Overview

• We have reviewed Taurus 2018-2 UK DAC in light of a deterioration in operating performance, which is likely to be exacerbated by COVID-19.
• Following our review, we have lowered our ratings on both classes of notes.
• Taurus 2018-2 UK is secured on a mixed-use office, retail, leisure, educational, and residential estate located in London, and its legal final maturity date is in May 2028.

LONDON (S&P Global Ratings) June 29, 2020--S&P Global Ratings today lowered its credit ratings on Taurus 2018-2 UK DAC's class A and B notes to 'AA+ (sf)' and 'A+ (sf)' respectively.

Rating rationale

Today's downgrade follows our updated review of the transaction's credit and cash flow characteristics. We believe that a drop in cash flows from the property, largely driven by increased vacancy levels and a decline in tenant performance, has worsened the notes' credit metrics.

While our S&P Global Ratings value has fallen, this has been mitigated by recent deleveraging, resulting in a one-notch downgrade to both classes of notes.

Transaction overview

The transaction is backed by one senior loan, originated in April 2018 to facilitate the acquisition by a joint venture between TH Real Estate (45%), PFA Global Real Estate (45%), and WeWork Companies Inc. (10%) of Devonshire Square Estate located in the City of London.

At closing, the loan backing this true sale transaction equaled £275.3 million, split into a £235.3 million acquisition facility plus a £40.0 capital expenditures (capex) facility. Since then, the loan has prepaid £14.3 million as a result of the loan being in cash trap, and the balance outstanding is currently £261.0 million. The borrower remains in breach of the cash trap covenant, which is set at a 10.7% debt yield ratio for the third successive interest payment date (IPD). As of the May 2020 IPD, the servicer reported a current debt yield of 9.3%.

The securitized loan balance is 95.0% of the whole loan (£248.0 million) with Bank of America Merrill Lynch International Ltd. holding a 5.0% (£13.1 million) interest that ranks pari passu with the securitized loan to satisfy EU risk retention requirements.

The property's current market value is £583 million (dated March 2020), which equates to a loan-to-value (LTV) ratio of 44.8% (including the capex facility). The three-year loan with two one-year extension options is interest only.

The loan is backed by Devonshire Square, a five-acre urban campus that was largely redeveloped in 2003. The campus includes 12 buildings that offer 637,328 sq. ft. of lettable space. Of this, 82% is office space, with the remainder predominantly a mix of retail and leisure.

The Devonshire Square Estate is currently let to approximately 30 tenants and produces a reported net rent of £22.8 million per annum, down from £25.4 million per annum at the last IPD. The decline in net rent is largely to do with the loss of rent from The Devonshire Club in respect of 4 & 5 Devonshire Square. The club is in administration, and the landlords have indicated that they plan on converting the space into offices. Additionally, building 7 will become vacant once the sole tenant vacates shortly. Furthermore, there are large vacancies in buildings 9, 9A, and the Bengal Wing, which WeWork previously expressed an interest in occupying. Since WeWork's business plan is subject to an ongoing review, we understand that it may no longer be taking up space in these buildings, and the properties will be let on standard market leases instead.

According to the May 2020 investor report, following the administration of The Devonshire Club, the current vacancy rate for the property has increased to 17.5% from 10.3%, and the weighted-average unexpired lease term (WAULT) has dropped to 2.68 years from 7.22 years.

Devonshire Square's income is underpinned by WeWork, which is the largest tenant, accounting for approximately 40% of the rent and 30% of the total lettable space. A portion of the rental income attributed to the property is from a long-term revenue-sharing agreement (expiring in June 2023) on which WeWork pays the landlord a proportion of the membership sales to operate the WeWork branded space at buildings 8 and 10. The "rent" payable to the landlord under the terms of the revenue-sharing agreement is dependent upon the occupation and performance of WeWork. After the headline gross revenue is derived from membership sales, the income waterfall is as follows:

• Rates and service charges (estimated at £30.00 per sq. ft.).
• A priority rent reflecting £50.00 per sq. ft. to the landlords.
• WeWork building-related operating expenses (capped at £27.50 per sq. ft.).
• A 10% management fee to WeWork based on gross revenue.
• Remaining revenue to be split 50% to the landlords and 50% to WeWork as tenant.

Under the agreement, the landlords have an option to convert the revenue-sharing agreement to a standard commercial lease at the fair market rental value if the total distributions to the landlords under the agreement are less than an amount equal to £70.00 per sq. ft. in any annual period, subject to a WeWork cure right at the £70.00 per sq. ft. threshold. We understand that to date there has been no expression of intent to exercise this option.

The portfolio average gross rent is £52 per sq. ft. This compares to an average market rent of £62 per sq. ft. Overall, the portfolio rental levels are lower than market levels, and the estate is considered to be under-rented. However, since closing, the transaction's reported net rental income has decreased 35% to £22.8 million. We believe this is largely due to increased vacancy on the estate and reduced income levels from WeWork. Given the current uncertainties in the market and the deteriorating occupancy levels of the estate as a whole, we have revised our long-term operating and cash flow assumptions.

Our S&P Global Ratings net cash flow (NCF) has reduced to £28.1 million from £34.2 million. More specifically, our analysis has adjusted downward our long-term occupancy assumptions and reflected lower projected income under the revenue-sharing agreement with WeWork, as the company's future performance is uncertain and likely to continue to face difficulties.

