EUR 780 Million of CMBS Notes Affected
Frankfurt am Main, December 21, 2010 -- Moody's Investors Service has today confirmed the following class of Notes
issued by Fleet Street Finance Two plc (amount reflects initial outstanding):
EUR780M Class A Commercial Mortgage Backed Floating Rate Notes due 2017,
Confirmed at Baa2 (sf); previously on May 14, 2010 Downgraded
to Baa2 (sf) and Remained On Review for Possible Downgrade
Moody's does not rate the Class B, C and D Notes issued by Fleet
Street Finance Two plc.
Moody's rating addresses the expected loss posed to investors by the extended
legal final maturity in July 2017. The rating does not address
the Additional Note Margin Amount payable as defined in the amended Master
Definition and Construction Schedule nor the probability of payment of
such additional amounts or any related payments to the noteholders.
Moody's ratings address only the credit risks associated with the transaction;
other non-credit risks have not been addressed but may have significant
effect on yield to investors.
1) Rating Rationale
On 14 May 2010, Moody's downgraded the Class A Note to Baa2 (sf)
and kept the rating on review for further downgrade pending (i) the decision
with respect to either an extension of the existing liquidity facility
or a new liquidity facility or implementation of a liquidity reserve account
for the extended term of the transaction and (ii) the final outcome of
the insolvency proceedings of the tenant, Karstadt.
As explained in more detail below, today's confirmation of
the Baa2 rating of the Class A Note is primarily driven by both positive
and negative credit developments. The positive developments are
(i) the acquisition of the tenant, Karstadt by the investor Berggruen
and the conclusion of the insolvency proceedings; (ii) the implementation
of a liquidity reserve account for the extended term of the transaction;
(iii) a recently provided legal memorandum confirming the legally valid
existence of the borrower under German law and (iv) the overall net positive
impact of the implemented changes both at loan and transaction level on
the Class A Note. The offsetting negative issues are (i) the still
weak credit quality of the tenant; (ii) the significant decline in
the value of the property portfolio since closing and also compared to
the previous rating action in April 2010 resulting from newly negotiated
lower rents and (iii) the deterioration of the German property market
since securitisation.
The current rating would be subject to downgrade pressure if certain base
case assumptions change. Moody's base case assumes that i)
Karstadt remains solvent during the remaining loan term and ii) the severity
calculations uses market values for the best eight department store properties
in the portfolio and vacant possession values for the remaining properties.
Even though the default probability of the loan is high under the base
case, a second bankruptcy, given the weak credit quality of
the tenant would likely lead to a further downgrade. Additionally,
if the recovery assumptions for the best eight department store properties
did not hold, then the current rating of the Class A Note could
potentially decline to a sub-investment grade level. On
the other hand, there could potentially be a positive rating change
if the credit quality of the tenant improved significantly beyond expectations
combined with a considerably improved German commercial real estate market,
as it would improve both property value and the ability of refinancing
of the loan on its new maturity date in 2014. In addition,
property sales that significantly delever the loan could have a positive
impact on the rating of the Class A Note.
2) Transaction Overview and Current Performance
Fleet Street Finance Two plc closed in October 2006 and represents the
securitisation of a single commercial mortgage loan originated by Goldman
Sachs Credit Partners L.P. The securitised loan ("Senior
Loan") is a part of a large financing transaction involving a senior-mezzanine
structure, where the mezzanine loan is funded outside the transaction.
The Senior Loan and a part of the mezzanine loan ("Mezzanine Loan",
together "Loans") share substantially the same property collateral.
Both Loans are secured by first-ranking, legal mortgages
on primarily retail properties located in Germany; however the Mezzanine
Loan is contractually subordinated. The Mezzanine Loan will not
receive any rental or other cashlow until the Senior Loan is repaid in
full.
The portfolio initially consisted of 109 properties and comprised 94.2%
retail properties (89.6% department stores and 4.6%
specialist stores), 3.5% parking, 1.3%
office and 1.1% other use properties (by portfolio value)
with concentration in Bavaria (26.7%), Berlin (18%)
and North Rhine Westphalia (17.6%). Currently (as
per the July 2010 investor report) there are 88 properties in the portfolio
with a similar split in terms of property type and geographical distribution
as per closing.
At closing, 100 of the 109 properties were fully let to W2005/Seven
BV ("Master Lessee"), which in turn sublet the properties to Karstadt
Warenhaus GmbH, which accounted for approximately 98% of
the rental income and Quelle GmbH accounting for approximately 2%
of the rental income. Following the opening of formal insolvency
proceedings in relation to both tenants in September 2009, Quelle
GmbH is currently in the process of being liquidated and properties occupied
by it have already been vacated; while for the Karstadt Warenhaus
GmbH, the insolvency proceedings were concluded when the investor
Berggruen acquired the company as of 1 October 2010. With the acquisition,
significantly reduced rental levels were agreed between Karstadt and the
borrower.
