DBRS Morningstar Downgrades Ratings of Viridis (European Loan Conduit No.38) DAC, Confirms Negative Trend

DBRS Ratings Limited (DBRS Morningstar) downgraded its ratings of the Commercial Mortgage-Backed Floating-Rate Notes Due July 2029 (the notes) issued by Viridis (European Loan Conduit No. 38) DAC (the Issuer), as follows:

-- Class A notes to AA (sf) from AAA (sf)
-- Class B notes to A (low) (sf) from AA (low) (sf)
-- Class C notes to BBB (sf) from A (low) (sf)
-- Class D notes to BB (sf) from BBB (low) (sf)
-- Class E notes to B (high) (sf) from BB (high) (sf)

All trends are negative.

CREDIT RATING RATIONALE

The rating downgrades reflect the fact that, although the loan is currently performing, the cash flow generated by the property and the vacancy level have not materially improved since issuance and the sponsor is still quite far away from completing the initial business plan. There is uncertainty regarding the refinancing of the loan, which matures on 20 July 2024, unless there is a material improvement in the rental income generated by the property within the next 12 months and/or there is an equity injection from the Sponsor. It is also expected that the loan will be in debt yield (DY) cash trap at the July 2023 interest payment date (IPD). The loan-to-value ratio (LTV) has also increased since the reduction in the market value of the property based on the August 2022 revaluation by Savills. DBRS Morningstar also expects to see a further reduction in the market value of the property in the upcoming 2023 valuation. The Negative trends on the notes reflect the current reduced liquidity on the office sector.

The transaction was originally backed by a GBP 192 million senior loan, which was split into two facilities: Facility A, which totalled GBP 150 million (which is the securitised loan), and Facility B (a syndicated loan, not forming part of the commercial mortgage-backed securities (CMBS) transaction), which totalled GBP 42 million. The senior loan refinanced the borrower’s existing debt. The senior loan was advanced by Morgan Stanley Bank, N.A. to Aldgate Tower S.A.R.L., which is controlled by Brookfield Property Partners L.P. (Brookfield) and China Life Insurance Company Limited (China Life). The senior loan was secured by the Aldgate Tower (a modern Grade A office tower) in the outskirts of the City of London.

In April 2021, Savills valued the Aldgate Tower building at GBP 330 million, representing a 58.2% day-one LTV. The LTV at the April 2023 IPD increased to 64.0% from 58.2% at issuance. The increase in the LTV is due to the August 2022 revaluation by Savills, which reduced the market value of the property by 9.1% to GBP 300 million. The Servicer confirmed that a 2023 valuation will be carried out. Given the current reduced liquidity in the office sector, we expect to see a further reduction in the market value of the property in the 2023 revaluation. The April 2023 investor report confirms that the DY increased to 7.24% from 6.10 % at the April 2021 cut-off, and 6.81% in the April 2022 investor report.

There are no DY or LTV financial covenants applicable either prior to a permitted transfer or following a permitted transfer. DBRS Morningstar’s view is that potential performance deteriorations can be captured and mitigated by the presence of the tightening cash trap covenants in the facility agreement. The loan is structured with increasingly stringent DY cash trap covenants requiring the sponsors to improve the asset performance in order to remain compliant with the loan terms. The DY covenants are tested quarterly on each IPD in years 2 and 3 at 7% and 8%, respectively. Additionally, the structure includes a senior LTV cash trap covenant set at 70% LTV for the three-year loan term.

Given the increasingly stringent DY cash trap covenants and the long-run trend of the DY, DBRS expects that the DY cash trap will be breached at the July 2023 IPD. . If the DY cash trap covenant is breached at the July 2023 IPD, after accounting for payments of interest, the remaining excess cash will be transferred to the cash trap account.

The current loan balance stands at GBP 192 million. The Net Debt is the principal amount outstanding less cash held in the deposit, reserve and cash trap accounts. In April 2023, the Net Debt amount was GBP 191,999,800.

