UK retail CMBS ratings are still under pressure
Two of the three Fitch-rated UK CMBS backed only by dominant shopping centres experienced further downgrades, and all remain on Negative Outlook following our latest rating actions.
The severe value corrections during the Covid-19 pandemic are captured in our downgrades since its onset, but the cost-of-living shock will maintain pressure on mall cash flows. We expect rental yields to fall but remain above long-term averages for at least 18 months, as changes will be driven by falling income more than improved investor sentiment.
Fitch judges the Trafford Centre Finance and Meadowhall Finance transactions, secured on malls in northern England, have lost over 40% of estimated rental value (ERV) since 2019, 2x the impact on London’s Westfield Stratford City Finance No. 2. This suggests a regional component to the stress, although the London mall is younger and located in a regenerating urban area.
Each faces higher non-recoverable operating costs than before the pandemic. This indicates difficulty passing on costs to tenants in the aftermath of company voluntary arrangements (CVAs), higher expenses from upgrading or operating Covid-19-secure stores, vacancy impact and the shift from longer-term triple net leases towards shorter-term or turnover-based arrangements. Landlord costs are likely to remain higher even as vacancy falls.
Meadowhall’s borrower avoided loan default during the pandemic by initiating a short-term restructuring, including covering some costs. Drawn liquidity has been repaid, and the loan is performing again. Trafford avoided loan default thanks to financial support from its new sponsor (suggesting noteholders benefitted from Intu’s replacement).
Further sponsor support is not guaranteed, but transaction reporting suggests collections have improved and that – barring major trading disruption – both transactions should pay 2022 and 2023 debt service with no or little liquidity support. With far lower leverage and financed interest-only (at 1.64%), Westfield paid interest without liquidity support.
Recent lease terms across the three centres vary, with many signed above quoted ERV, offsetting others let on steep discounts – as low as zero rent – albeit typically on short terms. Turnover-only income shows tenants’ considerable bargaining power. The risk of CVAs can lead to legacy leases being restructured more favourably even for successful brands. Lack of lease comparability increasingly obscures ERV, indicating revenue weakness across the sector.
Giving up over 55% of 2018 value, as for Meadowhall and Trafford, would challenge any refinancing effort. Trafford faces two bullets (totalling GBP90 million) in April 2024 that without a major performance turnaround will test its sponsor’s commitment. Meadowhall faces no bullets until maturity. One positive from higher inflation is that rising interest rates have reduced swap breakage costs.
Were Trafford or Meadowhall loans to default, class A noteholders would wield substantial control over mortgage enforcement. Both transactions are complex, long-dated and partially amortising, with differing liquidity support for various scheduled note repayments. Cash flow and liquidity permitting, class A noteholders might favour a protracted workout, locking in effective funding costs for longer and decaying swap breakage costs. However, this increases the risk of more liquidity (that must be repaid before class A) being drawn for junior interest or principal.
Meadowhall’s class A notes can withstand harsher rating stresses than Trafford’s. The latter’s higher leverage and larger junior debt-service burden mean projected cash flows would not cover a meaningful delay to liquidation before liquidity runs out. Meadowhall’s non-senior bonds can draw on liquidity only to cover interest, boosting a receiver’s flexibility to accrue recovery benefits from a longer workout.
Westfield has lost about 40% of value since 2019, but as the least levered or complex – its GBP750 million loan backs a single 42.6% loan/value tranche – is well positioned to refinance in 2026. Westfield’s intact ‘AAAsf’ rating demonstrates the resilience of simple, low-leverage debt structures.
