DBRS Morningstar Confirms Ratings on Pearl Finance 2020 DAC with Stable Trends

DBRS Ratings GmbH (DBRS Morningstar) confirmed its ratings on the following classes of Commercial Mortgage-Backed Floating Rate Notes due November 2032 issued by Pearl Finance 2020 DAC (the Issuer):

-- Class A1 at AAA (sf)
-- Class A2 at AAA (sf)
-- Class B at AA (high) (sf)
-- Class C at A (low) (sf)
-- Class D at BBB (sf)
-- Class E at BBB (low) (sf)

All trends are Stable.

The rating confirmations follow the transaction’s stable performance over the last 12 months, with no material changes since issuance despite the Coronavirus Disease (COVID-19) pandemic.

The transaction is a securitisation of a EUR 335.4 million senior commercial real estate (CRE) loan backed by a pan-European portfolio of light-industrial and logistics assets managed collectively by Mileway, M7 Real Estate Ltd., and Normandie Capital but owned by Blackstone Real Estate Partners (the Sponsor). The senior loan is divided into two term facilities, term A and term B, with the term facility A advanced to non-French borrowers and the term facility B advanced only to French borrowers.

At closing, Bank of America Europe DAC (BofA or the loan seller) advanced the senior loan to the borrowers and then the Issuer purchased the senior loan from BofA using the commercial mortgage-backed security (CMBS) note issuance proceeds and an Issuer loan provided by the loan seller. The issuer loan represents 5% of the total senior loan amount.

The senior loan matures on 15 November 2022, but can be extended three times for one year each up until 15 November 2025. The borrowers purchased an interest cap agreement to hedge against increases in the interest payable under the loan. The initial cap agreement was provided by BNP Paribas and covers 95% of the outstanding loan balance with a strike rate of 1.25%. After the expected note maturity date (17 November 2025), the Euribor rate payable at note level will be capped at 4%.

The senior loan margin directly mirrors the weighted-average (WA) coupon on all the issued notes, but will not exceed 3.95%; therefore, there is no excess spread in the transaction and the borrowers bear the Issuer’s costs. The senior loan pays interest quarterly in arrears and there is no scheduled amortisation before the completion of a permitted change of control (CoC), at which time the borrowers must repay the aggregate outstanding principal amount of the senior loan in quarterly instalments equal to 0.25% of the outstanding principal amount as at the date of the permitted CoC (i.e., 1% per annum). Apollo Global Management, Inc. provided a mezzanine facility of EUR 69.0 million, which is contractually and structurally subordinated to the securitised senior loan.

The senior loan is backed by 61 assets across six European countries and can be divided into three subportfolios. The Sponsor acquired two of these subportfolios, Lotus and Cromwell, at the end of 2019. The Lotus portfolio comprises 22 assets in France while the Cromwell portfolio consists of 12 assets in the Netherlands, Denmark, and France. The Sponsor purchased the remaining 27 assets in the Netherlands, the Republic of Ireland, Finland, Denmark, Germany, and France (which formed the United subportfolio) over time.

The senior loan is denominated in euros whereas the Danish assets and income are denominated in Danish kroner (DKK). In the absence of a currency swap, United Denmark 2019 Holdco S.à r.l. (the Danish Holdco) is making monthly currency spot trades to convert DKK into euros, thus ensuring that the Danish net rental income is in euros when it reaches the relevant rental income account. As the Sponsor did not arrange any hedging between DKK and euro income, DBRS Morningstar applied an exchange rate of DKK 7.6282 per euro, the highest exchange rate allowed by the Danish central bank, for all non-AAA (sf) rated investment-grade stress scenarios and a higher exchange rate of DKK 12.1086 per euro in the AAA (sf) stress scenario.

