The performance of commercial mortgage-backed securities (CMBS) and multi-family transactions in Europe, the Middle East and Africa (EMEA) exhibited further deterioration during Q2 2009, says Moody's Investors Service in its latest Surveillance Report for the sector.
The rating trend of EMEA CMBS in Q2 2009 was significantly negative, with many transactions experiencing multiple notch downgrades, driven mostly by loan performance-related concerns.
In the report, Moody's comments on various performance-related and transaction counterparty-linked events that impacted the transactions it monitors in Q2 2009. The rating agency highlights that there were no signs of a slowdown in the pace of performance deterioration in the EMEA commercial real estate loan universe over the quarter. Property values decreased further, driven by further increasing property yields and weaker occupational markets. Although Moody's notes that towards the end of Q2 2009, the yield widening for prime UK commercial properties with beneficial lease profiles slowed down to some extent, the negative commercial property market environment combined with the still limited amount of capital in the market available for commercial real estate investments is putting increasing pressure on securitised loans.
"The number of transactions that experienced adverse events continued to rise during Q2 2009," says Lifang Chen, a Moody's Senior Associate and co-author of the report. "The cumulative number of loans on the respective servicer's watchlists, in default and/or in special servicing continued to increase at a fast pace during the quarter. Meanwhile, the performance of loans was negatively impacted by both the sustained pressure on property values and declining property cash flows as more tenants had difficulties in making rental payments, especially in the retail sector. In addition, the occupational markets showed further signs of weakening as rental values fell and vacancy levels increased in many markets."
Moody's expects the deterioration in EMEA CMBS loan performance to accelerate further over the coming months. "In Moody's view, the prevalent factor in performance deterioration will be the failure of borrowers to refinance loans with upcoming maturity amid the significant property value declines experienced and the current lack of available financing in most commercial real estate markets," says Deniz Yegenaga, a Moody's Associate Analyst and co-author of the report. "Even if commercial real estate lending and investment markets recover from their current state, most loans will be highly levered at maturity unless property values recover substantially, which Moody's does not expect to happen in the near- to medium-term."
In addition to increased refinancing risk, Moody's cautions that weaker occupational markets and adverse tenant performance will also result in more loans suffering payment defaults during their term, resulting in further increasing delinquency rates throughout EMEA CMBS transactions over the coming quarters.
"In light of the recent performance of EMEA commercial property markets and the near- to medium-term outlook for future property value developments, principal losses on EMEA CMBS loans are inevitable," says Ms. Yegenaga. In Moody's view, due to the expected enforcement timing, which is also driven by the strategy of special servicers, losses on EMEA CMBS transactions will occur in most cases towards the mid to end of the respective transaction term. However, Moody's expects that first losses will be allocated to certain transactions over the course of the next few quarters. "These losses will relate to defaulted loans for which the servicer and other relevant parties see limited scope for property management and will instead pursue an immediate sale of the mortgaged properties," adds Ms. Chen.
The report also provides an analysis of Moody's rating actions in the CMBS sector since October 2008. "The outlook for and the performance of the underlying commercial real estate markets deteriorated significantly in Q4 2008," says Christian Aufsatz, a Moody's Senior Vice President and co-author of the report. Moody's began taking rating actions on UK CMBS in October 2008 in anticipation of heightened refinancing risk for loans maturing in 2009.
"A total of 111 classes of notes in 43 EMEA CMBS transactions were placed on review for possible downgrade in April 2009 and significant rating actions started in May 2009," Mr. Aufsatz adds. So far, Moody's focus has been on UK CMBS and it envisages finalising its review of this segment during Q3 2009. In Q4 2009, the rating agency aims to complete its review of pan-European CMBS.
During Q2 2009, Moody's downgraded a total of 87 tranches in 27 transactions. The majority of the rating actions comprised multiple-notch downgrades, resulting from the adjustment of Moody's forward-looking EMEA CMBS central scenarios and to date mainly affecting UK CMBS transactions. Moody's notes that the trend of forward-looking and performance-related downgrades being more pronounced than rating actions linked to changes on the ratings of transaction counterparties continued throughout the quarter.
Moody's confirmed the ratings of 17 classes of notes in six transactions during Q2 2009. By the end of the quarter, 139 tranches in 53 transactions remained on review for possible downgrade, one tranche remained on review for possible upgrade and one tranche remained on review with direction uncertain. Global Arab Network