DBRS Morningstar Downgrades Class A2, B, C, D, and E Notes of FROSN-2018 DAC

DBRS Ratings GmbH (DBRS Morningstar) downgraded its ratings on the Class A2, Class B, Class C, Class D, and Class E notes of FROSN-2018 DAC (the Issuer) as follows:

-- Class A2 to AA (high) (sf) from AAA (sf)
-- Class B to A (high) (sf) from AA (low) (sf)
-- Class C to BBB (high) (sf) from A (low) (sf)
-- Class D to BB (high) (sf) from BBB (low) (sf)
-- Class E to B (high) (sf) from BB (low) (sf)

The ratings on the Class RFN and Class A1 notes have been confirmed as follows:

-- Class RFN at AAA (sf)
-- Class A1 at AAA (sf)

All trends are Stable.

The rating downgrades reflect the performance decline and the likely decrease in the value of the remaining portfolio after the sales of 15 assets since 30 April 2019. The rating confirmations on the senior tranches are driven by the robust loan covenant setting and structural features, which are expected to protect senior noteholders in case of covenant breaches.

FROSN 2018 DAC is a securitisation of one floating-rate EUR 590.9 million senior commercial real estate loan, which was advanced by Morgan Stanley and Citibank, N.A., London Branch. The loan refinanced the existing indebtedness of the borrowers in addition to providing capex to the underlying collateral. The collateral comprised 63 mixed office and retail properties located throughout Finland. As of the Q4 2019 interest payment date (IPD), nine properties were sold and the sales of another six assets were completed in Q1 2020, bringing down the whole senior loan balance to EUR 473.2 million. However, these six assets were still included in the Q1 2020 investor report. For the avoidance of doubt, DBRS Morningstar conducted its review based on a pool of 48 assets (48-Portfolio) and a total senior loan amount of EUR 307.9 million.

In term of performance, based on the 30 September 2019 rent roll and excluding the six disposed assets in Q1 2020, reported gross rental income (GRI) of the remaining 48-Portfolio has seen a 13.0% GRI drop to EUR 49.4 million compared with EUR 56.8 million at issuance. The occupancy of the 48-Portfolio also went down to 63.8% as of 30 September 2019 compared with 67.3% at issuance. DBRS Morningstar has revised its underwritten vacancy rate up by 4.5 percentage points to 24.5%. The new DBRS Morningstar net cash flow (NCF) is EUR 27.9 million.

DBRS Morningstar also remains cautious on the future cash flow of the remaining assets as 36.5% of their GRI is set to expire before September 2020, with another 21.4% expiring before September 2021. In the context of the current Coronavirus Disease (COVID-19) outbreak and increasing competition from new office buildings, it is highly likely that GRI would further decrease in the next few months. In addition, DBRS Morningstar expects the upcoming portfolio revaluation, due in May 2020, to register a lower double-digit percentage drop in the portfolio’s market value.

DBRS Morningstar noted that the 15 disposed assets represented 40.0% of market value (MV) but only 22.1% of area at issuance. As a result, the MV/sqm of the 48-Portfolio has decreased to EUR 1,295.7/sqm based on the May 2019 valuation compared with EUR 1,312.5/sqm for the same 48 properties or EUR 1693.9/sqm for the whole portfolio (63 properties) at inception, thus confirming a reduction of the remaining portfolio’s value. Accordingly, DBRS Morningstar has revised its cap rate up to 8.3% from 7.5% to reflect the lower asset quality of the remaining 48-Portfolio. The new DBRS Morningstar value is EUR 336.9 million.

As mentioned above, there is a senior EUR 13.9 million capex facility included in the transaction. Since inception, a EUR 2.9 million capex facility has been released to the borrowers representing a total capex spending of EUR 4.5 million based on a loan-to-cost ratio of 65.0%. As of Q1 2020, the remaining unutilised capex reserve is EUR 10.9 million. The unutilised capex reserve is excluded from covenant calculation and will be used to pay down the loan at repayment date.

