DBRS Morningstar Confirms Ratings on Emerald Italy 2019 SRL with Negative Trends

DBRS Ratings GmbH (DBRS Morningstar) confirmed its ratings on the following classes of commercial mortgage-backed floating-rate notes due September 2030 issued by Emerald Italy 2019 SRL as follows:

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

All trends remain Negative.

The rating confirmations follow the loan’s deleveraging and full repayment of deferred interest, with the performance of the underlying collateral remaining stable since the last rating action. However, the specially serviced loan was not extended and was not repaid at maturity, with a standstill on acceleration and enforcement put in place until 15 September 2023. The negative trends assigned to the notes reflect the uncertainty surrounding the retail market and the sales process.

The transaction is a securitisation of a EUR 105.8 million Italian commercial real estate loan, comprising a EUR 100.4 million term loan and a EUR 5.4 million capital expenditure (capex) loan, advanced by JPMorgan Chase Bank, N.A., Milan Branch and arranged by J.P. Morgan Securities PLC. The loan is secured against a portfolio of two retail malls and one shopping centre located in the Lombardy region of northern Italy. The borrower is Investire Società Di Gestione Del Risparmio S.P.A., acting on behalf of an Italian real estate alternative closed-end fund (fondo comune di investimento immobiliare alternative di tipo chiuso riservato) named Everest, which is ultimately owned by Kildare Partners.

The loan suffered cash flow deterioration as a result of the Coronavirus Disease (COVID-19) pandemic-related store closures and was transferred into special servicing in June 2020 following an uncured payment default. In October 2021, the noteholders approved a standstill agreement until the initial loan maturity date on 15 September 2022. The borrower intended to use this period to prepare an exit plan or meet the conditions for a maturity extension to 15 September 2023. However, the loan was not extended and not repaid at maturity on 15 September 2022 after the extension conditions, including appropriate hedging in place, were not satisfied. The special servicer agreed to a standstill period with the borrower until 15 September 2023, during which the key terms of the loan will continue to apply with default interest of 2% accruing on all overdue amounts (EUR 94.8 million). The floating rate loan is now unhedged. The borrower appointed a sales broker whereas the special servicer appointed a sales monitor to monitor the progression of the marketing and sale of the properties.

The loan’s rental cash flow performance remained stable over the past 12 months. Annual contracted rent remained relatively unchanged at EUR 12.2 million reported in June 2022 compared with EUR 12.1 million in June 2021 because of a slight decline in vacancy, which stood at 12.1% in Q2 2022. Arrears substantially declined but remain high, with 90+-day arrears of EUR 1.1 million reported in June 2022, down from EUR 2.2 million in June 2021.

The borrower was able to fully meet its debt obligations and repay deferred interest, including amortisation, over the past year. The loan balance has reduced by EUR 6.3 million since DBRS Morningstar’s last rating action on 1 October 2021, with principal receipts distributed sequentially towards repayment of the Class A notes. In total, the loan has amortised by EUR 11.0 million since closing, bringing the loan balance down to EUR 94.8 million as of September 2022.

Going forward, due to the accruing default interest and unhedged floating rate (3 months Euribor), the debt service costs will increase substantially. Coupled with high arrears levels, this could result in loan interest shortfalls that could affect the junior classes in the transaction.

Jones Lang LaSalle Incorporated (JLL) conducted a new valuation of the properties on 30 June 2022 and concluded a market value (MV) of EUR 134.0 million, a 0.4% decrease from Cushman & Wakefield’s valuation of the properties’ MV as of October 2021 and a 17.0% decrease from the value at closing. As a result, the loan-to-value ratio stood at 70.8% in September 2022.

DBRS Morningstar notes that the property sales will go ahead in challenging market conditions, given the limited time period and rising interest rates, which are likely to weaken investor activity in an already-pressured secondary shopping centre sector. To reflect the risk associated with the dependence on the collateral value, DBRS Morningstar updated its cap rate assumption to 9.5% from 9.0% and lowered its portfolio valuation to EUR 90.1 million from EUR 95.7 million, representing a 32.3% haircut to JLL’s updated valuation. However, this did not trigger any changes to the ratings as the loan’s reduced balance counteracted the DBRS Morningstar-assumed lower value in the analysis. As a result, DBRS Morningstar confirmed the ratings on all classes with Negative trends, reflecting the continued uncertainty surrounding the retail market and the sales process.

The loan matured on 15 September 2022. The final legal maturity of the notes is in September 2030. The sequential payment trigger has occurred and is continuing, with all principal in respect of the loan applied to the notes on a sequential basis. The Class X diversion trigger event has also occurred and is continuing.

The transaction benefits from a EUR 4.6 million liquidity facility (EUR 5.3 million at closing) available to cover interest on the Class A and Class B notes. The facility amortises in line with amortisation of the Class A and Class B notes. According to DBRS Morningstar’s analysis, the facility would provide coverage for around 16 months of interest coverage based on the unhedged three-month Euribor and relevant margins for the Class A and Class B notes.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (17 May 2022).

Notes:
All figures are in euros unless otherwise noted.

The principal methodology applicable to the ratings is “European CMBS Rating and Surveillance Methodology” (17 December 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/401817/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, quarterly tenancy schedules and transaction notices provided by Securitisation Services S.p.A. and CBRE Loan Services Limited.

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 1 October 2021, when DBRS Morningstar confirmed its ratings on all classes of notes with Negative trends.

The lead analyst responsibilities for this transaction have been transferred to Violetta Volovich.

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

Sensitivity Analysis: To assess the impact of changing the transaction parameters on the rating, DBRS Morningstar considered the following stress scenarios as compared with the parameters used to determine the rating (the base case):

Class A Risk Sensitivity:
-- A 10% decline in DBRS Morningstar’s net cash flow (NCF), expected rating on the Class A notes at BBB (sf)
-- A 20% decline in DBRS Morningstar’s NCF, expected rating on the Class A notes at BBB (low) (sf)

Class B Risk Sensitivity:
-- A 10% decline in DBRS Morningstar’s NCF, expected rating on the Class B notes at BBB (low) (sf)
-- A 20% decline in DBRS Morningstar’s NCF, expected rating on the Class B notes at BB (sf)

Class C Risk Sensitivity:
-- A 10% decline in DBRS Morningstar’s NCF, expected rating on the Class C notes at B (low) (sf)
-- A 20% decline in DBRS Morningstar’s NCF, expected rating on the Class C notes at CCC (low) (sf)

Class D Risk Sensitivity:
-- A 10% decline in DBRS Morningstar’s NCF, expected rating on the Class D notes at CCC (sf)
-- A 20% decline in DBRS Morningstar’s NCF, expected rating on the Class D notes at CC (low) (sf)

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar's outlooks and ratings are monitored.

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: Violetta Volovich, Senior Analyst
Rating Committee Chair: Christian Aufsatz, Managing Director
Initial Rating Date: October 9, 2019

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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 (17 December 2021), https://www.dbrsmorningstar.com/research/389947/european-cmbs-rating-and-surveillance-methodology.
-- Legal Criteria for European Structured Finance Transactions (22 July 2022), https://www.dbrsmorningstar.com/research/400166/legal-criteria-for-european-structured-finance-transactions.
-- Interest Rate Stresses for European Structured Finance Transactions (22 September 2022), https://www.dbrsmorningstar.com/research/402943/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 (17 May 2022), https://www.dbrsmorningstar.com/research/396929/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.