Morningstar DBRS Downgrades Credit Ratings on Salus (European Loan Conduit No. 33) DAC With Negative Trends

DBRS Ratings Limited (Morningstar DBRS) took the following credit rating actions on the notes issued by Salus (European Loan Conduit No. 33) DAC (the Issuer):

-- Class A downgraded to A (high) (sf) from AA (high) (sf)
-- Class B downgraded to BBB (sf) from A (low) (sf)
-- Class C downgraded to BB (high) (sf) from BBB (low) (sf)
-- Class D downgraded to BB (low) (sf) from BB (sf)

The trends on all credit ratings are Negative.

CREDIT RATING RATIONALE
The credit rating downgrades result from the further increase in Morningstar DBRS' cap rate assumption for the underlying property by 55 basis points (bps) to 6.30% from 5.75% as at Morningstar DBRS' last review of the deal in July 2024. At the time, Morningstar DBRS had already raised its cap rate by 55 bps to 5.75% from 5.20% to reflect the aged property valuation (March 2023), the transaction's reduced tail period, and its refinancing risk. The senior loan's extended maturity into the tail period is approaching on 20 January 2025 and, in Morningstar DBRS' view, the sale of the Citypoint asset is unlikely to take place on schedule, or at least not likely to be executed at a sale price in line with the sponsor's expectations.

If the borrower does not manage to refinance or sell the property within loan maturity, the servicer would not be able to grant another 12-month extension without noteholders' consent first. While the improved cash flow metrics of the portfolio might point towards a noteholder-approved restructuring, Morningstar DBRS is of the opinion that the senior loan is highly likely to default at its maturity and, as a result, to be transferred into special servicing.

The transaction is a securitisation of a GBP 367.5 million floating-rate senior commercial real estate loan that Morgan Stanley & Co. International Plc (Morgan Stanley) advanced in November 2018 to CityPoint Holdings I Ltd., which is controlled by Brookfield Asset Management Inc. (the Sponsor). The senior loan is split into two pari passu facilities: Facility A, which totals GBP 354.0 million, and Facility B (the capital expenditure (capex) facility), which totals GBP 13.5 million. Facility A refinanced the borrower's existing debt, whereas the capex facility financed some refurbishment works that the Sponsor planned at issuance. Additionally, there is a nonsecuritised mezzanine facility totalling GBP 91.9 million that is contractually and structurally subordinated to the senior facilities. For the purposes of complying with the applicable risk retention requirements, Morgan Stanley also advanced a GBP 18.4 million vertical risk retention (VRR) loan to the issuer.

The senior loan is secured by a single asset known as Citypoint, a 36-storey office tower in the City of London originally built for British Petroleum in 1967. The building offers 704,657 square feet (sf) of office space and more than 60,000 sf of retail space, including several restaurants and one of the largest health club in the Square Mile, Nuffield Health. It is one of the largest office buildings in the City of London and underwent a comprehensive reconstruction in 2001. Since then, the owner has maintained the property to a high standard with ongoing refurbishment works and, as such, the building does not show any significant signs of obsolescence. In particular, as part of the Sponsor's business plan to capture the asset's reversionary value potential, during the course of 2020-21, levels five to eight (the podium floors) underwent a comprehensive refurbishment at a cost of around GBP 167 per sf (psf) to provide high-quality Grade A offices and an additional floor area and walkway. Landscaped terraces were also included, and the dedicated podium reception was refurbished.

After the refurbishment, there was letting activity on level eight with the execution of a new lease to an already occupying tenant, Squarepoint Capital LLP, that commenced on 1 March 2023. The contracted rent for the new lease is GBP 1.47 million per annum (GBP 59 psf) and the lease commenced on 1 December 2023. More recently, the borrower signed a new lease with Phaidon International (UK) Ltd for the whole level seven, with an annual contracted rent of GBP 2.4 million (GBP 56 psf) and a 10-year term commencing in March 2025. As a result, the building's physical occupancy increased to 88.3% at the October 2024 interest payment date (IPD) from 81.6% as of the July 2024 IPD. Moreover, based on the October 2024 IPD servicer report, Morningstar DBRS understands that terms have been agreed with a new tenant to occupy level six on a 10-year term commencing in April 2025, which would boost occupancy up to 95% upon completion of the lease. Therefore, level five is still the only vacant level in the building, and negotiations are ongoing with potential new tenants.

