DBRS Morningstar Assigns Provisional Ratings to Usil European Loan Conduit No. 36 Designated Activity Company

DBRS Ratings GmbH (DBRS Morningstar) assigned the following provisional ratings to the notes to be issued by Usil European Loan Conduit No. 36 Designated Activity Company (Usil Eloc No. 36 DAC or the Issuer):

--Class RFN Notes rated AAA (sf)
--Class A-1 Notes rated AAA (sf)
--Class A-2 Notes rated AAA (sf)
--Class B Notes rated AA (low) (sf)
--Class C Notes rated A (low) (sf)
--Class D Notes rated BBB (sf)
--Class E Notes rated BB (high) (sf)
--Class F Notes rated B (high) (sf)

All notes carry a Stable trend.

The Issuer is the securitisation transaction of a EUR 723.9 million, floating-rate senior commercial real estate loan (the senior loan) advanced by both Morgan Stanley Principal Funding, Inc. and Morgan Stanley Bank, N.A. to borrowers sponsored by Blackstone Group L.P. (Blackstone or the Sponsor). The senior loan is backed by a portfolio of 100 German, predominantly light-industrial and warehouse assets. The purpose of the loan is to refinance the original acquisition loan and fund a progressive capex programme. In addition to the senior loan, there is also a EUR 105.6 million mezzanine loan, which is structurally and contractually subordinated to the securitised senior loan.

Blackstone acquired the portfolio in Q4 2017 along with M7 Real Estate Ltd. (M7 or the asset manager) as part of the growth of its wider European logistics platform. The majority of the portfolio (i.e., 92 of the assets) was purchased from Hansteen, while the remaining eight assets were brought in from M7’s own funds. The assets are located in major cities across Germany. North Rhine-Westphalia houses 35.7% of market value (MV), Hesse 15.2% of MV and the state of Berlin 12.4% of MV. The remaining assets are located across the states of Bavaria, Baden-Württemberg, Bremen, Lower Saxony, Saxony-Anhalt and Saxony. The portfolio mix is highly granular, offering over 2,000 units with 66% units less than 5, 000 square metres (sqm).

The transaction includes a EUR 44.8 million capex facility as part of the senior loan and a further EUR 6.9 million from the mezzanine loan to support Blackstone’s EUR 66 million capex budget over the life of the loan. Since acquisition, Blackstone has largely concentrated on stabilising the portfolio’s occupancy. To date, Blackstone has already spent approximately EUR 14 million of capex on property maintenance and reconstruction, enabling the management to keep a tenant retention rate of over 75%.

As of the June 2019 cut-off date, 87.4% of the portfolio’s net lettable area (NLA) was occupied by 1,064 tenants. The top ten tenants contribute 18.7% of the gross rental income (GRI). The largest tenant, Toom Baumarkt GmbH, contributes 4.3% to the GRI, with no other tenant in the portfolio representing more than 2.5%. The portfolio is 2.5% under-rented according to the market rent assessed by Jones Lang LaSalle SE (JLL), consequently providing opportunity for the management to marginally increase rent while maintaining the integrity of the weighted-average unexpired lease term (WAULE) of 3.27 years. Furthermore, the deployment of capex funds over the term of the loan should also present an opportunity for the sponsor to extract more reversionary value from the portfolio.

The senior loan is interest-only (IO) prior to permitted change of control and has a two-year maturity with three one-year extension options subject to certain conditions, including hedging. Based on JLL’s September 2019 valuation of EUR 1,015.3 million and valuing the assets on an individual basis, the senior loan represents a loan-to-value (LTV) of 71.3%. However, the value used by the arranger (Morgan Stanley) for covenants calculation is based on JLL’s portfolio appraisal that assumes if the portfolio was sold as a whole it would attract a premium of approximately 5.0% or a portfolio value of 1,066.7 million, which translates to an LTV of 67.9%. The DBRS Morningstar net cash flow (NCF) is EUR 49.2 million, a 17.0% haircut compared with the arranger’s net operating income (NOI) of 59.3 million and DBRS Morningstar’s value is EUR 745.6 million (LTV of 97.1%). The high DBRS Morningstar LTV is mitigated by cash trap covenants set at an LTV of 71.16%, and, prior to the second anniversary of the loan utilisation date, a debt yield (DY) of 7.6%, which increases to 8.0% once the first loan extension options is exercised. The DY at the cut-off date was 8.2%. The latest expected loan maturity date, considering potential extensions, is 15 February 2025.

The loan structure does not include financial default covenants prior to a permitted change of control but provides other standard events of default including (1) any missing payment, including failure to repay the loan at the maturity date; (2) borrower insolvency; and (3) a loan default arising as a result of any creditors’ process or cross-default. In DBRS Morningstar’s view, potential performance deteriorations would be captured and mitigated by the presence of cash trap covenants such as (1) an LTV cash trap covenant set at 71.2% and (2) a DY cash trap covenant as previously detailed. Following a permitted change of control, the borrowers are required to amortise the loan on each interest payment date by 0.25% of the aggregate outstanding principal amount of the senior loan. Additionally, after a permitted change of control, the following financial covenants would trigger an event of default (unless the permitted change of control is to the current mezzanine lender) if (1) the senior DY falls below the lesser of (a) 7.15% and (b) 85% of the DY as of the latest interest payment date (IPD) prior to the permitted change of control or (2) the senior loan LTV ratio is less than the LTV ratio as of the latest IPD prior to the permitted change of control plus 12.5%.

