Morningstar DBRS Takes Rating Actions on ERNA S.r.l.
CMBSDBRS Ratings GmbH (Morningstar DBRS) took the following credit rating actions on the notes issued by ERNA S.r.l. (the Issuer):
-- Class A notes confirmed at AA (low) (sf)
-- Class B notes upgraded to A (high) (sf) from BBB (high) (sf)
The trends on all credit ratings are Stable.
CREDIT RATING RATIONALE
The credit rating actions reflect the strong transaction's deleveraging and stable cash-flow metrics, in line with Morningstar DBRS' expectations.
ERNA S.r.l. is the securitisation of four Italian senior commercial real estate loans: the Aries loan, the Ermete loan, the Nucleus loan, and the Raissa loan. The loans are secured predominantly by telephone exchange properties spread across Italy, but the Nucleus loan portfolio also includes some office, warehouse, garage, and residential spaces. The loans were granted as refinancing facilities to four borrowers all ultimately owned and controlled by TPG Sixth Street Partners (the Sponsor).
The Originators, Zodiac Holdings LLC and Nucleus Investments LLC, are ultimately controlled by the Sponsor. To maintain compliance with the applicable regulatory requirements, the Originators retained an ongoing material economic interest of no less than 5.0% by subscribing to the unrated and junior-ranking EUR 15.8 million Class Z notes. This retention note is fully subordinate within the structure as it will not receive any principal payment until the Class A and Class B notes are repaid in full.
The aggregate principal amount of the four facilities was EUR 315.8 million at issuance. At the time, the business plan from each borrower envisaged to dispose of the assets that were considered noncore over the course of the underlying loans' term, before a block exit was sought. Since issuance, the borrowers have successfully completed the disposal of 386 assets out of the initial 648, thus leaving the underlying pool with 262 properties as of the October 2024 interest payment date (IPD).
On 20 July 2024, the borrowers repaid the EUR 2.8 million then outstanding Ermete loan in full and made further voluntary prepayments across the other three loans. The resulting principal proceeds were first applied reverse sequentially to repay in full the Class C notes (EUR 7.8 million outstanding as of April 2024 IPD), and then applied pro rata to the Class A and Class B notes. The voluntary repayments were part of a broader restructuring proposal, which was approved by the noteholders and became effective on 20 July 2024. As a result of the restructuring, the outstanding loans' maturity date was extended by two years to 20 July 2026 from 20 July 2024, with the notes' final legal maturity date being also extended by two years to 25 July 2033 from 25 July 2031, resulting in an unchanged notes' tail period of seven years. Moreover, the Class A notes margin increased from 225 basis points (bps) to 275 bps, while the Class B notes margin increased from 360 bps to 500 bps. The Class Z notes margin remained at 550 bps. The new loan margins are reflecting the weighted average (WA) of the new notes' margins. According to the latest investor report, as of October 2024 the loans' margin was 3.4938%.
As also envisaged under the terms of the restructuring, starting from the July 2024 IPD, loan-level excess cash flows and all net disposal proceeds above the release price have been fully swept to prepay the loans. At notes' level, disposal proceeds up to the allocated loan amount have been applied sequentially, while release premiums and disposal proceeds above the release price have been applied pro rata to the notes (except for the Class Z notes), as well as principal payments from excess cash flow (which are always subject to the sequential payment trigger).
The whole transaction's outstanding balance decreased to EUR 107.1 million at the October 2024 IPD, which reflects a 26.8% decline from EUR 146.2 million outstanding at the April 2024 IPD (pre-restructuring) and a more pronounced 66.1% decline from EUR 315.8 million at cut-off in June 2019. The EUR 59.4 million Nucleus loan is still the largest in the pool (55.5% by outstanding balance), followed by the Raissa loan (30.2%) and the Aries loan (14.3%).
On 31 December 2023, Colliers Valuation Italy Srl (Colliers) and CBRE Valuation & Advisory Services (CBRE) appraised the aggregate market value (MV) of the 262 properties outstanding as of the October 2024 at EUR 403.2 million. On a like-for-like basis, thus excluding the sold properties, this is only 2.6% lower than the initial valuation of EUR 414.0 million at issuance. The transaction's WA loan-to-value ratio (LTV) stood at 27.9% at the October 2024 IPD, down from 42.6% at issuance. At the single loan level, the 111 properties left in the Nucleus portfolio were valued at EUR 192.1 million (30.9% LTV), the 80 properties backing the Raissa portfolio at EUR 114.9 million (28.1% LTV), and the remaining 71 properties in the Aries portfolio at EUR 96.1 million (16.0% LTV).