As a result of the new lettings, contracted rent increased by 9.5% to GBP 34.4 million as of October 2024 IPD from GBP 31.4 million as of the April 2024 IPD. Projected net rental income stood at GBP 31.7 million in October 2024, thus resulting in a debt yield of 8.6%, which is above the cash-trap covenant of 8.0%. In March 2023, Savills Plc (Savills) revalued the property at GBP 670.0 million, which is 9.5% lower than the previous valuation of GBP 740.0 million from Knight Frank LLP in September 2021, but still 11.6% higher than the initial valuation of GBP 600.0 million that Jones Lang LaSalle Incorporated conducted in October 2018. The senior loan's loan-to-value ratio remained constant at 54.9%, in compliance with the cash trap covenant of 72.5%.

Morningstar DBRS maintained its stabilised net cash flow (NCF) assumption at GBP 25.3 million. In addition, Morningstar DBRS increased its cap rate assumption by 55 bps to 6.3% from 5.75% to further account for increased refinancing risk and other transaction-specific weaknesses. The increased cap rate translates into an updated Morningstar DBRS value of GBP 401.6 million, which represents a 40.0% haircut to Savills' valuation dated March 2023. At the previous review in July 2024, Morningstar DBRS' value was equal to GBP 439.9 million, thus reflecting a 34.3% haircut to the most recent valuation. In Morningstar DBRS' opinion, the current market value of the asset is likely lower given the widening of yields in the office market. The Sponsor put the asset on sale in September 2024 without attaching a formal price tag, but it is publicly known that they are seeking offers over GBP 500 million, which could mean a price as much as 25% lower than the latest valuation of GBP 670 million. Although this would be sufficient to fully repay the GBP 459.4 million outstanding debt secured against the building, the lack of deals of similar magnitude (i.e., big London offices) makes it difficult to pin down the property's exact current market value.

The senior loan was initially scheduled to mature on 20 January 2022 with two one-year conditional extension options available to the borrower. The borrower exercised these options, extending the senior loan's maturity to 22 January 2024. The borrower then requested an additional 12 months' maturity extension to 20 January 2025. In December 2023, the servicer agreed to the extension conditional to certain amendments to the senior loan including, but not limited to, increasing the loan margin by 0.35% to 2.50% per annum for the period from 20 January 2024 to 20 January 2025 and a one-off maturity fee of 0.25% of the principal amount outstanding of the senior loan, both to be passed on to the noteholders and the VRR lender. The senior loan is interest only and currently accrues quarterly interest at the aggregate of compounded Sterling Overnight Interest Average (Sonia) and a credit adjustment spread of 0.1193%, plus the 2.5% annual margin. It is fully hedged up until January 2025 with an interest rate cap provided by Wells Fargo Bank, N.A. with a strike rate of 2.5%.
The liquidity facility outstanding balance stood at GBP 20.0 million as of the April 2024 IPD, unchanged since issuance, and covers the Class A through Class D notes. According to Morningstar DBRS' analysis, the outstanding amount of the liquidity facility provides coverage of 13.7 months based on the interest rate cap strike rate of 2.5% or 9.1 months based on the 5.0% Sonia cap payable on the notes after the expected note maturity date.

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 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 Factors in Credit Ratings (13 August 2024) https://dbrs.morningstar.com/research/437781.

Notes:
All figures are in British 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.

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 Credit 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 the servicer reports published by Mount Street Mortgage Servicing Limited.

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 23 July 2024, when Morningstar DBRS confirmed its credit rating on the Class A notes and downgraded credit ratings on the other classes of notes.

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 credit rating of Class A notes to A (sf)
-- 20% decline in Morningstar DBRS NCF, expected credit rating of Class A notes to BBB (high) (sf)

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

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

Class D Risk Sensitivity:
-- 10% decline in Morningstar DBRS NCF, expected credit rating of Class D notes to B (low) (sf)
-- 20% decline in Morningstar DBRS NCF, expected credit rating of Class D notes to 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 GmbH for use in the European Union.

Lead Analyst: Deniz Gokce, Senior Analyst
Rating Committee Chair: David Lautier, Senior Vice President
Initial Rating Date: 11 December 2018

DBRS Ratings Limited
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Registered and incorporated under the laws of England and Wales: Company No. 7139960

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
--Interest Rate Stresses for European Structured Finance Transactions (24 September 2024)
https://dbrs.morningstar.com/research/439913.
--Legal and Derivative Criteria for European Structured Finance Transactions (19 November 2024)
https://dbrs.morningstar.com/research/443196.

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/439604.

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