We have then applied our 6.25% capitalization (cap) rate against this S&P Global Ratings NCF and deducted 5% of purchase costs to arrive at our S&P Global Ratings value, which has declined 13% since closing.

Loan And Collateral Summary:

• Securitized debt balance: £248.0 million
• Debt yield: 9.30%
• Whole LTV ratio: 44.5%
• Net rental income: £22.8 million
• Vacancy rate: 17.5%
• Market value: £583 million
• Net initial yield: 4.1%

S&P Global Ratings' Key Assumptions:

• S&P Global Ratings vacancy: 12.5%
• S&P Global Ratings expenses: 5.0%
• S&P Global Ratings NCF: £28.1 million*
• S&P Global Ratings value: £406 million
• S&P Global Ratings cap rate: 6.25%
• Haircut-to-market value: 30%
• S&P Global ratings LTV ratio (before recovery rate adjustments): 62%

*Our S&P Global Ratings NCF reflects a premium to the reported net rental income because our analysis has given credit to the potential of re-leasing the existing vacant space up to our long-term structural vacancy assumption of 12.5%. In doing so, the analysis has also factored in, as a capital item, costs related to the releasing of vacant space, and we have assumed a combined re-letting period and rent-free period equivalent to three years, in line with market assumptions.

Other analytical considerations

Our ratings analysis also includes an analysis of the transaction's payment structure and cash flow mechanics. We assess whether the cash flow from the securitized assets would be sufficient, at the applicable rating levels, to make timely payments of interest and ultimate repayment of principal by the legal maturity date for each class of notes, after taking into account available credit enhancement and allowing for transaction expenses and external liquidity support.

The risk of interest shortfalls is mitigated by a £13 million facility that provides liquidity support to service the interest shortfalls on the class A and B notes, if needed. To date, there has been no drawing from this liquidity facility to pay interest on the notes. Our assessment of the payment structure and cash flow mechanics does not constrain our ratings in this transaction.

Our analysis also included a full review of the legal and regulatory risks, operational and administrative risks, and counterparty risks. Our assessment of these risks remains unchanged since our previous review and is commensurate with the ratings assigned.

Rating actions

Our ratings in this transaction address the timely payment of interest, payable quarterly in arrears, and the payment of principal no later than the legal final maturity date in May 2028.

In our view, the transaction's credit quality has declined, driven in large part by material decreases in rental income at the property and declines in tenant performance, which we believe are likely to persist, to some extent, over the medium term. Furthermore, the market disruption resulting from the spread of COVID-19 may negatively affect the property's leasing potential.

The combination of the above factors results in a reduced assumption of the long-term sustainable cash flow for the property and, in turn, a lower S&P Global Ratings value. The impact of this has been somewhat mitigated by the recent prepayment of the loan. We have therefore lowered our ratings on the class A notes to 'AA+ (sf)' from 'AAA (sf)' and the class B notes to 'A+ (sf)' from 'AA- (sf)'.

S&P Global Ratings acknowledges a high degree of uncertainty about the evolution of the coronavirus pandemic. The consensus among health experts is that the pandemic may now be at, or near, its peak in some regions, but will remain a threat until a vaccine or effective treatment is widely available, which may not occur until the second half of 2021. We are using this assumption in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Environmental, social, and governance (ESG) factors relevant to the rating action:

• Health and safety.

Related Criteria

• Criteria | Structured Finance | General: Counterparty Risk Framework: Methodology And Assumptions, March 8, 2019
• Criteria | Structured Finance | General: Incorporating Sovereign Risk In Rating Structured Finance Securities: Methodology And Assumptions, Jan. 30, 2019
• Legal Criteria: Structured Finance: Asset Isolation And Special-Purpose Entity Methodology, March 29, 2017
• Criteria | Structured Finance | General: Global Framework For Assessing Operational Risk In Structured Finance Transactions, Oct. 9, 2014
• General Criteria: Methodology Applied To Bank Branch-Supported Transactions, Oct. 14, 2013
• Criteria | Structured Finance | CMBS: European CMBS Methodology And Assumptions, Nov. 7, 2012
• Criteria | Structured Finance | CMBS: CMBS Global Property Evaluation Methodology, Sept. 5, 2012
• Criteria | Structured Finance | General: Criteria Methodology Applied To Fees, Expenses, And Indemnifications, July 12, 2012
• General Criteria: Global Investment Criteria For Temporary Investments In Transaction Accounts, May 31, 2012
• General Criteria: Methodology: Credit Stability Criteria, May 3, 2010
• Criteria | Structured Finance | General: Methodology For Servicer Risk Assessment, May 28, 2009
• Criteria | Structured Finance | CMBS: Methodology For Analyzing Loan-Level Limited Purpose Entities In European CMBS, Sept. 1, 2004

Related Research

• European CMBS: Assessing The Liquidity Risks Caused By COVID-19, May 6, 2020
• European CMBS Monitor Q1 2020, April 21, 2020
• Credit FAQ: A Deeper Dive Into The Potential Credit Effects Of COVID-19 On European CMBS, April 2, 2020
• European CMBS: Assessing The Credit Effects Of COVID-19, March 24, 2020
• S&P Global Ratings Definitions, Sept. 18, 2019
• 2017 EMEA CMBS Scenario And Sensitivity Analysis, July 6, 2017
• Application Of Property Evaluation Methodology In European CMBS Transactions, April 28, 2017