The senior loan carries a floating rate of Sterling Overnight Index Average (Sonia; floored at 0%) plus a 2.85% margin for a three-year term. The interest rate risk is fully hedged with a prepaid cap, with a maximum strike rate of 1.0% provided by Standard Chartered Bank, and a term expiring on the loan termination date.

The interest-only loan has a three-year term to 20 July 2024 and was structured with no extension options. There is no scheduled amortisation.

The loan previously benefited from a GBP 2.7 million capex/tenant improvement reserve (amortised to GBP 1.7 million in July 2021) and a GBP 5 million interest reserve. Both the reserves are no longer available. The property was fully let until just before issuance; however, as at the 20 April 2021 cut-off date, because of the loss of a key tenant, the property was only 72% occupied. This was mitigated by: (1) the transaction benefiting from a loan-level interest reserve of GBP 5 million, which could be released to the borrower on the latter of occupancy being greater than 90%, or the interest coverage ratio (which is the ratio of projected net rental income (NRI) to the sum of finance costs payable to the finance parties under the loan finance documents) equalling or exceeding 1.80x; and (2) a loan-level capex reserve of GBP 2.7 million (amortised to GBP 1.7 million at issuance, with the loan-level capex reserve being available to fund deficits in interest shortfall reserve amounts). At the January 2022 IPD, the conditions to release the loan-level interest reserve of GBP 5 million were temporarily met, and consequently GBP 5 million was released to the borrower at the borrower’s request. However, such condition was met only at the January 2022 IPD until the July 2022 IPD, when the occupancy rate was 90.3%. At the April 2023 IPD, the occupancy rate was 85.5%.

The transaction also benefits from an issuer liquidity reserve in an aggregate amount of GBP 5,789,448. The issuer liquidity reserve can be used to cover interest shortfalls on the Class A, B, C, and D notes. According to DBRS Morningstar’s analysis, the issuer liquidity reserve amount, as at closing, provided interest payment on the covered notes up to 17.6 months or 8.6 months based on the interest rate cap strike rate of 1% or on the Sonia cap of 4%, respectively.

The transaction, expected to repay on or before July 2024, is structured with a five-year tail period to allow the special servicer to work out the loan by July 2029 at the latest, which is the final legal maturity of the notes.

As of the April 2023 IPD, the servicer reported an adjusted NRI of GBP 13,904,366. Rent shall be deemed to have been received for any rent-free period that falls during the calculation period.

The weighted-average unexpired lease term (WAULT) and the weighted-average unexpired lease term to break option (WAULB) have also remained relatively long (i.e., longer than the maturity of the loan) at 7.05 years and 5.89 years, respectively.

The tenant profile is not very granular or diversified and currently includes a tenant that is in administration and a tenant whose rent is being paid by a guarantor. Both tenants are within the top five largest tenants by annual contractual rent. The property has significant tenant concentration and exposure to a single firm (a consultancy). In DBRS Morningstar’s view, the risk can be mitigated by the high credit quality of the tenant. The largest tenant represents 33.23% of the annual contractual rent in the portfolio and the second-largest tenant represents 21.88% of the annual contractual rent (so the two largest tenants represent 55.11% of the annual contractual rent), while the top five tenants provide in total circa 86.06% of the gross rental income (“GRI“) of the portfolio, and the top 10 tenants provide in total circa 99.37% of the annual contractual rent.

During the period 25 March 2023 to 23 June 2023, the collections for the period were 79.4%, 82% of these arrears were paid on or before the due date, and 13.6% were paid within three weeks of the due date. Total rent arrears are GBP 747,226 and there are also service charge arrears of GBP 220,140.

DBRS Morningstar updated the DBRS Morningstar net cash flow (NCF) to GBP 11,061,777 with a 20.4% haircut to the latest reported issuer NCF of GBP 13,904,366. DBRS Morningstar cap rate was also increased to 5.5% from 5%, resulting in a DBRS Morningstar value of GBP 201,123,218, which reflects a 32.96% haircut to the latest valuation.. DBRS Morningstar also updated the DBRS Morningstar maintained all other assumptions.

