- Our recent review of U.S. CMBS ratings resulted in 185 downgrades, comprising 88 SASB and large loan classes and 97 conduit classes.
- Meanwhile, our surveillance of European CMBS since the COVID-19 outbreak has resulted in rating actions on approximately 20% of the transactions we rate.
- Retail and lodging are the sectors hardest hit by the pandemic, and it remains uncertain how pandemic-related changes may affect the office and multifamily sectors.
S&P Global Ratings recently concluded its review of the U.S. commercial mortgage-backed securities (CMBS) ratings it had placed on CreditWatch with negative implications in May and June due to the COVID-19 pandemic's impact on the global economy and the underlying commercial real estate collateral backing the transactions. The review resulted in 185 downgrades across single-asset/single-borrower (SASB), large loan, and conduit transactions. Generally speaking, the rating actions were most severe in the SASB subsector backed by retail malls, which is experiencing considerable stress on several fronts. Lodging-backed SASB and large loan rating actions were mostly confined to the speculative-grade ('BB+' and below) rating categories, with only a few exceptions reaching the 'BBB' rating category. The conduit transactions that saw rating actions within higher rating categories generally had significant exposure to larger-sized, distressed retail, or lodging assets.
Since April, we have taken rating actions on approximately 20% of the European CMBS transactions we rate. We lowered 37 ratings on 10 transactions and placed three ratings on CreditWatch negative; we subsequently removed two of those ratings from CreditWatch. The downgrades primarily affected transactions backed by retail and hotel properties (nine deals), as well as one office-backed transaction with significant exposure to coworking office leasing company WeWork. The three CreditWatch placements affected two hotel transactions and were largely due to the unprecedented decline in cash flow from the underlying hotels and because the relevant classes did not benefit from any liquidity support. This meant an interest shortfall would immediately occur if the borrower failed to pay. We subsequently lowered these three ratings and removed two from CreditWatch. Still, despite the pressures on property-level cash flows, none of the European CMBS transactions we rate has had any interest shortfalls due to the pandemic, and only one issuer (Meadowhall Finance PLC) required a drawing on its liquidity facility. Some issuers were able to avoid drawings and/or interest shortfalls because some borrowers chose to make up shortfalls in cash at the property level by contributing more of their own equity. One transaction would have likely seen a missed interest payment if it had not been restructured with noteholder consent.
We will continue to monitor the performance of our rated CMBS transactions as more information regarding their performance becomes available. We may place additional classes on CreditWatch negative or take other rating actions as we deem appropriate.
About 9% Of U.S. CMBS Classes Were On CreditWatch Negative
We placed 219 ratings on U.S. CMBS transactions on CreditWatch negative in May and June. For perspective, this represents approximately 9% of the 2,574 U.S. CMBS classes we rate. The breakdown of the CreditWatch placements are as follows:
- On May 6, we placed our ratings on 123 classes from 22 U.S. SASB and large loan transactions on CreditWatch negative (for perspective, we rate 187 SASB and large loan deals). This included 67 classes from eight retail-backed deals and 56 classes from 14 lodging-backed transactions (see "Ratings On 123 Classes From 22 U.S. CMBS SASB And Large Loan Transactions Placed On CreditWatch Negative," published May 6, 2020).
- On June 3, 2020, we placed our ratings on 96 classes from 30 CMBS conduit transactions on CreditWatch negative (for perspective, we rate 180 private label conduits) (see "Ratings On 96 Classes From 30 U.S. CMBS Conduit Transactions Placed On CreditWatch Negative," published June 3, 2020).
The CreditWatch placements generally reflect our view of the pandemic's impact on the performance of the collateral properties and the retail and lodging sectors overall. They also reflect the uncertainty regarding the duration of the demand interruption due to a rapid decline in lodging and retail demand, and property closures. Overall, we considered many factors, include the following:
- Property level performance trends,
- Missed debt service payments,
- Servicer advancing,
- Special servicing transfers,
- Special servicing fees,
- Potential workouts,
- Transaction-specific performance,
- Structural characteristics and their potential effects on certain classes, and
- Loan maturity dates, since the ability to refinance may be constrained in the current environment.
