DBRS Morningstar Downgrades Class A, B, C, D, and E Notes of Elizabeth Finance 2018 DAC

DBRS Ratings Limited (DBRS Morningstar) downgraded its ratings on the Class A, Class B, Class C, Class D, and Class E notes of Elizabeth Finance 2018 DAC (the Issuer) as follows:

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

DBRS Morningstar changed the trend on the Class A notes to Negative from Stable, in line with the other classes of notes.

The downgrades follows the CBRE Group’s (CBRE) recent revaluation of the properties securing the GBP 66.2 million Maroon loan, which represents 76% of the total outstanding GBP 87.2 million securitisation balance. In January 2020, CBRE concluded that the value of the properties securing the Maroon loan declined by GBP 17.1 million to GBP 68.9 million over the year, resulting in a loan-to-value ratio (LTV) of 96%. Although DBRS Morningstar initially believed that the revaluation from CBRE appeared quite conservative given the performance of the Maroon loan’s portfolio improved over the past year, DBRS Morningstar notes the revaluation is now more in line with the current deteriorating UK retail sector, following the recent outbreak of the Coronavirus Disease (COVID-19). The current uncertainty about how the coronavirus outbreak and the UK’s future trading relationship with the European Union will affect the UK economy—and in particular, the UK retail property market— is reflected in the Negative trend assigned to the notes.

Elizabeth Finance 2018 DAC is a securitisation of two British senior commercial real estate loans advanced by Goldman Sachs International Bank. The two loans are the GBP 66.2 million Maroon loan (GBP 69.6 million at inception), which was advanced to three borrowers, and the GBP 20.6 million (GBP 21.1 million at inception) MCR loan that was advanced to Cypresshawk Limited. Both loans were refinancing facilities and have partially amortised since the origination date. The collateral securing the Maroon loan comprises three shopping centres located in England and Scotland; each property is held by property holding companies under the respective Maroon borrower. The MCR loan is secured by a campus-style office building located in Manchester, England. Oaktree Capital Management was the sponsor for the Maroon loan, while the sponsor of the MCR loan is Naeem Kauser as trustee of the Mussarat Children’s Trust.

The sharp decline in value of the three secondary shopping centres securing the Maroon loan has once again triggered a breach of the cash trap and default LTV covenants set at 70% and 75%, respectively. The loan was already transferred into special servicing for a LTV breach in June 2019 because of CBRE’s revaluation in January 2019, which saw the portfolio’s market value drop for the first time by 17.9% to GBP 86 million. At that time, the mezzanine lender cured the breach by depositing an equity cure amount of GBP 1.1 million to the cure account. As a result, the Maroon loan was transferred back to primary servicing in July 2019 as a corrected loan. The servicer recently confirmed that the loan was transferred into special servicing for a second time because of (1) the Maroon loan’s obligors’ failure to cure the breach and (2) the mezzanine lender’s loss of cure rights following its enforcement of the mezzanine-only security to take control of the mezzanine borrower in September 2019. DBRS Morningstar does not expect any enforcement action by the special servicer in the short term because of the current challenging environment within the UK retail sector. In addition, the upcoming first loan maturity in January 2021 has significantly increased the refinancing risk of the facility, while the outstanding default status of the loan does not allow for the borrower to exercise one of the two one-year extension options.

Based on an investors report from January 2020, the performance of the Maroon’s portfolio has been relatively stable since inception, with the net operating income (NOI) down by just 3.5% to GBP 8.2 million compared with GBP 8.5 million at issuance and current vacancy at 4.1% versus 11.6% at issuance. DBRS Morningstar maintained the net cash flow (NCF) at GBP 5.6 million, representing a haircut of 32% to the latest reported NOI. However, DBRS Morningstar revised its blended cap rate to 9.5% from 7.7% to reflect the expected negative impact of the coronavirus outbreak on the portfolio as well as the further deterioration of investors’ sentiment towards this asset class. The new DBRS Morningstar value is GBP 59.4 million and considers the moderate scenario outlined in the DBRS Morningstar commentary on global macroeconomic scenarios following the spread of the coronavirus (for more detail, please see https://www.dbrsmorningstar.com/research/359903/global-macroeconomic-scenarios-application-to-credit-ratings).

The MCR loan, which represents 24% of the outstanding securitised balance, continues to perform in line with expectations. As of a Q4 2019 investor report, the vacancy at the MCR office property remains low at 5.3%, while the debt yield (DY) at 12.8% and the LTV at 60.2% are comfortably compliant with the DY and LTV cash trap covenants of 9.6% and 72.3%, respectively. The expected loan maturity is in July 2023, and DBRS Morningstar views a potential prepayment of the MCR loan as credit negative for the transaction, as it would leave the noteholders fully exposed to the performance of the Maroon loan.

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 small and medium-size (SME) transactions, some meaningfully. The ratings are 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 British pound sterling 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 and valuation reports from CBRE and cash manager reports from U.S. Bank Global Corporate Trust.

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 28 August 2019, when DBRS Morningstar changed the trends on the subordinate classes to Negative from Stable.

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

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

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

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

Generally, 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.

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: 28 August 2018

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.