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European CMBS: Assessing The Credit Effects Of COVID-19


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European CMBS: Assessing The Credit Effects Of COVID-19

The global outbreak of the new coronavirus that causes COVID-19 has already had a significant impact on businesses and financial markets. S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak between June and August, and we are using this assumption in assessing the economic and credit implications of the pandemic. We believe measures to contain COVID-19 have pushed the global economy into recession (see "COVID-19 Macroeconomic Update: The Global Recession Is Here And Now" and "COVID-19 Credit Update: The Sudden Economic Stop Will Bring Intense Credit Pressure," published on March 17), which could also negatively affect employment levels, housing, and commercial real estate markets. As the situation evolves, we will update our assumptions and estimates accordingly.

These developments have potential implications for European commercial mortgage-backed securities (CMBS) transactions. However, we believe that some underlying commercial real estate sectors have more exposure to the associated risks than others do. So, how will these sectors be affected, and what are the mitigating factors?

Sector Impact Will Vary, May Not Lead To Wide-Scale Downgrades


Coronavirus-related disruption including layoffs and growing restrictions on person-to-person contact across Europe will likely lead to a reduction in consumer discretionary spending. This could significantly affect some retailers, many of which were already operating with razor-thin margins.

Governments across Europe have been offering support to retailers in the midst of the current crisis. Examples include tax relief or guarantees on short-term financing. On the other hand, many retailers have asked for a rent holiday while they close stores to abide by the restrictions on person-to-person contact. Assuming rent holidays are not granted, long-term leases (with a fixed component) will mitigate to some degree the risk posed by a short-term decline in retail tenants' sales. That said, even before the coronavirus outbreak, retailers had been asking for temporary rent cuts due to slowing sales. This is on top of a rise in insolvencies and company voluntary agreements over the past three years, which have resulted in store closures across Europe.

We have already incorporated the weakening trend for retail properties backing CMBS we rate. Nevertheless, we may consider adjusting our assumptions for vacancy rates and rental levels if we believe that they will not recover to our previously assumed levels over the long term. Data is not currently available to support such an adjustment, however, given the short time period since the coronavirus outbreak began.


We expect that the hotel sector will be one of the most affected by COVID-19, given that much of the tourism and business travel industry has ground to a sudden halt for an undetermined period of time.

Most of the hotel assets in the CMBS transactions that we monitor do not benefit from fixed leases, and as such, investors are more directly exposed to their underlying operational performance. In other words, if any given hotel is generating zero income, then no income will be passed through to the relevant CMBS vehicle, unless the borrower sponsor chooses to make up for the shortfall with their own funds. The sponsor might do this to prevent the loan from defaulting if it believes the cash flow constraints will last only for the short term, though the loans are typically non-recourse, so there is no obligation to do so.

At this stage, we believe it is too early to predict the long-term impact on the hotel market and tourism industry, as well as the individual hotel performance within CMBS portfolios. We would likely only take a rating action on a CMBS transaction if we were to believe that the operating cash flow of a given hotel portfolio will drop over the long term. Should any transaction face periods with zero or negligible income, we will consider whether it is suitably protected from an interest shortfall. If we believe that the risk of a temporary shortfall is not mitigated over the short term, we may downgrade some CMBS tranches.

Some hotels may temporarily repurpose themselves as hospitals or other treatment facilities, in an effort to relieve the growing pressure on health care systems. Such actions could help stem these properties' loss of income, presuming that the government would pay some form of rent. The Holiday Inn Heathrow Ariel hotel, which is part of the Ribbon Finance 2018 PLC portfolio, is one example of this, having recently converted into a quarantine center on a temporary basis.


Although offices across Europe are emptying as more and more of the population begins to work remotely, the credit impact for CMBS is not likely to be material, in our view. Tenants are, in most cases, still tied to paying rent regularly and on a long-term basis. Whether the economic stress will last long enough to cause tenants to default and vacate their offices en masse remains to be seen. So far, we do not have enough evidence to suggest this will happen.

We could see more imminent disruption in the co-working space, where serviced office providers are likely to have their business models put to the test. Such entities have mismatches between their short-term assets (subleases) and long-term liabilities (headleases), much like hotels. Companies that use co-working space to cope with the overspill from their own offices may not renew these contracts during the coronavirus outbreak, given that most or all of their employees will be working from home anyway. Such a scenario may present a liquidity stress for these properties, although most CMBS transactions include structural features to mitigate this risk. So far, it is difficult to say whether there will be a long-term impact on the co-working sub-sector, though we have no reason to believe that properties with this exposure couldn't return to previous occupancy levels.

We will closely monitor the performance metrics of office properties exposed to tenants linked to highly sensitive sectors, such as aviation, hospitality, and leisure, among others. Although we do not expect significant changes in the CMBS transactions we monitor, there may be isolated cases in which we need to review assumptions relating to operating performance, in particular, vacancy levels.

Industrial and logistics

Similar to the office market, the industrial and logistics real estate markets will be structurally protected from a short-term period of economic stress given that tenants in these properties have typically signed onto longer-term leases. That said, these tenants will face some struggles as transport restrictions and supply chain issues take form. Our view is that properties used for manufacturing activities are likely to experience greater operational strain than properties used for distribution and logistics. For example, production in China has fallen by over 12% year on year during the first two months of 2020, which will be a burden for tenants that rely on Chinese companies in the intermediary stages of their manufacturing process.