On 31 July 2020, Cushman & Wakefield Debenham Tie Leung Limited (C&W) valued the portfolio for a total market value (MV) of EUR 576.9 million, including a 3% portfolio premium, or EUR 560.1 million based on aggregated MVs of each property. Most of the MV is concentrated in France (41.6% of aggregated MV) and Finland (28.0% of aggregated MV). In relation to the Lotus portfolio, 22 of the 31 French assets are part of the sale-and-leaseback operation agreed on between Elis S.A. (rated BBB (low) with a Stable trend by DBRS Morningstar) and the prior owner of the portfolio. The 15-year leases on these premises are scheduled to expire in 2029 with no break options, thus providing good stability to the portfolio’s cash flow for the next eight years.

There have been no asset sales since issuance and the senior loan is performing in line with its covenants. In particular, the debt yield (DY) of 12.0% has remained consistently above the cash trap level of 9.53% while the loan-to-value (LTV) ratio has remained stable at 58.13% as the senior loan is nonamortising before a permitted CoC and there were no updated valuations of the underlying portfolio since issuance. Vacancy across the portfolio decreased to 3.3% as at the August 2021 interest payment date compared with 4.7% at issuance.

DBRS Morningstar maintained its net cash flow (NCF) assumption constant at EUR 27.5 million as at underwriting. In addition, DBRS Morningstar maintained its cap rate at 6.70% as at underwriting, which translates to a DBRS Morningstar value of EUR 410.9 million, representing a 26.6% haircut to the appraised MV of EUR 560.1 million (28.8% haircut to the portfolio’s MV, including the 3.0% premium).

To cover any potential interest payment shortfalls, Société Générale provided the Issuer with a liquidity facility of EUR 21.3 million. The liquidity facility covers the Class A1 to Class D notes. No drawings have been made since issuance. The Class E notes are subject to an available funds cap where the shortfall is attributable to a reduction in the interest-bearing balance of the senior loan as a result of prepayments. However, as the loan margin is based on the WA coupon rate of the notes and senior costs are covered by the borrowers, it is unlikely to trigger an available funds cap except in the event that the WA coupon exceeds the loan margin cap of 3.95%.

The loan structure does not include any default financial covenants prior to a permitted CoC. The default covenants of the loan only occur after a permitted CoC takes place, at which time the LTV must not be greater than 68.42% and the DY must not be less than 9.04%.

The legal final maturity of the notes is in November 2032, seven years after the fully extended loan maturity date. DBRS Morningstar believes that this provides sufficient time to enforce the loan collateral and repay the bondholders, given the security structure and jurisdiction of the underlying loan.

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, CRE values could be negatively affected, at least in the short term, affecting refinancing prospects for maturing loans and expected recoveries for defaulted loans. The ratings are based on additional analysis to expected performance as a result of the global efforts to contain the spread of the coronavirus.

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.

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 euros 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 CBRE Loan Services 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 12 November 2020, when DBRS Morningstar finalised its provisional ratings on the notes with stable trends.

The lead analyst responsibilities for this transaction have been transferred to Daniel Rakhamimov.

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 A1 Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class A1 Notes to AAA (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class A1 Notes to AAA (sf)

Class A2 Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class A2 Notes to AA (high) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class A2 Notes to AA (low) (sf)

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

Class C Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class C Notes to BBB (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class C Notes to BBB (low) (sf)

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

Class E Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class D Notes to BB (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class D Notes to B (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 Limited for use in the United Kingdom.

Lead Analyst: Daniel Rakhamimov, Assistant Vice President
Rating Committee Chair: Christian Aufsatz, Managing Director
Initial Rating Date: 29 October 2020

DBRS Ratings GmbH
Neue Mainzer Straße 75
60311 Frankfurt am Main Deutschland
Tel. +49 (69) 8088 3500

Geschäftsführer: Detlef Scholz
Amtsgericht Frankfurt am Main, HRB 110259

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.
-- Currency Stresses for Global Structured Finance Transactions (18 February 2021), https://www.dbrsmorningstar.com/research/373856/currency-stresses-for-global-structured-finance-transactions.

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.