Morningstar DBRS Places Credit Ratings on All Classes of HAUS (European Loan Conduit No. 39) DAC Under Review with Negative Implications

DBRS Ratings GmbH (Morningstar DBRS) placed its credit ratings on the following classes of commercial mortgage-backed floating-rate notes due July 2051 issued by HAUS (European Loan Conduit No. 39) DAC (the Issuer) Under Review with Negative Implications (UR-Neg):

-- Class A1 rated at AAA (sf)
-- Class A2 rated at AA (high) (sf)
-- Class B rated at A (high) (sf)
-- Class C rated at BBB (high) (sf)
-- Class D rated at BB (high) (sf)

CREDIT RATING RATIONALE
The UR-Neg credit rating action follows Morningstar DBRS' review of the loan performance and its key metrics. The rental cash flow performance has deteriorated further and has prompted significant concerns about the persistent delay of the execution of the business plan and the implementation of the capex programme. Morningstar DBRS expects additional information regarding the execution of the business plan to become available before taking any further rating actions.

The transaction is a securitisation of a EUR 318.75 million loan arranged by Morgan Stanley & Co. International plc in July 2021. The loan is secured by a portfolio of 6,284 multifamily residential units across 92 sites (equivalent to 59 properties) in Germany. The loan refinanced the acquisition of the portfolio by eight German borrowers, ultimately controlled by the sponsor, Brookfield Property Group L.P. (Brookfield).

At issuance, Brookfield had a majority interest in the portfolio (approximately 90%) with the seller (a group of high-net-worth individuals) retaining a minority stake. Following the seller's exit in March 2023, the sponsor gained full control and appointed MVGM Property Management Germany GmbH (MVGM) to speed up delivery of the initial business plan.

According to the initial business plan, the portfolio had suffered a period of underinvestment and the occupancy rate was around 60% at issuance. The business plan provided for a refurbishment programme aimed at creating significant revisionary upside in the first two years, with a modernisation rate of 75% of certain 2,024 residential units selected at inception. The refurbishment programme has been delayed and the total number of scheduled units in need of modernisation increased to 2,263, as reported on the April 2024 interest payment date (IPD). The capex guarantee of EUR 39.5 million and a rent guarantee of EUR 23.3 million funded by the seller at origination were fully utilised. The sponsor has continued to inject equity in lieu of the seller's guarantees to cover costs. In June 2023, Brookfield committed to EUR 56.6 million to cover capex and debt service. As of the April 2024 IPD, EUR 51 million has already been contributed, the majority of which has been spent towards operating costs and capex, and the remaining to service the debt. No financial shortfall is anticipated as the sponsor's top-up commitment runs until the end of December 2024 and Morningstar DBRS expects this to be renewed at that point.

The outstanding whole-loan amount has remained unchanged at EUR 318.75 million since origination because the loan is interest only until the initial loan maturity in July 2026 when, if extended, a cash sweep will commence. The loan may be extended on an annual basis until July 2046, provided certain conditions precedent are met.

The loan carried a floating rate of Euribor plus a 1.98% per annum (p.a.) margin for the first two years since closing, after which the margin stepped down to 1.84% p.a. until the initial maturity date. Following a potential extension of the loan in July 2026, the margin would step up to 3.25% p.a. The loan is fully hedged until July 2025, with a cap strike rate of 2.0% p.a. The subsequent hedging arrangement until initial loan maturity in July 2026 is expected to have a strike rate of 2.0% p.a., necessitating sponsor support.

After the expected note maturity date, or in the occurrence of a loan hedge default, the Euribor component of the rate of interest payable on the notes will be capped at 4.0% p.a.

As of the April 2024 IPD, the loan-to-value (LTV) ratio was 63.8%, down from 75.2% at the last review in August 2023 and from 67.9% at the cut-off date in March 2021. The decrease is driven by the increase in portfolio value. The latest valuation of EUR 500 million by Jones Lang LaSalle Limited (JLL) as of December 2023 showed an 18% increase from the previous appraisal of EUR 423.7 million as of October 2022, which was prepared by Knight Frank UK Limited (KF), and a 6.5% increase from EUR 469.7 million at cut off in March 2021 (also prepared by KF). Morningstar DBRS notes that the property yield implied in the latest valuation is lower than the one from the previous valuation, contrary to market evidence of a widening in secondary multifamily yields in Germany.

The loan does not have financial default covenants; however, there are cash trap covenants set at 77.9% for the LTV and 8.5% for the debt-yield (DY) starting from the third year and increasing to 9.0% from October 2024. Following the initial maturity date, DY and LTV covenants are set at 7.0% and 75%, respectively, and will be tested on an annual basis to extend the loan. The DY in April 2024 was 1.9%, down from 3.8% at last review, and from 4.9% at issuance. A DY cash trap event is ongoing since April 2022, but there has been no surplus cash to move to the cash trap account.