However, even if some existing tenants were to go bankrupt, most of the CMBS exposure comprises portfolios that generally have a greater proportion of logistics and distribution properties rather than manufacturing. The logistics subsector has experienced robust demand for space from a variety of prospective occupiers in different industries. This should prevent vacancies from spiking dramatically. Furthermore, we anticipate stable demand in online shopping. In fact, while face-to-face retail will be limited across Europe, demand for e-commerce could increase as it attracts new users. Therefore, we believe that the logistics real estate sector is in a reasonable position to weather the current storm.

Student housing

For student housing, the risk relates to timing. In the U.K., where all of the existing CMBS exposure is, the majority of universities have either canceled their courses and exams or moved them online, which has resulted in some students moving home. Even so, U.K. students are still locked into paying rent on their residences for the rest of the current academic year (unlike in the U.S., where many have closed, and refunds are being provided for the rest of the term). While it looks as though additional income from summer lettings (outside of the academic term) may be lost, this only represents a small proportion of the total income.

The key question is whether the coronavirus will affect the lease-up for the next academic year, beginning in the third quarter. Unite, one of the major student housing providers in the U.K., already claims to have pre-let 77% of its space for the next academic year, the same percentage it had at this stage last year. At the same time, there have been news reports that overseas students (23% of U.K. students in 2018) are canceling or postponing their enrollments or admissions for U.K. universities because of uncertainty related to the shutdown of secondary schools and cancellation of this summer's examinations.

Given the limited data at present, it is still too early to predict whether this will change our long-term view on occupancy or rental levels for the sector. In the short term, as with other sectors, liquidity stress will be largely mitigated by the structural features in the transactions along with the strength of the sponsor.

CMBS Are Generally Well-Equipped To Deal With Liquidity Stress

Notwithstanding any long-term impact that the coronavirus outbreak may have, many European CMBS transactions have certain structural features that mitigate the risk of temporary interest shortfalls.

For example, most investment-grade (and some speculative-grade) rated notes benefit from some form of liquidity support. Given the current low interest rate environment, there is generally plenty of coverage available for those tranches to pay their interest over an extended period of reduced--or, in the cases of operational assets such as hotels--zero income. Typically, liquidity support equals 4%-5% of the note balance, and the cost of debt often varies between 1.5% and 2.5%. Therefore, we could reasonably estimate that the available commitment could cover at least a one- to two-year period with no income, on average (assuming also a continued low interest rate environment).

Classes not covered by a liquidity facility typically can defer interest unless it is or becomes the most-senior class of notes. Under our criteria, we may not immediately lower our ratings on classes that have experienced interest shortfalls. We would use both qualitative and quantitative considerations to assess whether these interest shortfalls were temporary or permanent and in line with the maximum amount of time until full interest repayment for that rating assigned.

As mentioned previously, most of the properties that back CMBS transactions have tenants tied to long-term leases. This means most will remain on the hook to continue paying rent over the stressed period regardless of whether their workforce stays at home. Moreover, as we explained in the section on hotels, the underlying sponsors may pay out of pocket to cover any lost amounts to the transaction.

Only Long-Term Effects Will Change Our Property Value Assumptions

Cash flow implications

If we believe the sustainable levels of cash flow for a given property or portfolio could change over a long-term period, we may revise our opinion of the collateral's cash flow generating capability. For example, vacancies may rise as tenants go bust, and this could coincide with declining market rents. All else being equal, a decline in our opinion of property cash flow will lower our recovery value estimate at all rating levels, which may subsequently lead to lower ratings. However, our analysis accounts for a long-term property value. For many transactions, the economic stress induced by the coronavirus may simply represent a temporary dip in operating performance, in which case we would not expect to take a negative rating action.

Yield implications

Central banks have been cutting policy rates as part of wider stimulus packages to steady the European economy. All else being equal, this could mean that property market yields will remain at historical lows. This may not necessarily be the case, as the previous financial crisis showed that interest rates and yields can move in opposite directions. However, given that current recessionary pressures are due to the sudden and severe effects of the global pandemic rather than a structural issue in the real estate or CMBS market, yields may remain where they are. In any case, because we apply long-term averages, we already incorporate the effect of widening yields in our ratings for most transactions. The gap between property market yields before the coronavirus outbreak and their long-term averages, based on our observations, has usually been about 100 to 250 basis points (bps), except for retail where the gap is closer to 50-150 bps. Should yields move beyond their long-term averages, we may lower our recovery values, and subsequently, our ratings.

Related Research

  • European ABS And RMBS: Assessing The Credit Effects Of COVID-19, March 30, 2020
  • Coronavirus Impact: Key Takeaways From Our Articles, March 27, 2020
  • COVID-19: The Steepening Cost To The Eurozone And U.K. Economies, March 26, 2020
  • European Corporate Securitizations: Assessing The Credit Effects Of COVID-19, March 26, 2020
  • European CLOs: Assessing The Credit Effects Of COVID-19, March 25, 2020
  • Global Covered Bonds: Assessing The Credit Effects Of COVID-19, March 25, 2020
  • COVID-19 Macroeconomic Update: The Global Recession Is Here And Now, March 17, 2020
  • COVID-19 Credit Update: The Sudden Economic Stop Will Bring Intense Credit Pressure, March 17, 2020
  • Credit FAQ: Will Mortgage Payment Suspensions Related To COVID-19 Affect European RMBS?, March 13, 2020

This report does not constitute a rating action.

Primary Credit Analyst:Oliver Thomas, London + 44 20 7176 8589;
Secondary Contacts:Mathias Herzog, Frankfurt (49) 69-33-999-112;
Edward C Twort, London (44) 20-7176-3992;
Carenn K Chu, London (44) 20-7176-3854;
Amisha Unnadkat, London + 44 20 7176 3826;

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