DBRS Places Deco 8 – UK CONDUIT 2 P.L.C. Swap Under Review with Negative Implications

DBRS Ratings Limited (DBRS) has today placed the B (low) (sf) rating on the potential interest rate swap (IRS) termination amount that may be owed by Deco 8 – UK CONDUIT 2 P.L.C. (the Issuer or Deco 8) to Deutsche Bank AG (Deutsche Bank or the Swap Counterparty) Under Review with Negative Implications. The IRS references the Fairhold loan and is set to expire in 2036.

This rating action follows two notices to noteholders (RNS number: 8015M and RNS number: 9287M) on 1 August 2017 and 2 August 2017, respectively, in which the Swap Counterparty has informed the Issuer of an event of default (EOD) as the full periodic IRS amount due was not paid on 27 July 2017. The notices also explained that such failure to pay the Swap Counterparty was due to the liquidity facility provider rejecting to fund part of the liquidity drawing request amounting to approximately five million pounds. Likewise, amid the rejected liquidity drawing request, the Issuer failed to pay the full interest due on Class A2 of the CMBS, causing a note EOD.

After the note EOD, should the noteholders decide to direct the trustee to serve a note acceleration notice, the transaction payment priority would switch to the post-enforcement priority of payment, in which the DBRS-rated swap termination payments would rank pro rata and pari passu with Class A2 principal and interests. Given the current workout progress on the loans securing Deco 8, property valuations and the recent outcome of the Swiftgold loan, it is highly likely that there would be a shortfall between the recovery proceeds and total amounts due to Class A2 noteholders (principal and interest) and the Swap Counterparty, hence causing a loss for the Swap Counterparty. As such, a Class A2 note acceleration would very likely cause a downgrade of the IRS.

As outlined in more detail in DBRS’s press release dated 7 April 2017 (DBRS Downgrades Remaining Swap Rating for Deco 8 – UK Conduit 2 Plc) there is still a possibility for the Swap Counterparty to be paid in full if the Class A2 notes were not accelerated, and if the Fairhold loan was worked out before the maturity date of the Class A2 note in April 2018. However, following the July 2017 payment date, this scenario has become less likely, resulting in today’s Under Review with Negative Implications rating action.

The IRS in the commercial mortgage-backed security (CMBS) is an Issuer-level swap that provides 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 Rating and Surveillance Methodology” 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 British pounds unless otherwise noted.

The principal methodology applicable to the rating is: European CMBS Rating and Surveillance Methodology.

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

DBRS is undertaking a review and will remove the rating from this status as soon as it is appropriate.

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 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 DBRS commentary “The Effect of Sovereign Risk on Securitisations in the Euro Area” on: http://www.dbrs.com/industries/bucket/id/10036/name/commentaries/

The sources of data and information used for this rating include Irish Stock Exchange, Deutsche Bank AG, London Branch, Situs Asset Management Limited and Solutus Advisors Limited.

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

At the time of the initial rating DBRS was not supplied with third-party assessments. However, this did not impact the rating analysis.

DBRS considers the data and information available to it for the purposes of providing this rating to be of satisfactory quality.

DBRS 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 07/04/2017, when DBRS downgraded the swap rating to B (low) (sf) with Negative Trend.

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

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

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

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

This rating is Under Review with Negative Implications. Generally, the conditions that lead to the assignment of reviews are resolved within a 90-day period.

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 and US regulations only.

Lead Surveillance Analyst: Rick Shi, Senior Financial Analyst
Rating Committee Chair: Christian Aufsatz, Managing Director
Initial Rating Date: 30 June 2014

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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
-- 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