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Meddle East - Unfavourable tenant market having a negative impact on CMBS

Global Arab Network - - Maha Karim

Monday, 02 November 2009 17:34

Weaker occupational markets and adverse tenant performance across EMEA property markets are having an increasingly negative impact on commercial mortgage-backed securities (CMBS) and multi-family transactions in Europe, the Middle East and Africa (EMEA), says Moody's Investors Service in its latest Surveillance Report for the sector. Market participants have started to become more optimistic as Q3 2009 showed the first signs that property values in some markets have reached the bottom and values are now slightly increasing. "We however remain sceptical of this recovery and anticipate further value declines until 2010 in all EMEA CMBS markets" says Christian Aufsatz, a Moody's Senior Vice President and co-author of the report.

"The overall performance deterioration that started during 2008 and accelerated during H1 2009 as property values continued falling and occupational markets weakened further, continued unabated into Q3 2009" says Viola Karoly, a Moody's Analyst and co-author of the report. As a consequence of declining occupancy levels, increasing rental arrears and the additional costs that result from these problems, a growing number of loans are either already experiencing cash flow problems or anticipating them in the near future. In turn, this has led to in an increasing number of loans that have defaulted as a result of breaching their interest or debt service cover ratio (ICR and DSCR) covenant requirements. "Payment defaults during loan term have also become significantly more prevalent" says Ms Karoly. The rate at which defaulted loans were transferred into special servicing also increased as fewer events of default are expected to be cured with many sponsors unable or unwilling to support their loan.

In the report, Moody's comments on various performance-related and transaction counterparty-linked events in Q3 2009 that impacted the transactions it monitors. "The adverse performance and the expectation of further deterioration of the performance of commercial real estate loans translated into a high level of rating actions during Q3 2009 within EMEA CMBS" says Lifang Chen, a Moody's Associate Analyst and co-author of the report. The majority of the downgrades were multiple notches like during Q2 2009.

Over the coming quarters, Moody's expects payment defaults to continue increasing, driven by both insufficient property cash flows to make debt service payments as well as the inability of borrowers to refinance their loans amid the significant property value declines experienced and the substantial decrease in available financing in most commercial real estate markets. 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. "Payment defaults at loan maturity will become increasingly prevalent over the next few years as the majority of securitised loans mature between 2010 and 2013", adds Ms Chen. Until end-Q3 2009, a loss on EMEA CMBS collateral portfolios had only occurred in one transaction (HoteLoC plc in 2007).

The second loss in EMEA CMBS is expected to be realised in 2010, for a UK single-borrower transaction where after the loan defaulted and was transferred into special servicing in 2008 (due to a loan-to-value (LTV) covenant breach), the appointed receivers decided on a quick sale of the property portfolio in today's depressed property market.

"We believe that with the already realised property value declines and the expectation that commercial property values will not materially recover over the next five years, ultimate losses on more EMEA CMBS collateral portfolios are inevitable" says Mr Aufsatz. "Generally, our expectation is that in many cases special servicers will not pursue immediate sale of the properties securing defaulted loans but rather continue to collect the rental cash flows where possible and dispose of the properties under more favourable conditions, which may reduce ultimate losses" adds Ms Karoly.

The report also provides an analysis of Moody's rating actions in the CMBS sector since October 2008. Between October 2008 and September 2009, Moody's took performance and performance expectation related rating actions on 242 classes of notes in 73 transactions (approximately 37% of all EMEA CMBS transactions monitored by Moody's). The majority of rating actions until mid-Q3 2009 occurred in relation to UK CMBS (54transactions affected), but since then the focus has shifted to Pan-European CMBS (until end-Q3 2009, 17 transactions). As of end-Q3 2009, four UK CMBS transactions remained on review for possible downgrade due to performance reasons. "Moody's envisages finalising the rating review on these transactions during the first weeks of Q4 2009 and finalising its review of pan-European CMBS transactions during Q4 2009" says Mr Aufsatz. "However, after completing these reviews, further review actions and rating actions cannot be ruled out", he adds.

During Q3 2009, Moody's downgraded a total of 84 classes of notes in 37 transactions. The majority of the rating actions comprised multiple-notch downgrades, resulting from the adjustment of Moody's forward-looking EMEA CMBS central scenarios. Two classes of notes in two transactions were upgraded during Q3 2009 with both upgrades resulting from counterparty rating linkage. In Q3 2009, Moody's also confirmed the ratings of 23 classes of notes in nine transactions which were previously on review for possible downgrade. As of end-Q3 2009, a total of 67 classes of notes remained on review: 66 classes of notes in 31 transactions remained on review for possible downgrade and one class remained on review with direction uncertain.

The report -- entitled "EMEA CMBS Q3 2009: Surveillance Review" -- is a quarterly publication which reports the findings of Moody's ongoing monitoring of rated CMBS and multi-family transactions in EMEA. Moody's EMEA CMBS monitoring team currently monitors 196 transactions.

Global Arab Network

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