The property and tenancy profiles are granular, with the top 10 assets accounting for 39.1% of the portfolio net cold rent and 39.3% of the lettable area as of April 2024. According to the most recent servicer report, the annual contractual rent as at April 2024 was EUR 16.9 million, down from EUR 18.5 million in April 2023, and the projected net rental income was EUR 6.0 million, down from EUR 12.2 million last year. The significant decrease in projected net rental income is due to both an increase of vacant units and irrecoverable costs over the last quarter, which has been magnified by annualisation. The occupancy was down to 52.5% in April 2024, from 56.9% in April 2023. According to the April 2024 servicing report, a total of 1,126 units have been refurbished (equivalent to 50% modernisation rate of the total number of units in need of modernisation), of which 295 have been let, since the acquisition. The leasing of refurbished units has occurred at market rates with an average of EUR 7.3 per square metre (sqm) per month. MVGM has been reviewing 661 refurbished units: 300 of the 661 are occupied and 127 are deemed to be vacant units ready for letting in the coming quarter. It is also reported that the property manager will change its business strategy by commencing pre-letting ahead of refurbishment completion. Of the subsidised rent-capped units (between EUR 4.21/sqm to EUR 5.21/sqm), 430 leases, out of a total 514, will expire on 31 December 2024, while the remaining restrictions (84) expire on 31 December 2026. The expiry of the rent-capped restriction will free 6.7% of the residential stock to be let at market rent in the first instance, and 8% in total.

Morningstar DBRS will review its underwriting assumptions focusing on the cash flow assumptions and the timing of the business plan execution and its assessment of the long term stabilised capitalization rate.

For the purpose of satisfying U.S., EU and U.K. risk retention requirements, the transaction includes a vertical risk retention (VRR) loan with the Issuer as the borrower of the VRR loan. At closing, the principal amount of the VRR loan was EUR 16.61 million inclusive of EUR 657,895 as a portion to fund the liquidity reserve amount. The Issuer used EUR 12.5 million of the proceeds from the issuance of the Class A1 notes and the proportionate VRR loan amount to fund its liquidity reserve in an aggregate amount of EUR 13.157 million. The Issuer can use its liquidity reserve to cover interest shortfalls on the Class A1, Class A2, and Class B notes. As of April 2024, the liquidity facility balance stands at EUR 13.154 million. Morningstar DBRS estimates that the liquidity reserve amount can provide interest payments on the covered notes for up to 15 months or 10 months based on the interest rate cap strike rate of 2.0% or on the Euribor cap of 4.0%, respectively.

The transaction includes Class X notes of EUR 100,000, not rated by Morningstar DBRS. Interests due to Class X noteholders are subordinated to interest payments on all other Classes of notes. The Class X interest diversion trigger event followed the loan's DY breach of 5.5% in August 2022 and Class X interests were not distributed since. The Class X interest amount and the VRR loan proportion of that amount have been diverted to the Issuer's transaction account and credited to the Class X diversion ledger. The amount credited to the ledger was EUR 5.4 million on the May 2024 notes payment date. Once the trigger is cured, the held amount will be released to the Class X noteholders. Only following a sequential payment trigger event and enforcement of the note security the funds can be applied as available funds to the transaction's waterfall.

The transaction is structured with a five-year tail period after final loan repayment date in July 2046 to allow the special servicer to work out the loan by July 2051, which is the notes' final legal maturity.

Morningstar DBRS' credit ratings on the applicable classes address the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents. Where applicable, a description of these financial obligations can be found in the transactions' respective press releases at issuance.

Morningstar DBRS' long-term credit ratings provide opinions on risk of default. Morningstar DBRS considers risk of default to be the risk that an issuer will fail to satisfy the financial obligations in accordance with the terms under which a long-term obligation has been issued.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factor(s) that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024) https://dbrs.morningstar.com/research/427030.

Notes:
All figures are in euros unless otherwise noted.

The principal methodology applicable to the credit ratings is European CMBS Rating and Surveillance Methodology (17 January 2024) https://dbrs.morningstar.com/research/426818.

Other methodologies referenced in this transaction are listed at the end of this press release.

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

Morningstar DBRS is undertaking a review and will remove the credit 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 credit rating action.

For a more detailed discussion of the sovereign risk impact on Structured Finance credit ratings, please refer to "Appendix C: The Impact of Sovereign Ratings on Other Morningstar DBRS Credit Ratings" of the "Global Methodology for Rating Sovereign Governments" (15 July 2024) at: https://dbrs.morningstar.com/research/436000 .

The sources of data and information used for these credit ratings include Regulatory Information Service (RIS) notice, quarterly servicer reports provided by Mount Street Mortgage Servicing Limited, quarterly cash manager reports prepared by U.S. Bank Global Corporate Trust Limited, and the valuation reports prepared by JLL and KF.

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

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

Morningstar DBRS considers the data and information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

Morningstar DBRS does not audit or independently verify the data or information it receives in connection with the credit rating process.

The last credit rating action on this issuer took place on 16 August 2023 when Morningstar DBRS confirmed its credit ratings on the Class A1 notes at AAA (sf) and downgraded the Class A2 notes to AA (high) (sf) from AAA (sf), the Class B notes to A (high) (sf) from AA (low) (sf), the Class C notes to BBB (high) (sf) from A (low) (sf), and the Class D notes to BB (high) (sf) from BBB (low) (sf).

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

This credit ratings are 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 Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication.

For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Patrizia Catanese, Assistant Vice President
Rating Committee Chair: Christian Aufsatz, Managing Director
Initial Rating Date: 29 July 2021

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The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

-- European CMBS Rating and Surveillance Methodology (17 January 2024),
https://dbrs.morningstar.com/research/426818
-- Legal Criteria for European Structured Finance Transactions (28 June 2024),
https://dbrs.morningstar.com/research/435165
-- Derivative Criteria for European Structured Finance Transactions (28 June 2024),
https://dbrs.morningstar.com/research/435260
-- Interest Rate Stresses for European Structured Finance Transactions (28 June 2024),
https://dbrs.morningstar.com/research/435278
-- Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024), https://dbrs.morningstar.com/research/427030

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

For more information on this credit or on this industry, visit dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.