DBRS Morningstar Confirms Ratings on Sage AR Funding No. 1 Plc with Stable Trends

DBRS Ratings Limited (DBRS Morningstar) confirmed its ratings on the following classes of Commercial Mortgage-Backed Floating Rate Notes due November 2030 issued by Sage AR Funding No. 1 Plc (the Issuer):

-- Class A at AAA (sf)
-- Class B at AA (high) (sf)
-- Class C at A (high) (sf)
-- Class D at BBB (sf)
-- Class E at BB (low) (sf)
-- Class F at B (sf)

All trends are Stable.

The rating confirmations follow the transaction’s stable performance over the last 12 months, with no material deviation from issuance and in spite of the Coronavirus Disease (COVID-19) pandemic.

The transaction is a securitisation of a GBP 220 million floating-rate senior social housing backed loan (the Senior Loan) advanced by the Issuer to a single borrower, Sage Borrower AR1 Limited (the Borrower). The Senior Loan is on-lent by the Borrower to its parent, Sage Rented Limited (SRL), a for-profit registered provider of social housing, and was used to finance SRL’s acquisition of properties as well as associated costs and expenses. The Senior Loan is backed by 1,609 residential units comprising mostly houses or apartments located across England. The loan term was five years with an expected final repayment date on 15 November 2025.

Sage Housing Limited (Sage) was established in May 2017 and is majority-owned by Blackstone Inc. The portfolio is a mixture of new-build houses and flats in new purpose-built schemes dating from 2017. Each scheme is generally in a good residential location close to transport links and amenities. Approximately 60% of the portfolio is in London, the South East, and the South West. SRL has appointed Places for People (PFP) for the day-to-day management of the units.

The Senior Loan interest comprises two parts: (1) Sonia (subject to zero floor) plus a margin that is a function of the weighted average (WA) of the aggregate interest amounts payable on the rated notes; and (2) the lower of excess cash flow and 9% fixed interest on the retention tranche (Class R).

To hedge against increases in the interest payable under the loan resulting from fluctuations in Sonia, the Borrower entered into an interest cap agreement with Merrill Lynch International (the Hedging Counterparty), with a purchased cap strike rate of 0.5%, for the full notional amount of the rated notes. As at the current review date, the Hedging Counterparty has a rating which is commensurate with that of DBRS Morningstar’s ratings criteria. The hedge will initially be in place for two years only; however, it must be renewed annually for the remaining term of the loan. If the hedge is not extended as described, there will be a loan event of default and sequential payment trigger event on the notes.

The Senior Loan has a rated loan-to-value (LTV) ratio of 67.76%, calculated on Savills market value subject to tenancy (MVSTT) of GBP 308.4 million dated 18 September 2020. There is no scheduled loan amortisation. Subject to partial prepayments of the loan, the Borrower shall repay the loan in full on the termination date. The final legal maturity of the notes is expected to be on 17 November 2030, five years after the Senior Loan maturity on 15 November 2025.

There have been no asset sales since issuance and the Senior Loan is performing in line with its covenants. In particular, the rated debt yield (DY) of 4.24% has remained consistently above the cash trap level of 3.75% while the rated LTV is well below the cash trap level of 78.0%. Vacancy across the portfolio dropped to 2.52% as at the August 2021 interest payment date compared with 9.0% at issuance, as Sage has continued to proactively lease up any vacancies across the schemes.

DBRS Morningstar maintained its net cash flow (NCF) assumption constant at GBP 8.5 million as at underwriting. In addition, DBRS Morningstar maintained its cap rate at 4.25% as at underwriting, which translates to a DBRS Morningstar value of GBP 200.2 million, representing a 35.1% haircut to MVSTT.

The transaction benefits from a liquidity reserve facility of GBP 6.5 million, which is provided by Deutsche Bank AG London Branch. The liquidity reserve facility may be used to cover shortfalls on the payment of interest due by the issuer to the holders of the Class A to Class C notes. No drawings have been made under the liquidity reserve facility since issuance.

The loan structure does not include any default financial covenants prior to a permitted change of control (CoC). The default covenants of the loan only occur after a permitted CoC takes place and when the rated LTV is higher than 85%. Additionally, the new obligors must ensure that, after the CoC date, the rated DY is not less than 85% of the rated DY on the date of the permitted CoC.

