DBRS Downgrades the Rating of One and Discontinues the Ratings of Two Swaps Related to European CMBS DECO 8 – UK CONDUIT 2 P.L.C.

DBRS Ratings Limited (DBRS) has today downgraded the rating of one potential interest rate swap (IRS) termination amount that may be owed by the commercial mortgage-backed securities (CMBS) issuer to Deutsche Bank AG (Deutsche Bank or the Swap Counterparty) in relation to the DECO 8 – UK CONDUIT 2 P.L.C. (the Transaction or Deco 8) as follows:

-- Deco 8, Swap ref 1475920L (initial GBP 71.6 million notional, referencing Fairhold loan) (the Fairhold Swap) downgraded to BB (low) (sf) with a Negative trend from A (sf) with a Stable trend.

At the same time, DBRS has discontinued the ratings of two other Deco 8 IRS following their expiry on 20 April 2016:

-- Deco 8, Swap ref 1406167L (initial GBP 208.6 million notional, referencing Mapley II loan) Disc. - Repaid
-- Deco 8, Swap ref 3483394L (initial GBP 220.7 million notional, referencing Lea Valley loan) Disc. - Repaid

The downgrade of the Fairhold Swap follows a review of the transaction performance, namely the allocation of losses as per the April 2016 interest payment date (IPD): classes D through G and a large part of class C have been written off (total GBP 138.7 million). The loss allocation is largely due to the GBP 132.2 million write-off related to the Lea Valley loan, which generated net recoveries of approximately GBP 78.3 million (allocated to classes A1 and A2 of the CMBS on the January 2016 IPD), substantially below the most recent property portfolio valuation of GBP 89.4 million (as of 23 October 2014).

The adverse performance of the Lea Valley loan increases the risk of the now most senior class of the CMBS (class A2) not being redeemed at legal final maturity in April 2018. In Deco 8, the legal final maturity date of classes A1 and A2 is in April 2018, whereas the legal final maturity of class B and below is January 2036. Previously, DBRS assumed that principal and/or recovery payments from the securitised loans would be sufficient to repay class A2 in full on or before the April 2018 maturity date.

Non-payment of class A2 principal in April 2018 would constitute a note event of default, which in turn could result in the post-enforcement priority of payments becoming applicable after a note acceleration notice is served. In addition, if a note acceleration notice was served following the note event of default, this would constitute an event of default under the swap itself, crystallising the mark-to-market of the swap at that point in time (termination payment).

In the post-enforcement priority of payments, payments to the Swap Counterparty would rank pro rata and pari passu to interest and principal due on class A2 of Deco 8. This is in contrast to the pre-enforcement priority of payments, under which payments to the Swap Counterparty rank senior to principal due on class A2. As a result, before April 2018, the payments to the Swap Counterparty of the Fairhold Swap depend on the performance of the Fairhold loan only (payments rank effectively senior to principal due on the loan). In situations where the Fairhold loan is not worked out (the loan is currently in special servicing) on or before April 2018, and class A2 remains outstanding on that date, the payments to the Swap Counterparty would depend on the performance of all remaining loans in the portfolio (payments to the Swap Counterparty would rank pro rata and pari passu to payments due on class A2).

The Fairhold loan defaulted on its maturity date in January 2013 and has been in special servicing since April 2013. The swap maturity is in 2036, and DBRS estimates the current swap mark-to-market (potential termination payment) at approximately GBP 30 million. The reported valuation of the ground lease portfolio is GBP 84.9 million (as of July 2013); the DBRS value assessment is GBP 77.7 million. Hence, as long as the Fairhold Swap payments depend solely on the recoveries of the Fairhold loan, with a DBRS loan-to-value (LTV) of 39%, the potential terminal payment would be well covered. If the special servicer were to sell the loan collateral before April 2018, a full recovery of the swap mark-to-market would be likely in DBRS’s view; however, the securitised senior loan with a current outstanding balance of GBP 59.1 million would likely suffer a principal loss.

In the scenario where the Fairhold loan is not worked out on or before April 2018, and class A2 of Deco 8 remains outstanding on that date, the performance of the other loans and the Fairhold loan itself becomes important.

All remaining six loans in the portfolio are currently in special servicing. For the largest loan, Mapeley II (GBP 189 million), the special servicer announced in May 2016 that there are negotiations with third parties for a full refinancing of the loan by October 2016, according to a transaction notice. However, as the outstanding balance of class A2 is currently GBP 238.4 million, a full recovery of the Mapeley II loan would not be sufficient to repay the class. Excluding the Fairhold loan, the aggregate balance of the four smaller loans remaining in Deco 8 is GBP 24 million. Therefore, even when assuming full recovery for each of the smaller loans (unlikely, in DBRS’s view, considering reported LTV levels of 177% to 229%), the combined principal cash flow of Mapeley II and these smaller loans would not be sufficient to repay class A2. Consequently, the full repayment of class A2 depends on the Fairhold loan itself. For this reason, DBRS is of the opinion that the Swap Counterparty is likely to suffer a loss if the Fairhold loan is not worked out on or before April 2018.

