Morningstar DBRS Places All Classes of Viridis (European Loan Conduit No. 38) DAC Under Review With Negative Implications

DBRS Ratings Limited (Morningstar DBRS) placed its credit ratings on the following classes of the commercial mortgage-backed floating-rate notes (the notes) due July 2029 issued by Viridis (European Loan Conduit No. 38) DAC (the Issuer) Under Review with Negative Implications (UR-Neg.).

-- Class A rated AA (sf)
-- Class B rated A (low) (sf)
-- Class C rated BBB (sf)
-- Class D rated BB (sf)
-- Class E rated B (high) (sf)

CREDIT RATING RATIONALE
The UR-Neg. status on the notes reflects the upcoming maturity of the underlying loan on 20 July 2024 and refinancing efforts not having been finalised as of now. Morningstar DBRS understands from a RIS notice dated 18 July 2024 that the servicer is in discussions with Aldgate Tower S.A.R.L. (the borrower) regarding its exit strategy and consented to the borrower's request to extend the loan maturity from 20 July 2024 to 20 January 2025. According to the notice, as a condition precedent to the amendments, the loan facility agent has received from the borrower signed term-sheet(s) from lender(s) in respect of the refinancing of the property on a 50% loan-to-value (LTV) basis. China Life Insurance (Group) Company (China Life), majority owner of the joint venture controlling the borrower together with Brookfield Property Partners L.P, agreed to provide the funds in connection with the refinancing of the loans according to the RIS notice.

As part of the amendment, the borrower agreed to pay an extension fee equal to 0.25% of the outstanding principal amount of the loans as of 17 July 2024, procure that an amount of not less than GBP 10.0 million is standing to the credit of the cash trap account as of 20 July 2024 and ensure that the hedging agreements, which are required to be in the form of an interest rate cap with a maximum strike rate of 1.00%, will be in place for a term ending no earlier than the extended maturity date. The borrower also provided certain undertakings including that a refinancing loan agreement is signed by no later than 20 October 2024.

While Morningstar DBRS understands refinancing efforts are ongoing, this does not entirely eliminate refinancing risk of the transaction. As of the April 2024 interest payment date (IPD), the loan is in cash trap with respect to its LTV and debt yield (DY), which are 73.8% and 6.0%, respectively. The recent headwinds facing the office sector and the current performance of the loan increase the uncertainty surrounding the refinancing prospects. In addition, bringing the LTV down to 50% based on the most recent valuation would require an equity injection of GBP 62.0 million by China Life by Morningstar DBRS' calculation. A loan event of default will occur if the borrower has not confirmed in writing that China Life has received all necessary approvals to participate in the refinancing equity injection by 15 September 2024.

The transaction was originally backed by a GBP 192 million senior loan, which was split into two facilities: Facility A (which is the securitised loan), which totalled GBP 150 million, and Facility B (a syndicated loan, not forming part of the transaction), which totalled GBP 42 million. The senior loan is secured by Aldgate Tower (a modern Grade A office tower) on the outskirts of the City of London. In April 2021, Savills valued the Aldgate Tower building at GBP 330 million, representing a 58.2% day-one LTV. The interest-only loan has a three-year term to 20 July 2024 and was structured with no extension options. There is no scheduled amortization.

The asset was most recently valued by Knight Frank LLP, which concluded to a value of GBP 260.0 million as of July 2023, showing a 13.3% decline over the previous GBP 300.0 million valuation dated August 2022 by Savills. This decline in value resulted in the LTV increasing to 73.8% from 64.0% since Morningstar DBRS' last round of surveillance. DY also showed deterioration between the April 2023 IPD and April 2024 IPD. DY declined to 6.0% from 7.2% between the two IPDs, driven by a decline in the adjusted net rental income to GBP 11.6 million from GBP 13.9 million over the same period. The decline is mainly attributed to the upcoming maturity of the leases of two key tenants at the time of the calculation, which account for 7.22% and 3.79% of the annual contractual rent according to the April 2024 servicer report. The bigger tenant vacated their premises on 30 April 2024, and the other is expected to vacate in August 2024. The reduction in projected rent because of these tenants terminating, and the associated void costs, led to a decline in adjusted net rental income. The April 2024 servicer report indicates a vacancy rate of 14.5% for the collateral. However, adjusting for these two terminations would bring the vacancy up to circa 23% by Morningstar DBRS' calculation.

