DBRS Ratings Limited (DBRS Morningstar) finalised its provisional ratings on the following classes of commercial mortgage-backed floating-rate notes issued by Magenta 2020 PLC (the Issuer):
-- Class A notes at AAA (sf)
-- Class B notes at AA (low) (sf)
-- Class C notes at A (low) (sf)
-- Class D notes at BBB (low) (sf)
-- Class E notes at BB (sf)
All trends are Stable.
The Issuer is the securitisation of a GBP 270.9 million loan (the initial senior loan was GBP 274.75 million) advanced to DTP Subholdco Limited (the borrower) to provide acquisition financing to DTGO Corporation Limited (the sponsor) to acquire a portfolio of hotels from Marathon Asset Management. The sponsor also acquired a 25% stake in the operating platform Valor Hospitality Europe Limited (Valor Europe); however, the senior loan was not used to fund the acquisition of this stake. The lender and lead arranger is Goldman Sachs Bank USA (Goldman Sachs). A GBP 65.3 million mezzanine loan to DTP Regional Hospitality Group Limited was also advanced to the borrower group and is structurally and contractually subordinated to the senior loan but is not part of the transaction. DBRS Morningstar understands that the sponsor has paid a total of GBP 465 million for the acquisition, including the payment for the purchase of the Valor stake, or GBP 460 million without.
The senior loan is secured by 17 hotels located across the UK. Valor Europe manages these hotels and operates them under various franchise agreements with InterContinental Hotels Group (IHG), Hilton, and Marriott. The portfolio comprises three hotels operated under the Hilton Double Tree brand, seven hotels flagged by Crowne Plaza, three by Hilton Garden Inn, two AC by Marriott, one Holiday Inn, and one Indigo. The valuer, Savills - London Office (Savills), has estimated the total market value (MV) (net of the standard asset sale purchaser costs, which vary between English and Scottish jurisdictions) to be GBP 435.55 million, or GBP 128,747 per room based on the 3,383 rooms in the portfolio. The resulting senior loan-to-value ratio (LTV) of the portfolio is 63% but following a mandatory repayment of GBP 3.86 million on 10 January 2020, the LTV is now 62.2%. The portfolio is concentrated in North West England and the East Midlands, where 55% of the total portfolio MV lies; these two regions comprise nine hotels, or 1,847 rooms, and also 56.0% of the 12-month trailing (T-12) EBITDA ended November 2019. DBRS Morningstar’s value assumption for the portfolio is GBP 347.8 million (a 20.2% haircut), resulting in a 78% stressed LTV.
The portfolio benefits from a stabilised occupancy rate of 83.6% as at the end of November 2019 with a revenue per available room (RevPAR) of GBP 72.2 per night and an average daily rate (ADR) of GBP 86.4. According to STR data, the portfolio’s overall performance is slightly better than its competitive set. For the T-12 ending November 2019, the portfolio generated GBP 133.8 million in revenue, and after deducting costs and expenses, the EBITDA for the same period was GBP 35.0 million and the net operating income (NOI) was GBP 30.3 million after management fees and deductions for furniture, fixture, and equipment (FF&E). For the year ending December 2018 (T-12 December 2018), the NOI was GBP 30.2 million. DBRS Morningstar’s stressed net cash flow (NCF) assumption for the portfolio is GBP 27.0 million.
All hotel properties in the portfolio, with the exceptions of Peterborough and Liverpool (upper midscale), are graded as upscale hotels. DBRS Morningstar notes that all the obligors are property-owning companies (PropCos); however, DTP Hospitality UK Limited, which is a guarantor under the senior loan facility and an entirely separate entity to the PropCos, employs approximately 1,300 people.
Three of the properties are freehold, three are part-freehold and part-long leasehold, and the remaining 11 are held wholly under long leasehold interests. The unexpired term for the leaseholds ranges from 78 years to 965 years with seven of these only paying a peppercorn rent. The lease sum in total across the portfolio amounts to approximately GBP 500,000, and this was factored into the valuation. DBRS Morningstar notes that the franchise fee will increase slightly this year (2020), and to maintain the current level of NCF generated by the portfolio, turnover, and gross operating profit will have to increase accordingly.
Prior to the senior loan utilisation date of 10 December 2019, fire safety inspections were carried out, and nine of the 17 properties were found to be potentially noncompliant with current building fire safety regulations, particularly the properties’ external cladding and fire prevention systems. Legally, the obligation is to comply with building regulations at the time of construction or when substantial building works are carried out. New or updated building regulations are not retrospective in application so even if a building does not comply with current building regulations, this in itself is not a breach of law. In relation to the nine potentially noncompliant properties, the vendor and the sponsor obtained the fire safety reports (prepared by BuroHappold Engineering), and the original senior lender received reliance on these as a condition precedent to its funding of the senior loan. Recommendations were made within the reports citing remediation works to include replacements of cladding, render, insulation, sheathing elements, and firestopping & cavity barrier installation, amongst other things. All such remediation work should be completed over a two-and-a-half-year period in a planned manner to effectively remediate and minimise disruption to the day-to-day operation of the hotels. The sponsor confirmed that the interim measures recommended by the independent consultant have been implemented at the hotels.