To maintain compliance with applicable regulatory requirements, the loan seller retained an ongoing material economic interest of no less than 5% of the securitisation via a Vertical Risk Retention (VRR) loan that will be advanced by the loan seller to the Issuer at closing.

The transaction includes a Reserve Fund Note (RFN), which acts as the liquidity reserve. After issuance, the EUR 20.0 million RFN proceeds and the EUR 1.05 million VRR loan contribution will be deposited into the transaction’s liquidity reserve. The liquidity reserve works similarly to a typical liquidity facility by providing liquidity to pay property protection advances, senior costs and interest shortfalls (if any) in relation to the corresponding VRR loan interest and the Class A1, Class A2 and Class B notes. The RFN notes rank pari passu with the Class A1 notes. According to DBRS Morningstar’s analysis, the liquidity reserve amount is equivalent to approximately 17.5 months’ coverage on the covered notes, based on the annual interest rate cap strike rate of 1.75% and 10.8 months’ coverage based on the LIBOR cap after loan maturity of 5.0% per year.

The Class E notes and Class F notes are subject to an available funds cap where the shortfall is attributable to an increase in the weighted-average margin of the notes. The final legal maturity of the notes is expected to be in February 2030, five years after the fully extended loan term. Given the security structure and jurisdiction of the underlying loan, DBRS Morningstar believes the final legal maturity date provides sufficient time to enforce, if necessary, on the loan collateral and repay the bondholders.

The transaction includes a Class X diversion trigger event, meaning that if the Class X diversion triggers, set at 7.6% for DY, which increases to 8.0% once a loan extension is exercised, and 71.16% for LTV, were breached, any interest and prepayment fees due to the Class X noteholders will instead be paid directly to the Issuer transaction account and credited to the Class X diversion ledger. However, such funds can potentially be used to amortise the notes only following a sequential payment trigger event or the delivery of a note acceleration notice.

Notes:
All figures are in euros unless otherwise noted.

The principal methodology applicable to the ratings is the “European CMBS Rating and Surveillance Methodology”.

DBRS Morningstar has applied the principal methodology consistently and conducted a review of the transaction in accordance with the principal methodology.

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

These may be found on www.dbrs.com at: http://www.dbrs.com/about/methodologies.

For a more detailed discussion of the sovereign risk impact on Structured Finance ratings, please refer to “Appendix C: The Impact of Sovereign Ratings on Other DBRS Credit Ratings” of the “Global Methodology for Rating Sovereign Governments” at: https://www.dbrs.com/research/350410/global-methodology-for-rating-sovereign-governments.

The sources of data and information used for these ratings include Morgan Stanley & Co. International PLC.

DBRS Morningstar did not rely upon third-party due diligence in order to conduct its analysis.

DBRS Morningstar was not supplied with third-party assessments. However, this did not impact the rating analysis.

DBRS Morningstar considers the data and information available to it for the purposes of providing these ratings to be of satisfactory quality.

DBRS Morningstar does not audit or independently verify the data or information it receives in connection with the rating process.

These ratings concern a newly issued financial instrument. These ratings are the first DBRS Morningstar ratings on this financial instrument.

Information regarding DBRS Morningstar ratings, including definitions, policies and methodologies, is available on www.dbrs.com.

To assess the impact of changing the transaction parameters on the rating, DBRS Morningstar considered the following stress scenarios, as compared to the parameters used to determine the rating (the Base Case):

Class RFN Notes Risk Sensitivity:
-- 10% decline in DBRS NCF, expected rating of Class RFN at AA (high) (sf)
-- 20% decline in DBRS NCF, expected rating of Class RFN at AA (high) (sf)

Class A-1 Notes Risk Sensitivity:
-- 10% decline in DBRS NCF, expected rating of Class A-1 at AA (high) (sf)
-- 20% decline in DBRS NCF, expected rating of Class A-1 at AA (high) (sf)

Class A-2 Notes Risk Sensitivity:
-- 10% decline in DBRS NCF, expected rating of Class A-2 at AA (low) (sf)
-- 20% decline in DBRS NCF, expected rating of Class A-2 at A (low) (sf)

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

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

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

Class E Notes Risk Sensitivity:
-- 10% decline in DBRS NCF, expected rating of Class E at B (sf)
-- 20% decline in DBRS NCF, expected rating of Class E at not rated (NR) (sf)

Class F Notes Risk Sensitivity:
-- 10% decline in DBRS NCF, expected rating of Class F at B (low) (sf)
-- 20% decline in DBRS NCF, expected rating of Class F at not rated (NR) (sf)

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings GmbH are subject to EU and US regulations only.

Lead Analyst: Christopher Horst, Senior Financial Analyst
Rating Committee Chair: Christian Aufsatz, Managing Director
Initial Rating Date: 21 October 2019

DBRS Ratings GmbH
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60311 Frankfurt am Main Deutschland
Geschäftsführer: Detlef Scholz
Amtsgericht Frankfurt am Main, HRB 110259

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

-- Legal Criteria for European Structured Finance Transactions
-- Derivative Criteria for European Structured Finance Transactions
-- Interest Rate Stresses for European Structured Finance Transactions
-- European CMBS Rating and Surveillance Methodology

A description of how DBRS Morningstar analyses structured finance transactions and how the methodologies are collectively applied can be found at: http://www.dbrs.com/research/278375.

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

This press release was modified on 5 March 2020 to change two references of the legal entity from DBRS Ratings Limited to DBRS Ratings GmbH.