DBRS Morningstar Upgrades and Confirms Credit Ratings on Pearl Finance 2020 DAC; Maintains Stable Trends

DBRS Ratings GmbH (DBRS Morningstar) took the following credit rating actions on the Commercial Mortgage-Backed Security (CMBS) notes due November 2032 issued by Pearl Finance 2020 DAC (the Issuer):

-- Class A1 notes confirmed at AAA (sf)
-- Class A2 notes confirmed at AAA (sf)
-- Class B notes confirmed at AA (high) (sf)
-- Class C notes upgraded to AA (low) (sf) from A (low) (sf)
-- Class D notes upgraded to A (sf) from BBB (sf)
-- Class E notes upgraded to BBB (high) (sf) from BBB (low) (sf)

The trends on all credit ratings remain Stable.

CREDIT RATING RATIONALE
The credit rating upgrades on the Class C to Class E notes result from the improved operational performance of the underlying properties over the last 12 months (LTM).

The transaction is a securitisation of a EUR 316.6 million (EUR 335.4 million at issuance) senior commercial real estate loan backed by a pan-European portfolio of light-industrial and logistics assets collectively managed by Mileway, M7 Real Estate Ltd., and Normandie Capital but owned by Blackstone Real Estate Partners (the sponsor). 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 CMBS note issuance proceeds and an issuer loan provided by the loan seller. The issuer loan represents 5.0% of the total senior loan amount. BNP Paribas SA, Société Générale, and Merrill Lynch International acted as joint arrangers.

The securitised portfolio comprises 60 assets (61 at issuance) spread across six different European countries, namely France (37.4% by market value), Finland (26.5%), Denmark (11.7%), Germany (10.0%), Ireland (7.9%), and the Netherlands (6.5%). On 15 January 2023, Jones Lang LaSalle (JLL) revalued the portfolio at EUR 716.4 million, including a 5.0% portfolio premium. JLL’s previous valuation for the portfolio was dated 31 October 2021, and was equal to EUR 690.9 million, which also included a 5.0% portfolio premium. On a like-for-like basis, thus excluding the French Pantin 31 Chem asset sold in November 2021, the new valuation reflects a 3.7% increase since the previous one. As a result, the senior loan’s reported loan-to-value ratio decreased to 44.2% at the August 2023 interest payment date (IPD), compared with 45.8% last year and 58.1% at issuance, remaining well below the current cash-trap covenant of 68.42%.

The securitised portfolio has maintained a consistently high and stable occupancy rate of above 96.0% since closing (specifically, 96.4% on the August 2023 IPD). This aligns with the relatively low market vacancy in the pertinent European markets, highlighting the appeal of high quality logistics assets for occupiers due to robust demand and a shortage in supply.

The sponsor has been able to capture the reversionary potential of the portfolio since issuance, mainly by signing new lease contracts with shorter terms and by re-gearing the expiring ones at a higher contractual rent, which is gradually converging towards the estimated rental value (ERV).

Net rental income has increased by 11.8% to EUR 40.0 million on the August 2023 IPD, up from EUR 35.8 million last year, thus resulting in a debt yield of 12.6%, which is well above the current cash trap covenant of 9.5%.

The tenant profile remains stable since issuance, with the top five tenants representing approximately 41.2% of the total rental income. The largest tenant is M.A.J., under Elis S.A. (Elis Group), and covers approximately 14.8% of total contracted rent. Through its subsidiaries Elis, M.A.J., LES LAVANDIERES, THIMEAU, and R.L.S.T., the securitised portfolio’s cumulatively exposure towards the Elis Group equals 18.5% of the total contracted rent as of August 2023. The Elis Group is a leading French service provider specialising in the maintenance and rental of flat linen, workwear, and various hygiene and facility services. Its business is highly diversified in terms of its customer base and end markets. As of 15 March 2023, DBRS Morningstar rates the Elis Group at BBB (low) with a Positive trend.

As reported in the August 2023 IPD servicer report, 226 leases will be maturing over the next 12 months, reflecting 138,580 square meters and a contractual rent of EUR 9.6 million. However, DBRS Morningstar is of the opinion that the good quality and attractive locations of the underlying assets, coupled with the strong fundamentals of their respective sub-markets, will be key in re-negotiating lease terms or, eventually, re-letting these units at lease expirations, with further achievable reversionary potential for the portfolio in the next 12 months.

