Fitch downgrades UAE CMBS Vehicle NO. 1 Limited class A notes, affirms class B and C

Fitch has simultaneously revised the Outlooks on all three tranches to Negative from Stable. The rating actions are as follows:

- $27.5m class A due June 2016 (XS0305277047) downgraded to 'A+' from 'AA-'; Outlook revised to Negative from Stable

- $12.9m class B due June 2016 (XS0305277393) affirmed at 'A'; Outlook revised to Negative from Stable

- $12.5m class C due June 2016 (XS0305277476) affirmed at 'BBB'; Outlook revised to Negative from Stable

The downgrade of the senior note class reflects Fitch's view on Dubai's weaker credit fundamentals, whilst the affirmations reflect the stable performance of the transaction to date. The Negative Outlooks are driven by the ongoing deterioration of, and uncertainty in, Dubai's commercial property market.

Rents in the subject property remained more affordable than in most comparable locations in the city during the recent property boom. Consequently, Fitch believes that there is less scope for rental declines in the subject property than in Dubai as a whole, where a surge in development completions is coinciding with a fall-off in occupational demand. However, the rental and capital value decline in the larger Dubai office market has now become significant enough to warrant Negative Outlooks.

The collateral has been revalued twice by Jones Lang LaSalle (JLL) since closing. The first reported revaluation in June 2008 resulted in an increase in value of 25% since closing, whilst the more recent valuation in December 2008 showed only a slight subsequent decline of 3%, and an overall increase in value of 21% since closing. Fitch estimates a higher market value decline (MVD) of 37% since the June 2008 valuation, and 22% since closing. This results in a Fitch loan-to-value ratio (LTV) of 75.2% (63.7% on the Fitch-rated debt), compared to the reported LTV of 49.2% (41.3% on the Fitch-rated debt). The LTV covenant is 75%.

Since closing, the property has operated at negligible vacancy levels, which are slightly lower than the trend in the larger TECOM area. Re-letting has caused passing rent (and net operating income) to increase by 17%, which remains 5% below the estimated rental value (ERV) of Dhs39.3m quoted in April 2007. This has, in turn, led the interest coverage ratio (ICR) to rise to 1.70x from 1.47x (vs ICR cash trap and default triggers of 1.4x and 1.3x, respectively). The ICR has increased despite a rise in operating expenses in the last two quarters, which saw the cost margin rise to 43% in December 2008 and 47% in March 2009, compared to 30-35% in all preceding quarters.

The existing rent roll is extensive, with an average lease contributing only 1% of passing rent. There is also a significant concentration in a handful of larger leases: the top five tenants represent nearly half the rent roll, which could be a source of future income volatility. In addition, as is customary in TECOM, all leases are granted for one- or two-year terms, and for the collateral, the weighted-average (WA) lease term is just 0.5 years. However, term risk has been minimised by a guarantee provided by TECOM until January 2012 for a minimum annual rent (net of TECOM fees) of Dhs27m, compared to current rent of Dhs31.7m and annual interest expenses of approximately Dhs15.8m. While this comfortably covers interest expenses during most of the term, the guarantee falls away six months prior to loan maturity in July 2012. The strength of the guarantee is not fully capitalised, because the loan is scheduled to amortise only partially during its term and is therefore still exposed to balloon risk by maturity, as evidenced by Fitch's exit LTV of 71.4% (59.9% on the Fitch-rated debt).

Fitch will continue to monitor the performance of the transaction.