According to the servicer report as of October 2024 IPD, gross rental income (GRI) and net rental income (NRI) for the aggregate portfolio stood at EUR 33.4 million and EUR 26.5 million, respectively. The transaction's WA debt yield (DY) increased to 24.8% as of October 2024 from 13.0% as at issuance.
As of the October 2024 IPD, the Raissa and Aries portfolios were still fully occupied by Telecom Italia S.p.A. on WA unexpired lease terms of 12.0 years and 13.75 years, respectively. The collateral is mainly used to house local telephone exchanges. The tenant's credit profile has substantially improved earlier this year, once Italy's biggest telecoms group finalised the sale of its domestic fixed-line access network to U.S. fund KKR. As of October 2024, the Raissa and Aries portfolios generated net rental income (NRI) of EUR 8.5 million and EUR 6.5 million, respectively. As a result, their respective debt yields (DY) stood at 26.2% for Raissa and 42.6% for Aries.
The Nucleus portfolio is mixed, with 48.7% of its outstanding MV made of offices, 36.1% of warehouse space, 13.5% of garage space, and only 1.7% of telephone exchanges and antennas. Enel Italia S.p.A. (Enel) is the largest tenant, contributing 94.2% of the total Nucleus portfolio's contracted rent as at the October 2024 IPD. The investment-grade tenant is one of Europe's leading energy companies and the main distributor of electricity in Italy. As of the October 2024 IPD, the Nucleus portfolio generated NRI of EUR 11.5 million, thus resulting in a DY of 19.4%. The Nucleus portfolio's WA unexpired lease term was 12.95 years, while physical vacancy stood at 17.03%.
The three loans are 90% hedged via cap agreements with Merrill Lynch International as counterparty, with a strike rate of 3.25% and a termination date that coincides with the final loan maturity date on 20 July 2026.
Morningstar DBRS did not change its underwriting assumptions, but only updated its net cash flow (NCF) to account for the disposed properties. Morningstar DBRS NCFs resulted in EUR 6.5 million, EUR 4.6 million, and EUR 9.0 million for the Raissa, Aries, and Nucleus loans, respectively. Based on the unchanged cap rate assumptions of 8.0% for the Raissa and Aries loans, and 8.5% for the Nucleus loan, the Morningstar DBRS values for each portfolio resulted in EUR 81.2 million, EUR 57.8 million, and EUR 106.2 million, respectively. The aggregate Morningstar DBRS value of EUR 245.2 million represents a haircut of 39.2% to the outstanding portfolio's aggregate MV of EUR 403.2 million.
The transaction benefits from a EUR 5.4 million outstanding liquidity facility as of October 2024 IPD, down from EUR 15.0 million at issuance, provided by Bank of America Merrill Lynch International DAC, Milan Branch. The liquidity facility can be only used to cover interest shortfalls on the Class A notes. According to Morningstar DBRS' analysis, the outstanding commitment amount could provide an interest coverage on the Class A notes of approximately 13 months based on a 3.25% strike rate, or approximately 10.5 months of coverage based on the Euribor cap of 5.0% payable on the notes after their expected maturity date.
The credit ratings on the Class A and Class B notes materially deviate from the higher credit ratings implied by the Direct Sizing Hurdles, which are a substantial component of Morningstar DBRS' European CMBS Rating and Surveillance methodology. Morningstar DBRS considers a material deviation to be a rating differential of three or more notches between the assigned rating and the rating implied after the application of the relevant methodology. In this case, the level of liquidity support available to the Class A notes is below the level Morningstar DBRS typically expects in order to mitigate payment disruption risk. Moreover, the liquidity facility cannot be used to cover any potential interest shortfalls on Class B 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, or 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 tframewoark can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (13 August 2024) at https://dbrs.morningstar.com/research/437781 .
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.
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 quarterly investor reports provided by Securitisation Services S.p.A as at the October 2024 IPD, and the valuation reports from Colliers and CBRE dated 31 December 2023.
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 21 December 2023, when Morningstar DBRS upgraded its credit ratings with Stable trends and removed the notes from Under Review with Positive Implications status.
Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on http://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 of Class A Notes of AA (low) (sf)
-- 20% decline in Morningstar DBRS NCF, expected rating of Class A Notes of AA (low) (sf)
Class B Risk Sensitivity:
-- 10% decline in Morningstar DBRS NCF, expected rating of Class B Notes of A (high) (sf)
-- 20% decline in Morningstar DBRS NCF, expected rating of Class B Notes of A (high) (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: Violetta Volovich, Assistant Vice President
Rating Committee Chair: David Lautier, Senior Vice President
Initial Rating Date: 10 May 2019
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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
-- 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.
Ratings
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