DBRS Morningstar increased its stabilised net cash flow (NCF) assumption to EUR 32.0 million from EUR 26.1 million at its last review, to reflect the improved performance of the property portfolio over the LTM. In addition, DBRS Morningstar maintained its cap rate assumption at 6.7%, as at issuance, which translates to a DBRS Morningstar Value of EUR 478.8 million, representing a 33.2% haircut to JLL’s most recent valuation and reflecting a DBRS Morningstar LTV of 66.1%. Our DBRS Morningstar Value is 22.6% higher than the EUR 390.7 million at the last review and 16.5% higher than the EUR 410.9 million at closing.

The senior loan carries a floating interest rate with a Euribor benchmark plus a margin, which directly mirrors the weighted-average 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% (i.e., 1% per annum) of the outstanding principal amount as at the date of the permitted CoC.

The senior loan was initially scheduled to mature on 15 November 2022, with three conditional one-year extension options available to the borrowers to extend the senior loan up until 15 November 2025 (the fully extended loan maturity). The first two conditional extension options were exercised by the borrowers, thus extending the initial maturity to the second extended maturity date on 15 November 2024. As a pre-condition for the extension, the borrowers had to enter into a new cap agreement with BNP Paribas with a strike rate of 2.0% and a termination date that coincides with the newly extended loan maturity date. The aggregate cap notional amount is 95.0% of the senior loan outstanding balance as at the August 2023 IPD.

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.

The legal final maturity of the CMBS notes is in November 2032, seven years after the fully extended senior 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 and properties.

To cover any potential interest payment shortfalls, Société Générale provided the Issuer with a liquidity facility of EUR 21.3 million at issuance. The liquidity facility covers the Class A1 to Class D notes. The outstanding balance at the August 2023 IPD stood at EUR 20.1 million, which DBRS Morningstar deems to be sufficient to provide approximately 20 months of coverage based on the cap strike rate and approximately 14 months of coverage based on the 4.0% Euribor cap payable on the notes after the expected note maturity date.

DBRS Morningstar’s credit ratings on the notes address the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents. The associated financial obligations for each of the rated notes are the related Interest Payment Amounts and the related Class Outstanding Balances.

DBRS Morningstar’s credit ratings do not address non-payment risk associated with contractual payment obligations contemplated in the applicable transaction document(s) that are not financial obligations. For example, the ratings on the notes do not address Euribor Excess Amounts, Pro Rata Default Interest Amounts and Note Exit 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
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/416784/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

Notes:
All figures are in euros unless otherwise noted.

The principal methodology applicable to the credit ratings is:

“European CMBS Rating and Surveillance Methodology” (19 October 2023);
https://www.dbrsmorningstar.com/research/422173/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 credit 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/421590.

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 servicer reports and quarterly data provided by CBRE Loan Servicing Limited and U.S. Bank Global Corporate Trust Limited since issuance. DBRS Morningstar also received JLL's valuation report dated 15 January 2023 and the latest tenancy schedule provided by the servicer dated 30 June 2023.

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

At the time of the initial credit ratings, 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 24 November 2022, when DBRS Morningstar confirmed its credit ratings on the notes with Stable trends.

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 ratings, DBRS Morningstar considered the following stress scenarios as compared with the parameters used to determine the credit ratings (the Base Case):

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

Class A2 Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected credit rating of Class A2 notes to AAA (sf)
-- 20% decline in DBRS Morningstar NCF, expected credit rating of Class A2 notes to AAA (sf)

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

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

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

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

Lead Analyst: Andrea Selvarolo, Senior Analyst, Credit Ratings
Rating Committee Chair: Christian Aufsatz , Managing Director, Head of European Structured Finance
Initial Rating Date: 29 October 2020

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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 (19 October 2023),
https://www.dbrsmorningstar.com/research/422173/european-cmbs-rating-and-surveillance-methodology.
Currency Stresses for Global Structured Finance Transactions (1 February 2023),
https://www.dbrsmorningstar.com/research/409167/currency-stresses-for-global-structured-finance-transactions.
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 (15 September 2023),
https://www.dbrsmorningstar.com/research/420602/interest-rate-stresses-for-european-structured-finance-transactions.
Derivative Criteria for European Structured Finance Transactions (18 September 2023),
https://www.dbrsmorningstar.com/research/420754/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.