News

Debussy trigger breach eyed

Thursday 14 December 2017 16:04 London/ 11.04 New York/ 00.04 (+ 1 day) Tokyo

DBRS has downgraded its rating on the Debussy DTC class A notes to double-B (low) from triple-B (low) and placed the deal under review with negative implications. The move reflects the imminent decrease in credit characteristics of the UK CMBS, due to Toys 'R' Us's (TRU) proposed company voluntary arrangement (CVA), which could result in the transaction suffering an ICR trigger breach or interest payment default next year.

The £263.2m Debussy DTC is backed by a single interest-only loan that is secured by 30 TRU mega retail stores and one distribution centre, which are mainly located in secondary and tertiary markets in the UK. All properties operate under individual triple-net leases to Toys 'R' Us, with leases expiring in February 2036 or February 2037. TRU is currently paying above-market rent, with an annual rental rate increase based on the RPI, subject to a 1% floor and a 2.5% cap.

The loan matures in July 2020: there is no extension option, but the maturity date could be potentially extended to July 2023, two years before note maturity. The interest cover ratio currently stands at 138%.

The CVA proposal was announced on 4 December and TRU's creditors are scheduled to vote on it on 21 December. If agreed by at least 75% of its debtors, the CVA will enable TRU UK to restructure its finances and reposition its real estate portfolio. If more than half of its debtors vote against the CVA and no agreement is reached, TRU could be forced to file for bankruptcy in the UK, which is highly likely to result in store closures.

TRU currently operates 88 permanent and 21 temporary stores in the UK. The CVA proposal splits the property portfolio into five categories based on store profitability and size.

Under the proposal, Category 1 stores are performing well and do not require any modifications. Category 2 and 3 stores require downsizing: there would be seven months to agree the terms of a downsize, after which a 15% reduction in rent will be proposed as an alternative.

Additionally, the proposal entails immediate rent reductions for all unprofitable stores. Category 3 and 4 stores would have immediate rent reductions of 35%.

As Category 5 stores have been deemed to have no future viability, following an immediate rent reduction of 50%, store closures would begin in spring 2018.

The proposal also includes lease termination rights, with a 45-day notice period for properties in Categories 2 to 5, and will change the rent collection cycle for all property categories from quarterly in advance to monthly.

Of the 31 securitised assets in the Debussy transaction, seven (representing 13.3% of total annual rental income) fall into Category 1, while seven (16.6%) fall into Category 5, according to DBRS. The remaining 17 assets require a mix of downsizing and rent reductions.

The latest reported market value and vacant possession value of the portfolio are £359.4m and £196.4m respectively, based on the assumption that the assets would be let at current rent or market rent. Should the CVA proposal be implemented, TRU would pay below the currently reported market rent, which DBRS suggests may result in a possible ICR trigger breach and/or interest payment default during 2018 - thereby causing the loan to be transferred to the special servicer.

The deal features an ICR covenant whereby the borrower must ensure that rental income is at least 1.15 times debt service.

CBRE valued the property portfolio at £194.5m in 2013 on the basis of vacant possession. As such, Bank of America Merrill Lynch European securitisation analysts believe this could reflect the downside scenario for noteholders, if the CVA is rejected and the business put into administration. On this basis, they estimate that only the class A notes are covered with a loan-to-vacant-possession-value of 94.7%, while the class B and C notes could be exposed to principal shortfalls of roughly 80% and 100% respectively.

The BAML analysts also suggest that a new, lower property valuation based on the terms of the CVA could trigger a control valuation event. They calculate that if the valuation were to decline by a third, the controlling class would transfer to the class B notes.

DBRS notes that the transaction's £3m reserve account could be used to pay interest due on the securitised loan, if the change from a quarterly to a monthly collection cycle means rental income is insufficient to pay interest on the loan. Similarly, the £19.3m cash in the borrower security reserve account could be used to pay interest due on the class A notes, mitigating the risk of a note payment default.

Overall, the BAML analysts question the fact that the CVA has been filed on the part of the OpCo Toys 'R' Us, whereas the creditors of the OpCo are largely the PropCo - which is Toys 'R' Us Properties (UK). "Given that the OpCo and the PropCo ultimately have the same parent (Toys R Us Inc), in our understanding, is there potentially a net benefit from shifting value away from the PropCo to the OpCo at the expense of the PropCo's creditors?" they ask.

Based on the assessment that Debussy could continue to perform in the event of a TRU insolvency by reletting the properties to new tenants at significantly reduced market rental levels, it is unclear whether the tenant's proposed CVA would be less deleterious for the CMBS than reletting the properties. Further, in an insolvency process, a court appointed administrator would be accountable to maximise the value of the estate for all creditors.

"We think this has the benefit of assuring alignment of interests with creditors. Trading could continue out of the profitable stores, while unprofitable stores could be closed - which is not dissimilar to the OpCo's CVA proposal, in our view," the analysts observe.

Ahead of the CVA vote, separate Debussy class A, class B and class C noteholder meetings have been convened for 18 December. The meetings are being held to consider/pass an extraordinary resolution to amend the notice period required to convene a noteholder meeting and to reduce the percentage of noteholders required to sign an effective written extraordinary resolution. A group of noteholders holding over 80% of the principal amount outstanding of the notes contacted the issuer to request that amendments be made to enable directions to be given to the issuer, the note trustee and the servicer sooner than is currently permitted under the transaction documents.

S&P - the other rating agency on the deal - lowered its single-A minus rating on the Debussy class A notes to triple-B in July, following a review of the transaction, but is yet to take any action related to the CVA. DBRS confirmed its rating on the deal in July, but assigned a negative trend to the class A notes. It says it intends to review the transaction again once the outcome of the CVA proposal is more visible.

14/12/2017 16:04:18