Morningstar DBRS Finalizes Provisional Credit Ratings on the Secured Notes of Chestnut Notes Issuer LLC

DBRS, Inc. (Morningstar DBRS) finalized its provisional credit ratings on the Class A Notes, the Class B Notes, the Class C Notes, and the Class D Notes (together, the Secured Notes) issued by Chestnut Notes Issuer LLC pursuant to the Indenture dated as of July 28, 2023 (the Indenture), as amended by the First Supplemental Indenture dated as of July 25, 2024 and the Second Supplemental Indenture dated as of December 20, 2024, entered into between Chestnut Notes Issuer LLC, as the Issuer and U.S. Bank Trust Company, National Association, as Trustee:

-- Class A Notes at A (high) (sf)
-- Class B Notes at BBB (sf)
-- Class C Notes at BB (low) (sf)
-- Class D Notes at B (high) (sf)

The credit rating on the Class A Notes addresses the timely payment of interest (excluding any Defaulted Interest, as defined in the Indenture) and the ultimate return of principal on or before the Stated Maturity (as defined in the Indenture). The credit ratings on the Class B Notes, the Class C Notes, and the Class D Notes address the ultimate payment of interest (excluding any Defaulted Interest, as defined in the Indenture) and the ultimate return of principal on or before the Stated Maturity (as defined in the Indenture).

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 transaction's 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. The Morningstar DBRS short-term debt rating scale provides an opinion on the risk that an issuer will not meet its short-term financial obligations in a timely manner.

CREDIT RATING RATIONALE/DESCRIPTION

The credit rating actions are a result of Morningstar DBRS' review of the Second Supplemental Indenture, dated December 20, 2024, which amended the definition of PIKable Loan, as well as the satisfaction of certain conditions to finalize the credit ratings.

The Secured Notes are collateralized primarily by a portfolio of U.S. middle-market corporate loans. Chestnut Notes Issuer LLC is managed by 26North Direct Lending II LP, an affiliate of 26North Partners LP. Morningstar DBRS considers 26North Direct Lending II LP to be an acceptable middle-market corporate loan manager.

In its analysis, Morningstar DBRS considered the following aspects of the transaction:
(1) The integrity of the transaction structure.
(2) Morningstar DBRS' assessment of the portfolio quality.
(3) Adequate credit enhancement to withstand projected collateral loss rates under various cash flow stress scenarios.
(4) Morningstar DBRS' assessment of the origination, servicing, and middle-market corporate loan management capabilities of 26North Direct Lending II LP.

The transaction has a dynamic structural configuration that permits variations of certain asset metrics via the selection of an applicable row from a collateral quality matrix (the CQM). Depending on a given Diversity Score, the following metrics are selected accordingly from the applicable row of the CQM: Morningstar DBRS Risk Score, WAS Test, and Weighted-Average Recovery Rate (WARR). Morningstar DBRS analyzed each structural configuration as a unique transaction and all configurations (rows) passed the applicable Morningstar DBRS rating stress levels. The Coverage Tests and triggers as well as the Collateral Quality Tests that Morningstar DBRS reviewed in its analysis are presented below.

Coverage Tests:
Class A Overcollateralization Ratio Test: Actual 149.00%; Threshold 140.00%
Class B Overcollateralization Ratio Test: Actual 136.96%; Threshold 115.00%
Class C Overcollateralization Ratio Test: Actual 123.65%; Threshold 113.00%
Class D Overcollateralization Ratio Test: Actual 120.71%; Threshold 113.00%
Class A Interest Coverage Ratio Test: Actual 227.75%; Threshold 150.00%
Class B Interest Coverage Ratio Test: Actual 195.08%; Threshold 130.00%
Class C Interest Coverage Ratio Test: Actual 156.17%; Threshold 120.00%
Class D Interest Coverage Ratio Test: Actual 147.35%; Threshold 120.00%

Advance Rate Tests:
Class A Advance Rate: Actual 47.18%; Threshold 60.00%
Class B Advance Rate: Actual 53.08%; Threshold 67.50%
Class C Advance Rate: Actual 60.94%; Threshold 77.50%
Class D Advance Rate: Actual 62.90 %; Threshold 80.00%

Collateral Quality Tests:
Minimum Diversity Score Test: Actual 12.70; Threshold 8
Maximum Morningstar DBRS Risk Score Test: Actual 33.06%; Threshold 40.00%
Minimum WA Spread: Actual 5.25%; Threshold 5.00%
Minimum Average Recovery Rate Test: Actual 60.50%; Threshold 59.04%

Some particular strengths of the transaction are (1) the collateral quality, which consists of at least 95% of senior-secured middle market loans; (2) the adequate diversification of the portfolio of collateral obligations (Minimum Diversity Score Test of 8); and (3) the Collateral Manager's expertise in CLOs and overall approach to selection of Collateral Obligations.

Some challenges that were identified: (1) the expected weighted-average (WA) credit quality of the underlying obligors may fall below investment grade (per the Collateral Quality Matrix) and the majority may not have public ratings once purchased; and (2) the underlying collateral portfolio may be insufficient to redeem the Secured Notes in an Event of Default.

Morningstar DBRS analyzed the transaction using the Morningstar DBRS CLO Insight Model and its proprietary cash flow engine, which incorporated assumptions regarding principal amortization, principal prepayment, amount of interest generated, principal prepayments, default timings, and recovery rates, among other credit considerations referenced in Morningstar DBRS' "Global Methodology for Rating CLOs and Corporate CDOs" (November 19, 2024; https://dbrs.morningstar.com/research/443207) and CLO Insight Model v. 1.0.1.4.

Model-based analysis, which incorporated the above-mentioned Second Supplemental Indenture, produced satisfactory results. Considering the analysis, as well as the transaction's legal aspects and structure, Morningstar DBRS finalized the credit ratings on the Secured Notes.

To assess portfolio credit quality, Morningstar DBRS provides a credit estimate or internal assessment for each nonfinancial corporate obligor in the portfolio not rated by Morningstar DBRS. Credit estimates are not ratings; rather, they represent a model-driven default probability for each obligor that is used in assigning ratings to a facility.

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

Notes:
All figures are in U.S. Dollars unless otherwise noted.

The principal methodology applicable to the credit ratings is the Global Methodology for Rating CLOs and Corporate CDOs (November 19, 2024; https://dbrs.morningstar.com/research/443207) and the CLO Insight Model v. 1.0.1.4.

Other methodologies referenced in this transaction are listed at the end of this press release.

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

DBRS, Inc.
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Tel. +1 212 806-3277

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

Interest Rate Stresses for U.S. Structured Finance Transactions (February 26, 2024)
https://dbrs.morningstar.com/research/428623

Operational Risk Assessment for Collateralized Loan Obligations (CLOs) and Corporate Collateralized Debt Obligations (CDOs) (August 23, 2024) https://dbrs.morningstar.com/research/438315

Legal Criteria for U.S. Structured Finance (December 3, 2024) https://dbrs.morningstar.com/research/444064

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/417279.

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