sf), and Class E to B (low) (sf) from B (high) (sf) with Negative trends.

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on https://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 ratings (the base case):

Class RFN Risk Sensitivity:
-- 10% decline in Morningstar DBRS NCF, expected credit rating of Class RFN at AAA (sf)
-- 20% decline in Morningstar DBRS NCF, expected credit rating of Class RFN at AAA (sf)

Class A1 Risk Sensitivity:
-- 10% decline in Morningstar DBRS NCF, expected credit rating of Class A1 at BBB (high) (sf)
-- 20% decline in Morningstar DBRS NCF, expected credit rating of Class A1 at BBB (low) (sf)

Class A2 Risk Sensitivity:
-- 10% decline in Morningstar DBRS NCF, expected credit rating of Class A2 at BBB (low) (sf)
-- 20% decline in Morningstar DBRS NCF, expected credit rating of Class A2 at BB (sf)

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

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

Class D Risk Sensitivity:
-- 10% decline in Morningstar DBRS NCF, expected credit rating of Class D at below B (low) (sf)
-- 20% decline in Morningstar DBRS NCF, expected credit rating of Class D at below B (low) (sf)

Class E Risk Sensitivity:
-- 10% decline in Morningstar DBRS NCF, expected credit rating of Class E at below B (low) (sf)
-- 20% decline in Morningstar DBRS NCF, expected credit rating of Class E 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: Violetta Volovich, Assistant Vice President
Rating Committee Chair: David Lautier, Senior Vice President
Initial Rating Date: 22 March 2018

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

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].