The obligors are required to appoint a fire safety monitor to oversee the remediation and to open a fire safety account, always ensuring the amount held in it, aggregated with any amounts callable under available letters of credit, is at least equal to the then current estimate of the costs required to complete the remedial works. The cost of remediation is estimated to be approximately GBP 27 million. Should the aggregated amount be less than the current estimate, a remedial cash trap event will occur. In this event, any surplus proceeds in the debt service account are required to be applied towards the fire safety account from the relevant line item in the debt service account priority of payments (such line item falling after senior and mezzanine debt service but before any payments to the imminent costs ledger of the FF&E account, and payment of any surplus funds to the cash trap account, the mezzanine cash trap account, or the general account). An event of default will occur if a remedial works cash trap event continues for three months.
The senior loan bears interest at a floating rate equal to three-month Libor (subject to zero floor) plus a margin of 2.78% per year. The expected loan maturity date is 10 December 2021 with three one-year extension options available. The notes issued by the Issuer bear a final maturity date falling in December 2029, thereby providing a tail period of five years assuming the three one-year extension options are exercised. The interest amounts payable on the notes will be calculated by reference to the Sterling Overnight Index Average (Sonia). The Issuer and Goldman Sachs International, as swap provider, will enter into an interest rate swap agreement for the duration of the loan term to smooth any spikes in Sonia (linked to note payments) versus Libor (linked to loan payments).
DBRS Morningstar notes that Libor, other interest rates, and indices deemed to be benchmarks are the subject of ongoing national and international regulatory reform. In the event of the discontinuation of Libor, the hedge agreement may be terminated and (1) the loan falls back to a compounded daily Sonia rate, in which case, provided that changes are made to the observation period under the loan, there is no mismatch with the rate payable under the notes. or (2) the loan falls back to a rate that is not the compounded daily Sonia rate. Under scenario (2) the fallback under the swap would be determined in accordance with the ISDA Benchmarks Supplement. If the swap had remained in place after the senior loan initial termination date, break costs would be payable, which could result in payments received by the Issuer on any loan interest accrual period to be insufficient to pay in full all amounts due on the notes relating to the corresponding note interest period.
Starting 15 months after the closing date, the borrower is required to amortise the senior loan by 0.25% of the senior loan amount at issuance, per quarter, forming the base amortisation. In addition to the base amortisation, but only if the NOI debt yield (DY) for that period falls below 11.3%, the borrower is required to double the amortisation payment on each IPD, unless in each case the LTV is below 50.0%. The T-12 November 2019 NOI DY at cut-off was 11.8%. Scheduled amortisation proceeds will be distributed pro rata to the noteholders unless a sequential payment trigger is continuing, in which case the proceeds will be distributed sequentially. Before a sequential payment trigger event, in the case of a mandatory prepayment after property disposals, the senior allocated loan amount (ALA) along with release premiums will be allocated pro rata. The senior release price is set at 15% above the ALA of the disposed property. In the case of voluntary prepayments funded by equity, the note share amount will be allocated in reverse sequential order before any pro rata and sequential principal payment allocation.
The senior loan has LTV and DY covenants for cash trap and events of default. The LTV cash trap covenant is set at 67.19% whilst the DY cash trap covenant is triggered if the DY falls below 9.59% within the first six months, below 9.31% from six to 12 months, 9.03% from 12 to 30 months, 9.31% up to 36 months, or falls below 9.59% for the remaining term. The LTV default covenants are set at 72.19% whilst the DY default covenant is triggered if the DY falls below 8.75% within the first six months, below 8.41% from six to 12 months, below 8.08% from 12 to 36 months, or if it falls below 8.75% for the remaining term.
The interest rate risk is fully hedged until the initial senior loan maturity date by way of a prepaid cap with a strike rate of 1.5% provided by Standard Chartered Bank. If the term of the loan is extended, the interest rate risk must be hedged by way of a prepaid cap with a strike rate of not higher than 2.25%.
To maintain compliance with applicable regulatory requirements, Goldman Sachs will retain an ongoing material economic interest of no less than 5% of the securitisation via an issuer loan, which is to be advanced by Goldman Sachs Bank USA.