DBRS thinks that currently it is still very likely that the Fairhold loan will be worked out before April 2018. According to the special servicer of the loan, discussions remain ongoing regarding the exit strategy, with alternative strategies being investigated, should the borrower become uncooperative. DBRS notes that for the reasons mentioned above, the Swap Counterparty has an incentive to facilitate a loan work out before April 2018. However, to reflect the increased risk of a prolonged loan work out, DBRS has today downgraded the Fairhold Swap to BB (low) (sf) and assigned a Negative trend. The negative trend reflects that over time the risk of the swap’s defaulting at or shortly after April 2018 will increase.

The IRS in the CMBS are issuer-level swaps that provide for a fixed-rate payment to Deutsche Bank in exchange for a floating-rate (LIBOR) payment by Deutsche Bank to the bond. The swaps were intended to protect the individual loans and the capital structure in the CMBS against rises in interest rates. As part of its rating analysis, DBRS considers the adequacy of the collateral backing the respective loan and the CMBS to cover the swap termination payments, the performance of the collateral and the quality of the legal and financial structure. When rating swap termination payments, DBRS is assessing the ability of the securities to make the swap termination payments to the counterparty by the legal final maturity date of the transaction. DBRS also takes into account the position of swap payment in the pre- and post-enforcement priorities of payment. DBRS uses its European CMBS model to assess the recoverability of the value of the swap termination fees to determine if there is sufficient coverage to make these termination payments by the legal final maturity of the CMBS. To calculate the swap termination payments, DBRS first derives the net swap cash flow for each period by comparing (1) the fixed stream of payments from the notes to the swap counterparty against (2) the LIBOR payments that the counterparty would expect to pay to the notes. Next, DBRS aggregates the net swap cash flow for all future periods to derive the total potential swap termination payments. A rating is only assigned when, under such rating scenario, there is sufficient coverage of collateral to ultimately pay the swap termination payments should the notes default on swap payment obligations on any distribution date. The rating does not address (1) the likelihood that a swap termination event occurs on or before the swap termination date, (2) the payment of any swap termination payment owed by Deutsche Bank to the bond and (3) termination payments owed by the bond to Deutsche Bank if it is the defaulting party.

Notes:
All figures are in GBP unless otherwise noted.

The principal methodology applicable is: European CMBS Surveillance Methodology.

Other methodologies used are the European CMBS Rating Methodology, Legal Criteria for European Structured Finance Transactions, Derivative Criteria for European Structured Finance Transactions and Unified Interest Rate Model, which can be found on www.dbrs.com.

For a more detailed discussion of the sovereign risk impact on Structured Finance ratings, please refer to the DBRS commentary “The Effect of Sovereign Risk on Securitisations in the Euro Area” found at http://www.dbrs.com/industries/bucket/id/10036/name/commentaries.

DBRS has applied the principal methodology consistently and conducted a review of the transaction in accordance with the principal methodology.

In DBRS’s opinion, a discontinued-repaid rating action does not require the application of the entire principal methodology.

A review of the transaction legal documents was not conducted as the documents have remained unchanged since the most recent rating action.

The sources of information used for this rating include Deutsche Bank AG, London Branch, Situs Asset Management Limited and Solutus Advisors Limited. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

DBRS was not supplied with third party assessments. However, this did not impact the rating analysis.

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

The last rating action on this transaction took place on 1 July 2015 when DBRS confirmed the ratings of all swaps at A (sf).

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

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Information regarding DBRS ratings, including definitions, policies and methodologies, is available
on www.dbrs.com.

To assess the impact of the changing the transaction parameters on the rating, DBRS considered the following stress scenarios for the Fairhold loan only, as compared to the parameters used to determine the rating (the “Base Case”):

Swap ref 1475920L Sensitivity:
-- 10% decrease in DBRS NCF: BB (low) (sf)
-- 20% decrease in DBRS NCF: BB (low) (sf)

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a
12-month period. DBRS’s outlooks and ratings are monitored.

For further information on DBRS 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 regulations only.

Initial Lead Analyst: Erin Stafford, Managing Director
Initial Rating Date: 30 June 2014
Initial Rating Committee Chair: Mary Jane Potthoff, Managing Director

Lead Surveillance Analyst: Rick Shi, Senior Financial Analyst
Rating Committee Chair: Mary Jane Potthoff, Managing Director

DBRS Ratings Limited
20 Fenchurch Street, 31st Floor, London EC3M 3BY
United Kingdom

The rating methodologies used in the analysis of this transaction can be found at http://www.dbrs.com/about/methodologies:
-- European CMBS Surveillance
-- European CMBS Rating Methodology
-- Legal Criteria for European Structured Finance Transactions
-- Derivative Criteria for European Structured Finance Transactions
-- Unified Interest Rate Model for European Securitisations

A description of how DBRS analyses structured finance transactions and how the methodologies are collectively applied can be found at http://www.dbrs.com/research/278375.