DBRS Morningstar’s credit rating on Class A, B, C, D, and Class E of the commercial mortgage-backed floating notes issued by Viridis (European Loan Conduit No.38) DAC addresses the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents. The associated financial obligations are listed at the end of this Press Release.

DBRS Morningstar’s credit rating does not address nonpayment risk associated with contractual payment obligations contemplated in the applicable transaction documents that are not financial obligations. For example, pro rata default interest, Sonia Excess Amount, and prepayment fees.

DBRS Morningstar’s long-term credit ratings provide opinions on risk of default. DBRS Morningstar 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.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
General Considerations
There were no Environmental/ Social/ Governance factor(s) 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/416784.

Notes:
All figures are in Pound Sterling unless otherwise noted.

The principal methodology applicable to the credit ratings is the European CMBS Rating and Surveillance Methodology (14 December 2022) https://www.dbrsmorningstar.com/research/407379/european-cmbs-rating-and-surveillance-methodology.

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

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 credit 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.

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.

The sources of data and information used for these credit ratings include quarterly Investor Reports prepared by Mount Street Mortgage Servicing Limited.
DBRS Morningstar did not rely upon third-party due diligence in order to conduct its analysis.

At the time of the initial credit rating, DBRS Morningstar was not supplied with third-party assessments. However, this did not impact the credit rating analysis.

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

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

The last credit rating action on this transaction took place on 17 July 20, 2022, when DBRS Morningstar downgraded the notes to AA, A (low), BBB, BB, and B (high) on the Class A, Class B, Class C, Class D, and Class E Notes, respectively, and confirmed the Negative trend on all classes of notes.

Information regarding DBRS Morningstar credit 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 credit rating, DBRS Morningstar considered the following stress scenarios as compared with the parameters used to determine the credit rating (the Base Case):
Class A Risk Sensitivity:
-- a 10% decline in DBRS Morningstar’s NCF would lead to an expected rating of the Class A notes at A (sf)
-- a 20% decline in DBRS Morningstar’s NCF would lead to an expected rating of the Class A notes at BBB (high) (sf)
Class B Risk Sensitivity:
-- a 10% decline in DBRS Morningstar’s NCF would lead to an expected rating of the Class B notes at BBB (sf)
-- a 20% decline in DBRS Morningstar’s NCF would lead to an expected rating of the Class B notes at BB (high) (sf)
Class C Risk Sensitivity:
-- a 10% decline in DBRS Morningstar’s NCF would lead to an expected rating of the Class C notes at BB (high) (sf)
-- a 20% decline in DBRS Morningstar’s NCF would lead to an expected rating of the Class C notes at BB (low) (sf)
Class D Risk Sensitivity:
-- a 10% decline in DBRS Morningstar’s NCF would lead to an expected rating of the Class D notes at B (sf)
-- a 20% decline in DBRS Morningstar’s NCF would lead to an expected rating of the Class D notes at CCC (high) (sf)
Class E Risk Sensitivity:
-- a 10% decline in DBRS Morningstar’s NCF would lead to an expected rating of the Class E notes at CCC (high) (sf)
-- a 20% decline in DBRS Morningstar’s NCF would lead to an expected rating of the Class E notes at CCC (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://registers.esma.europa.eu/cerep-publication/. For further information on DBRS Morningstar historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

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

Lead Analyst: Sioban Sugrue, Assistant Vice President, Credit Ratings Legal
Rating Committee Chair: Mark Wilder , Senior Vice President, Credit Ratings Operational Risk
Initial Rating Date: June 28, 2021

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

The credit 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 (14 December 2022)
https://www.dbrsmorningstar.com/research/407379/european-cmbs-rating-and-surveillance-methodology.

Legal Criteria for European Structured Finance Transactions (30 June 2023) https://www.dbrsmorningstar.com/research/416730/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 (16 June 2023)
https://www.dbrsmorningstar.com/research/415976/derivative-criteria-for-european-structured-finance-transactions.

DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (4 July 2023), https://www.dbrsmorningstar.com/research/416784/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.