Besides the above-mentioned credit-negative points, DBRS Morningstar also recognises that the senior loan currently benefits from a high interest coverage ratio and a relatively moderate loan-to-value (LTV) ratio of 59.3%. Moreover, the LTV and debt yield (DY) cash trap covenants are set at a conservative level of 70% and 10%, respectively for the current year, and will continue to tighten on an annual basis, should the borrowers request to exercise the two remaining one-year extension options. The senior loan was extended on 15 February 2020 for one year. This is expected to motivate the sponsor to proactively manage the upcoming lease breaks or expiries to avoid triggering such cash trap covenants. As default financial covenants are not applicable before a permitted change of control, DBRS Morningstar does not foresee any obstacles for the current borrowers to exercise the next one-year extension option.

Regarding the current coronavirus outbreak, the Finnish government has started to loosen the lockdown implemented in mid-March. The asset manager has granted rent-free periods for tenants whose business was severely disrupted by the pandemic. Despite the rent-free period being granted, the asset manager is confident that the debt service and covenant tests will be met for the next IPD.

The coronavirus pandemic and the resulting isolation measures have caused an economic contraction, leading to sharp increases in unemployment rates and income reductions for many borrowers. DBRS Morningstar anticipates that delinquencies may arise in the coming months for many SME transactions, some meaningfully. The rating is based on additional analysis and adjustments to expected performance as a result of the global efforts to contain the spread of the disease. On 16 April 2020, the DBRS Morningstar Sovereign group published its outlook on the impact to key economic indicators for the 2020-22 period. For details see the following commentaries: https://www.dbrsmorningstar.com/research/359679/global-macroeconomic-scenarios-implications-for-credit-ratings and https://www.dbrsmorningstar.com/research/359903/global-macroeconomic-scenarios-application-to-credit-ratings. The DBRS Morningstar analysis considered impacts consistent with the moderate scenario in the referenced reports.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

For more information regarding structured finance rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/358308.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

Notes:
All figures are in euros unless otherwise noted.

The principal methodology applicable to the ratings is: “European CMBS Rating and Surveillance Methodology” (13 December 2019).

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.

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.

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.dbrsmorningstar.com/research/350410/global-methodology-for-rating-sovereign-governments.

The sources of data and information used for these ratings include investor reports from Mount Street Global Limited, cash manager reports from U.S. Bank Global Corporate Trust, and valuation report from CBRE 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 26 April 2019.

The lead analyst responsibilities for this transaction have been transferred to Rick Shi.

Information regarding DBRS Morningstar ratings, including definitions, policies, and methodologies, is available on 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 RFN Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class RFN at AAA (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class RFN at AAA (sf)

Class A1 Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class A1 at AA (high) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class A1 at A (high) (sf)

Class A2 Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class A at A (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class A at BBB (high) (sf)

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

Class C Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class C at BBB (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class C at BB (high) (sf)

Class D Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class D at B (high) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class D at B (low) (sf)

Class E Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating of Class E at CCC (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating of Class E 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://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings GmbH are subject to EU and U.S. regulations only.

Lead Analyst: Rick Shi, Associate Vice President
Rating Committee Chair: Christian Aufsatz, Managing Director
Initial Rating Date: 22 March 2018

DBRS Ratings GmbH
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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: http://www.dbrsmorningstar.com/about/methodologies

-- European CMBS Rating and Surveillance Methodology (13 December 2019), https://www.dbrsmorningstar.com/research/354637/european-cmbs-rating-and-surveillance-methodology.
-- Legal Criteria for European Structured Finance Transactions (11 September 2019), https://www.dbrsmorningstar.com/research/350234/legal-criteria-for-european-structured-finance-transactions.
-- Interest Rate Stresses for European Structured Finance Transactions (10 October 2019), https://www.dbrsmorningstar.com/research/351557/interest-rate-stresses-for-european-structured-finance-transactions.
-- Derivative Criteria for European Structured Finance Transactions (26 September 2019), https://www.dbrsmorningstar.com/research/350907/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: 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.

This press release was amended on 7 May 2020 to include information regarding the last rating date.