To comply with risk retention requirements, an entity within the Sage Group has retained a residual interest consisting of no less than 5% of the nominal and fair market value of the overall capital structure by subscribing to the unrated and junior-ranking GBP 11 million Class R notes. This retention note ranks junior in relation to interest and principal payments to all rated notes in the transaction.

The Coronavirus Disease (COVID-19) and the resulting isolation measures have caused an immediate economic contraction, leading in some cases to increases in unemployment rates and income reductions for many tenants and borrowers. DBRS Morningstar anticipates that vacancy rate increases and cash flow reductions may continue to arise for many CMBS borrowers. In addition, commercial real estate values could be negatively affected, at least in the short term, affecting refinancing prospects for maturing loans and expected recoveries for defaulted loans.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. These scenarios were last updated on 8 September 2021. DBRS Morningstar analysis considered impacts consistent with the baseline scenario in the below referenced report. For details, see the following commentaries: https://www.dbrsmorningstar.com/research/384150/baseline-macroeconomic-scenarios-for-rated-sovereigns and https://www.dbrsmorningstar.com/research/384482/baseline-macroeconomic-scenarios-application-to-credit-ratings.

On 16 June 2020, DBRS Morningstar published a commentary outlining how the coronavirus crisis is likely to affect DBRS Morningstar-rated CMBS transactions in Europe. For more details, please see: https://www.dbrsmorningstar.com/research/362693/european-cmbs-transactions-risk-exposure-to-coronavirus-covid-19-effect and https://www.dbrsmorningstar.com/research/362712/european-structured-finance-covid-19-credit-risk-exposure-roadmap.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

Notes:
All figures are in British pound sterling unless otherwise noted.

The principal methodology applicable to the ratings is: “European CMBS Rating and Surveillance Methodology” (26 February 2021).

Other methodologies referenced in this transaction are listed at the end of this press release. These may be found at: https://www.dbrsmorningstar.com/about/methodologies.

DBRS Morningstar 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 rating action.

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 Morningstar Credit Ratings” of the “Global Methodology for Rating Sovereign Governments” at: https://www.dbrsmorningstar.com/research/381451/global-methodology-for-rating-sovereign-governments.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. DBRS Morningstar analysis considered impacts consistent with the baseline scenarios as set forth in the following report: https://www.dbrsmorningstar.com/research/384482/baseline-macroeconomic-scenarios-application-to-credit-ratings.

The sources of data and information used for these ratings include servicer reports provided by Situs Asset Management Limited and U.S. Bank Global Corporate Trust Limited since issuance.

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

At the time of the initial ratings, 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.

The last rating action on this transaction took place on 26 October 2020 when DBRS Morningstar finalised its provisional ratings with Stable trends.

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

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

Class A Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of the Class A notes at AAA (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of the Class A notes at AA (sf)

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

Class C Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of the Class C notes at A (low) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of the Class C notes at BBB (sf)

Class D Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of the Class D notes at BBB (low) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of the Class D notes at BB (low) (sf)

Class E Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of the Class E notes at B (low) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of the Class E notes at CCC (sf)

Class F Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of the Class E notes at CCC (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of the Class E notes at CC (sf)

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

These ratings are endorsed by DBRS Ratings GmbH for use in the European Union.

Lead Analyst: Dinesh Thapar, Vice President
Rating Committee Chair: Christian Aufsatz, Managing Director
Initial Rating Date: 5 October 2020

DBRS Ratings Limited
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London EC3M 3BY United Kingdom
Tel. +44 (0) 20 7855 6600
Registered and incorporated under the laws of England and Wales: Company No. 7139960

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

-- European CMBS Rating and Surveillance Methodology (26 February 2021), https://www.dbrsmorningstar.com/research/374399/european-cmbs-rating-and-surveillance-methodology.
-- Legal Criteria for European Structured Finance Transactions (29 July 2021), https://www.dbrsmorningstar.com/research/382171/legal-criteria-for-european-structured-finance-transactions.
-- Interest Rate Stresses for European Structured Finance Transactions (24 September 2021), https://www.dbrsmorningstar.com/research/384920/interest-rate-stresses-for-european-structured-finance-transactions.
-- Derivative Criteria for European Structured Finance Transactions (20 September 2021), https://www.dbrsmorningstar.com/research/384624/derivative-criteria-for-european-structured-finance-transactions.
-- DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (3 February 2021), https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

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

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