3) Final Loan and Transaction Restructuring
On 24 February 2010, 28 July 2010 and 2 September 2010, a
restructuring of the transaction and the underlying financing as well
as changes to the master lease agreement were approved by noteholders.
There are some additional changes incorporated compared to the regulations
that were initially approved on 24 February 2010. The final approved
and agreed restructuring includes, inter alia, the following:
a) Main changes to the underlying financing:
(i) Extension of the Loan maturity date by three years to July 2014;
(ii) no testing of the LTV covenant until 2013, from January 2013
the LTV covenant will be 90% and will decrease to 85% from
the testing date in January 2014 onwards; (iii) no payments from
rental income or disposal proceeds will be made to the mezzanine lenders
or to the borrower before the full repayment of the securitised Senior
Loan; (iv) in addition to scheduled amortisation, a new schedule
of minimum additional total payments of cumulatively EUR 145 million until
January 2014; and (v) new hedging arrangements including a fully
paid cap with a strike of 2.25%.
b) Main changes to the transaction:
(i) Extension of the legal final maturity date of the notes by three years
to 2017; (ii) a fully sequential allocation of excess cash flow from
rents and all sales proceeds to the notes; and (iii) an increased
margin on the notes of approximately 50 basis points per annum (Moody's
rating does not address this Additional Note Margin Amount and the liquidity
facility cannot be drawn to cover shortfalls on these amounts); and
(iv) a liquidity reserve account substituting a liquidity facility during
the extended transaction term after loan maturity until the legal final
maturity date of the notes (please see below for further details).
c) Main changes to the master lease agreement:
(i) Rent reductions from originally EUR 123 million p.a.
to EUR 95 million p.a. gradually increasing to approximately
108 million p.a. in 2017; (ii) termination of the lease
agreement for four properties let to Karstadt and for all properties let
to Quelle; and (iii) split of the lease agreement into three separate
lease agreements (one for the sport stores, one for the premium
department stores (currently only the KaDeWe department store is included,
which is not part of the collateral for the Senior Loan) and one for the
remaining portfolio); and (iv) Karstadt agreed to exercise its five
year extension option for the majority of properties in the portfolio.
d) New basis swap for extended loan term:
The issuer entered into a new basis swap for the extended loan term.
The swap documentation does not fully comply with Moody's current published
criteria entitled "Framework for De-Linking Hedge Counterparty
Risks from Global Structured Finance Cashflow Transactions Moody's Methodology",
dated 18 October 2010. This does, however, not affect
the rating of the Class A Notes at the current rating level.
4) Moody's Analysis
a) Impact of Restructuring on Class A Notes
In Moody's opinion, the changes implemented with the restructuring
at Loan and transaction level are net positive for the Class A Notes.
The regulation at Senior Loan level that no payments from rental income
or disposal proceeds are made to the mezzanine lenders or to the borrower
before the full repayment of the securitised Senior Loan is beneficial
for the issuer as the senior lender. In addition, through
the fully sequential allocation of excess cash flow from rents and all
sales proceeds to the notes, the Class A Notes will most likely
benefit from a faster repayment and a subsequent increase in credit enhancement
as long as the tenant Karstadt meets its rental payment obligations.
b) Tenancy
Quelle, which only contributed a minor share to the total rental
income, is being liquidated while the insolvency proceedings for
the main tenant Karstadt have been concluded. Nevertheless,
as there is a high likelihood of a renewed insolvency of Karstadt over
the Loan term, the credit strength of the tenant is still weak and
results in a high default probability during the Loan term.
c) Rental Cash Flows
The agreed changes to the master lease agreement result in significantly
reduced rental cash flows over the following years. The rental
payments are sufficient to cover the interest payments and the original
scheduled amortisation of 1% p.a. To meet the additional
minimum amortisation amounts, the borrower needs, however,
to dispose of some of the properties. In Moody's base case
the potential excess cash flow will be EUR 132 million compared to EUR
145 million of additional minimum amortisation amounts. In its
modelling, Moody's has given partial benefit for the expected
excess cash flow.
d) Portfolio Value
Moody's was provided with a valuation as of October 2010.
