Moody’s has today downgraded all classes of EMEA CMBS issued by HAUS (EUROPEAN LOAN CONDUIT) DAC (“Issuer”):
….EUR 194.2M Class A1 Notes, Downgraded to Aa1 (sf); previously on Aug 23, 2021 Definitive Rating Assigned Aaa (sf)
….EUR 19.1M Class A2 Notes, Downgraded to Aa3 (sf); previously on Aug 23, 2021 Definitive Rating Assigned Aa2 (sf)
….EUR 24.6M Class B Notes, Downgraded to A1 (sf); previously on Aug 23, 2021 Definitive Rating Assigned Aa3 (sf)
….EUR 29.9M Class C Noes, Downgraded to A3 (sf); previously on Aug 23, 2021 Definitive Rating Assigned A2 (sf)
….EUR 47.6M Class D Notes, Downgraded to Ba1 (sf); previously on Aug 23, 2021 Definitive Rating Assigned Baa2 (sf)
RATING RATIONALE
Today’s rating action reflects the re-assessment of the expected loss of the underlying loan. The key driver for the rating downgrades is an increase in expected loss due to a lower Moody’s collateral property value and an increase in the loan’s default risk.
The portfolio of German residential properties is currently underperforming the business plan with low occupancy at around 58% and significant delays in the planned refurbishments of the units. The transaction’s loan-to-value (LTV) ratio has risen to 75.2% from 67.9% at closing based on a reported October 2022 valuation of EUR 423.7 million, just under 10% lower than at closing. This compares to a Moody’s LTV ratio of 91% which reflects Moody’s term value for the portfolio of EUR350.3 million based on a net cash flow of EUR20.6 million and a cap rate of 5.9%.
Moody’s rating action reflects a base expected loss in the range of 0%-10% of the current balance. Moody derives this loss expectation from the analysis of the default probability of the securitised loan (both during the term and at maturity) and its value assessment of the collateral.
At closing, the seller of the portfolio funded a total of EUR62.8 million of cash reserves comprising EUR23.3 million of rental guarantee to fund the shortfall between actual rent and an expected stabilised rental income of EUR35 million and a EUR39.5 million capex guarantee to fund the renovation. As of January 2023 IPD, the rental guarantee has been depleted, while EUR25.9 million remains undrawn from the capex guarantee as only EUR13.5 million has been utilised. Under the Sale and Purchase Agreement (SPA), if funds in the reserve are insufficient, the seller has to pay directly any difference between the available amount and the amount due under a Payment Confirmation to the Rent Guarantee Account of the relevant PropCo.
However, the seller has not complied with its obligations since the October 2022 IPD and Brookfield (Sponsor) has been topping up the rental guarantee reserve for the past two quarters. The Sponsor is also planning to restructure the joint venture and take full control in order to expedite the business plan completion. Moody’s view positively Brookfield’s support for the transaction, however completing the refurbishment plan and stabilising occupancy during the remaining three years of the initial loan term will pose a significant challenge.
DEAL PERFORMANCE
HAUS (EUROPEAN LOAN CONDUIT) DAC is a true sale transaction backed by a EUR318.75 million loan. The issuer used the notes proceeds to fund the liquidity reserve and to acquire a loan which funds the acquisition and related transaction closing costs of a portfolio of mostly 6,281 residential units in 59 properties predominantly located in Germany’s largest state of North-Rhine Westphalia. The ultimate majority sponsor of the borrower is Brookfield Asset Management Inc. a global and experienced real estate investment manager. The portfolio is managed by Belvona, a newly established (April 2020) management company.
The loan has an initial term of five years (first expected maturity), followed by 20 one-year extension options, provided that the LTV is no greater than 75% and the debt yield exceeds 7%, amongst other conditions stipulated in the Facility Agreement. The loan pays a floating interest of 3m Euribor plus a margin of 1.98% until the second year. The margin reduces to 1.84% for the remaining initial term, and it steps up to 3.25% thereafter. The loan is 100% hedged via a Euribor cap with a maximum strike rate of 2.0% until the first expected maturity; it reduces to 1% thereafter. Currently, the strike rate is 0.25% until July 2023. There is no scheduled amortisation until the first expected maturity when a EUR6.4 million annual amortisation starts.
The key driver of the portfolio’s underperformance is the slower-than-expected refurbishment plan and the stable but very high vacancy since closing. Of the 2,263 units scheduled for refurbishment works, only 289 (12.8%) have been completed since closing. Another 908 units have undergone work but were not identified for refurbishment at closing. Reportedly, the delay has been mainly driven by supply and labour shortages due to Covid-19 restrictions and further exacerbated by a significant increase in construction costs.
In turn, the slow delivery of the business plan has affected the leasing activity at the properties. Currently, vacancy stands at 41.7%, relatively unchanged since closing. Gross and net rental incomes remain well below closing expectations given the lack of material progress on the business plan. As a result, the rental guarantee which funded the shortfall between actual and the business plan income targets has been fully depleted. According to the latest servicer report, the non-payment by the seller continued for two IPDs, thus demonstrating non-compliance with their material obligations. In February and March, two waivers were granted to prevent the non-payment from triggering a Loan Event of Default. The waivers are conditional upon a series of obligations for Brookfield and will expire after 31 July 2023.
In addition, the sponsor and the Agent have agreed on the restructuring of the joint venture. According to the latest servicer report, an entity related to Brookfield will step into the rental and capex guarantees and replace the vendor. Moody’s understands this is a step towards Brookfield taking full control of the joint venture with the aim of expediting the delivery of the business plan.
The reported debt yield (DY) was 4.1% as of January 2023, and it stood at around 4% since closing. Currently, the transaction is in breach of its DY cash trap covenant and in the quarter ending in January 2023 EUR2.2 million was transferred to the Cash Trap Account. According to the transaction documents, if a Cash Trap Event is continuing, the amounts trapped will be applied in prepayment of the loan. A new valuation as of October 2022 is EUR423.7 million, just under 10% lower than at closing. Following the new valuation, the reported LTV sharply increased to 75.2% from 67.9% at closing. A further marginal decline in the market value of the properties would also trigger its LTV cash trap covenant which stands at 77.9%.
Moody’s Term Value has decreased to EUR350.3 million from EUR378.2 million at closing. Moody’s LTV has thus increased to 91.0% from 84.3% at closing. Moody’s Refi Value has decreased to EUR456.9 million from EUR472.6 million at closing. Moody’s LTV has thus increased to 69.8% from 67.4% at closing.
Moody’s updated valuation reflects a delay in completing the refurbishment program and stabilising occupancy and rental income closer to the end of the initial loan term in July 2026. Moody’s average net cash flow for the loan term is EUR20.6 million and increases to EUR23.5 million at the first expected maturity. The initial property grade for the portfolio is 3.5 but improves to 3.0 following the planned refurbishments. In determining Moody’s market value, we applied an overall average capitalisation rate of 5.9% for the initial term of the transaction and 5.1% at the first expected maturity date reflecting the improvement in our property grade.