On the closing date, the Issuer will establish a reserve that will be credited with the initial issuer liquidity reserve required amount. Part of the noteholders’ subscription for the Class A notes will be used to provide 95% of the liquidity support for the transaction, which is initially set at GBP 8.7 million, or 3.3% of the total outstanding balance of the notes. The remaining 5% will be funded by the issuer loan. DBRS Morningstar understands that the liquidity reserve will cover the interest payments to Classes A to C. No liquidity withdrawal can be made to cover shortfalls in funds available to the Issuer to pay any amounts in respect of interest due on the Class D notes or the Class E notes. Class E is subjected to an available funds cap where the shortfall is attributable to an increase in the weighted-average margin of the notes.
Based on a cap strike of 1.5%, DBRS Morningstar estimated the liquidity reserve will cover 17 months. On each note payment date relating to each note interest period beginning on or after the expected note maturity date, the Sonia component payable on the notes is capped at 5%, in this instance the liquidity reserve will cover 11 months of interest payments, assuming the Issuer does not receive any revenue.
The transaction includes Class X certificates. Interest payments due to the Class X certificates initially rank pro rata and pari passu to the interest due on the Class A notes. However, upon certain occurrences, including a Class X trigger event, interest payments on the Class X certificates become subordinated to payments due on the other notes. A Class X trigger event will occur if the loan is not repaid on or before its maturity date, the senior loan becomes specially serviced, and the issuer security is enforced following the occurrence of a note event of default. The Class X certificates will not be entitled to any principal payment. DBRS Morningstar does not rate the Class X certificates of this transaction.
All figures are in British pound sterling unless otherwise noted.
The principal methodology applicable to the ratings is: “European CMBS Rating and Surveillance Methodology.”
DBRS Morningstar has applied the principal methodology consistently and conducted a review of the transaction in accordance with the principal methodology.
Other methodologies referenced in this transaction are listed at the end of this press release.
These may be found on www.dbrs.com at: http://www.dbrs.com/about/methodologies.
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 Credit Ratings” of the “Global Methodology for Rating Sovereign Governments” at: https://www.dbrs.com/research/350410/global-methodology-for-rating-sovereign-governments.
The sources of data and information used for these ratings include Goldman Sachs International and its delegates, Allen & Overy LLP and Savills Group.
DBRS Morningstar did not rely upon third-party due diligence in order to conduct its analysis.
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.
These ratings concern a newly issued financial instrument. These are the first DBRS Morningstar ratings on this financial instrument.
This is the first rating action since the Initial Rating Date.
Information regarding DBRS Morningstar ratings, including definitions, policies and methodologies, is available on www.dbrs.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 rating (the Base Case):
Class A Notes Risk Sensitivity:
--A 10% decline in DBRS Morningstar NCF would not impact the Class A notes’ AAA (sf) rating
--A 20% decline in DBRS Morningstar NCF would lead to an expected downgrade of the Class A notes to AA (high) (sf)
Class B Notes Risk Sensitivity:
--A 10% decline in DBRS Morningstar NCF would lead to an expected downgrade of the Class B notes to A (low) (sf)
--A 20% decline in DBRS Morningstar NCF would lead to an expected downgrade of the Class B notes to BBB (high) (sf)
Class C Notes Risk Sensitivity:
--A 10% decline in DBRS Morningstar NCF would lead to an expected downgrade of the Class C notes to BBB (low) (sf)
--A 20% decline in DBRS Morningstar NCF would lead to an expected downgrade of the Class C notes to BB (high) (sf)
Class D Notes Risk Sensitivity:
--A 10% decline in DBRS Morningstar NCF would lead to an expected downgrade of the Class D notes to BB (high) (sf)
--A 20% decline in DBRS Morningstar NCF would lead to an expected downgrade of the Class D notes to BB (high) (sf)
Class E Notes Risk Sensitivity:
-- A 10% decline in DBRS Morningstar NCF would not affect the BB (sf) rating of the Class E notes
--A 20% decline in DBRS Morningstar NCF would lead to an expected downgrade of the Class E notes to B (high) (sf)
For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.
Ratings assigned by DBRS Ratings Limited are subject to EU and US regulations only.
Lead Analyst: Dinesh Thapar, Assistant Vice President
Rating Committee Chair: Christian Aufsatz, Managing Director
Initial Rating Date: 13 February 2020
DBRS Ratings Limited
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The rating methodologies used in the analysis of this transaction can be found at: http://www.dbrs.com/about/methodologies.
-- European CMBS Rating and Surveillance Methodology
-- Legal Criteria for European Structured Finance Transactions
-- Interest Rate Stresses for European Structured Finance Transactions
-- Derivative Criteria for European Structured Finance Transactions
A description of how DBRS Morningstar analyses structured finance transactions and how the methodologies are collectively applied can be found at: http://www.dbrs.com/research/278375.
For more information on this credit or on this industry, visit www.dbrs.com or contact us at email@example.com.