According to the valuer, the updated market value was approximately
EUR 1,330 million and the update vacant possession value was approximately
EUR 625.7 million, a 58% decline as compared to EUR
1,497 million at closing and a 49% decline as compared to
EUR 1,239 million as of year-end 2008. In its base
case, Moody's does not assume a fire sale of the portfolio even
in a renewed insolvency scenario of the tenant. The most likely
work-out scenario in Moody's view is that the best properties would
be re-let and operated as department stores and the remaining properties
in the portfolio would be sold without a tenant. As such,
Moody's did not use the updated vacant possession value as the basis for
its severity calculation, but a blended value considering the market
value for the eight best properties.. For the remaining
properties in the portfolio, Moody's has taken into account the
vacant possession value. Moody's current LTV for the securitised
Senior Loan is 117% based on the blended severity value of EUR
906 million.
e) Liquidity Reserve Account
The existing liquidity facility will expire in 2014 at the initial final
maturity date of the Notes, which is now the new loan maturity date.
During the extended tail period until 2017, instead of a liquidity
facility, amounts deposited in the borrower's English law account
(the "Account") can be used, among others, to cover cash flow
shortfalls to pay interest on the Class A Notes. On each IPD,
the borrower should fund the Account until a maximum amount of approximately
EUR 82.6 million is trapped, which will be continously reduced
in line with the amortisation of the Loan. The Account will be
managed by the servicer and fully controlled by the Issuer. Based
on the respective provision included in the deed of amendments,
only the servicer will have the sole signing and withdrawal rights to
this account, which it could only exercise upon an instruction from
the Issuer. The Issuer will be entitled to make withdrawals from
this account to cover any potential shortfall in Issuer's available interest
collections destined for payment of interest due under the Class A Notes
excluding the Additional Note Margin Amount. The borrower will
grant a security interest over the Account in favour of the Issuer pursuant
to an English law security agreement.
In Moody's opinion, due to the pronounced cross- jurisdictional
aspects and dependencies in relation to the intended solution, there
remain some considerable legal and operational risks for an uninterrupted
availability of such liquidity within the transaction. Especially
in the case of a potential insolvency of the borrower, the Issuer's
access to the Account and its ability to withdraw funds from the Account
might not be possible without any interruptions. This might have
negative consequences for the timely payment of interest on the Class
A Notes. Furthermore, there are in Moody's opinion,
uncertainties about (i) any potential preferential claims which might
come into existence in case of a reclassification of the intended English
law fixed charge over the account into a floating charge and (ii) the
status of such English security under Dutch law, if such law would
apply in a foreclosure scenario.
Moody's notes that through the implementation of the liquidity reserve
account as substitute of a liquidity facility, the future upside
potential of the current rating of the Class A Notes (in case of a significantly
improved tenant credit quality and an improved commercial property market)
might be limited due to the above mentioned structural and operational
weaknesses.
f) Valid existence of the borrower under the German law
In its press release on 14 May 2010, Moody's highlighted its
concern about the uncertainty over the legally valid existence of the
borrower under German law, given that it has never had an administrative
seat in Germany. At the time, Moody's was not provided
with a confirmation by the transaction lawyers on the valid existence
of the borrower under German law. As a result,, Moody's
stressed the enforcement timing and cost assumptions in its modelling
of the transaction. This was done to reflect the additional delays
and increased costs stemming from a potential enforcement process upon
a loan default.
Moody's takes comfort from a legal memo prepared for the servicer
and provided to Moody's that confirms that the borrower legally
validly exists under German law. It has therefore reduced its enforcement
cost and timing assumptions to the previously assumed levels.
5) Rating Methodology
The principal methodologies used in rating and monitoring the transaction
are "Update on Moody's Real Estate Analysis for CMBS Transaction in EMEA"
June 2005, "Moody's Updates on its Surveillance Approach for EMEA
CMBS" March 2009 and "Moody's Approach to Evaluating Distressed Exchanges",
March 2009, which are available on www.moodys.com
in the Rating Methodologies sub-directory under the Research &
Ratings tab. Other methodologies and factors that may have been
considered in the process of rating this issuer can also be found in the
Rating Methodologies sub-directory on Moody's web site.
The last Performance Overview for this transaction was published on 2
February 2010.
Further information on Moody's analysis of this transaction is available
on www.moodys.com. In addition, Moody's publishes
a weekly summary of structured finance credit, ratings and methodologies,
available to all registered users of our web site, at www.moodys.com/SFQuickCheck.
For updated monitoring information, please contact [email protected]
To obtain a copy of Moody's Pre-Sale Report on this transaction,
please visit Moody's website at www.moodys.com or contact
our Client Service Desk in London (+44-20-7772 5454).
Frankfurt am Main
Oliver Moldenhauer
Vice President - Senior Analyst
Structured Finance Group
Moody's Deutschland GmbH
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454
Frankfurt am Main
Marie-Jeanne Kerschkamp
MD - EMEA Structured Fin
Structured Finance Group
Moody's Deutschland GmbH
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main 60322
Germany
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454
Moody's confirms Class A CMBS Notes issued by Fleet Street Finance Two plc at Baa2 (sf)