The loan is structured with increasingly stringent DY cash trap covenants requiring the sponsors to improve the asset performance in order to remain compliant with the loan terms. The DY covenants are tested quarterly on each IPD in years 2 and 3 at 7% and 8%, respectively. Additionally, the structure includes a senior LTV cash trap covenant set at 70% LTV for the three-year loan term. Per the April 2024 servicer report, which indicates a DY of 6.0%, below the cash trap covenant of 8.0%, and LTV of 73.8%, above the cash trap covenant of 70%, the loan is in cash trap with respect to both metrics. There are no DY or LTV financial covenants applicable either prior to a permitted transfer or following a permitted transfer.

Morningstar DBRS' assumptions remained unchanged since its previous annual review, with Morningstar DBRS' Stabilised Net Cash Flow (NCF) at GBP 11.1 million and Morningstar DBRS' Cap Rate at 5.5%. This results in a Morningstar DBRS Value of GBP 201.1 million, which represents a 22.6% haircut to the latest valuation as of July 2023.

The senior loan carries a floating rate of Sterling Overnight Index Average (Sonia; floored at 0%) plus a 2.85% margin for a three-year term. The interest rate risk is fully hedged with a prepaid cap, with a maximum strike rate of 1.0% provided by Standard Chartered Bank, and a term expiring on the loan termination date.

The transaction also benefits from an issuer liquidity reserve in an aggregate amount of GBP 5,789,448. The Issuer's liquidity reserve can be used to cover interest shortfalls on the Class A, B, C, and D notes. According to Morningstar DBRS' analysis, the Issuer's liquidity reserve amount, as at closing, provided interest payment on the covered notes up to 17.6 months or 8.6 months based on the interest rate cap strike rate of 1% or on the Sonia cap of 4%, respectively.

The transaction is structured with a five-year tail period to allow the special servicer to workout the loan by July 2029 at the latest, which is the final legal maturity of the notes.

Morningstar DBRS' credit ratings on the applicable classes address the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents. Where applicable, a description of these financial obligations can be found in the transactions' respective press releases at issuance.

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

Notes:
All figures are in pound sterling 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.

Morningstar DBRS is undertaking a review and will remove the credit rating 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 DBRS Credit Ratings of the Global Methodology for Rating Sovereign Governments at: https://dbrs.morningstar.com/research/436000.

The sources of data and information used for these credit ratings include quarterly Investor Reports prepared by Mount Street Mortgage Servicing Limited and the most recent valuation report by Knight Frank LLP.

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 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 action on this issuer took place on 20 July 2023 when Morningstar DBRS downgraded the credit ratings on all of the notes issued by the Issuer.

The lead analyst responsibilities for this transaction have been transferred to Deniz Gokce.

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on https://dbrs.morningstar.com.

This credit rating is UR-Neg. Generally, the conditions that lead to the assignment of reviews are resolved within a 90-day period.

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 GmbH for use in the European Union.

Lead Analyst: Deniz Gokce, Senior Analyst
Rating Committee Chair: Mark Wilder, Senior Vice President
Initial Rating Date: 28 June 2021

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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 (28 June 2024), https://dbrs.morningstar.com/research/435165
-- Derivative Criteria for European Structured Finance Transactions (28 June 2024), https://dbrs.morningstar.com/research/435260
-- Interest Rate Stresses for European Structured Finance Transactions (28 June 2024), https://dbrs.morningstar.com/research/435278
-- 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 https://dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.