CreditWatch Resolutions And Downgrades
We continuously monitor the U.S. and European CMBS transactions we rate for signs of distress from factors including the COVID-19 pandemic and have taken rating actions accordingly. In the section below, we summarize the resolution of the U.S. CMBS ratings we had placed on CreditWatch negative, some notable rating actions, and the results of our surveillance of European CMBS.
U.S. SASBs and large loans
We lowered our ratings on 88 SASB and large loan classes, including 56 of our 67 ratings on eight retail-backed U.S. SASB transactions (10 of these classes were originally rated 'AAA') (see chart 1). The downgrades also include 32 classes from lodging-backed transactions--four of which were investment-grade (rated 'BBB' or 'BBB-'). Overall, the investment-grade ratings were lowered 3.7 notches on average, while the speculative-grade ratings were lowered about 2.5 notches on average.
We lowered our ratings on 97 conduit classes. Of the 96 U.S. conduit classes we had placed on CreditWatch negative in June, we lowered our ratings on 73, including 12 investment-grade classes (though none were rated 'AAA') and 61 speculative-grade classes (see chart 2). On average, we lowered the investment-grade classes 3.8 notches and the speculative-grade classes slightly under 2.0 notches. During the resolution process, we also lowered our ratings on 24 investment-grade classes that were not on CreditWatch: 14 rated 'A', eight rated 'BBB', and two rated 'AA'. These classes and transactions had incurred additional property-level collateral deterioration between June 3, when the original 96 classes were placed on CreditWatch negative, and late August, when the downgrades occurred (see chart 2).
Conduits with relatively greater concentration risk (i.e., when outsized loans comprise a relatively greater proportion of the pool) generally saw some of the more severe rating actions. For more information on our deal-specific rating actions (see "Various Rating Actions Taken On COMM 2012-CCRE4 Mortgage Trust," published Aug. 24, 2020, "Various Rating Actions Taken On J.P. Morgan Chase Commercial Mortgage Securities Trust 2013-LC11," published Aug. 24, 2020, and "Various Rating Actions Taken On Morgan Stanley Capital I Trust 2011-C1," published Aug. 27, 2020). Note that in recent vintages, we have rated fewer classes in the low investment- and speculative-grade rating categories (see "U.S. CMBS Conduit Update Q2 2019: 'BBB-' Levels Remain Too Low," published July 10, 2019, and "U.S. CMBS Conduit Update Q2 2020: COVID-19 Impact Still Emerging; Questions Remain," published July 16, 2020).
In Europe, we have taken rating actions on approximately 20% of the CMBS transactions we rate, which include 37 downgrades, 20 affirmations, and one upgrade (see table below). By rating category, we lowered 24 ratings that remained investment grade and lowered four ratings to speculative grade. By property type, the downgrades include 24 ratings backed by retail malls, five ratings partially secured by retail assets, and two ratings backed by an office property in Central London where WeWork is the largest tenant.
The rating actions also include one retail transaction, Intu (SGS) Finance PLC, where we lowered our ratings on three classes to 'D (sf)' from 'BB+ (sf)' after the transaction parties decided to restructure the rateable promise. The noteholders had approved a restructuring proposal in which the interest for the September interest payment date (IPD) was a payment-in-kind (i.e., it did not become due and payable but was instead added to the principal balance). According to the issuer and its advisors, the restructuring was designed to create a more stable platform for the properties to operate under and included the following terms: no interest would be paid on the September IPD, the existing liquidity reserve would not be used for interest payments, a new liquidity facility will be put in place to cover any potential future shortfalls, and the borrower must now produce more frequent reporting on the underlying assets. We subsequently raised the ratings to 'B- (sf)' from 'D (sf)' because the issuer had obtained new valuations of the properties, which led to a loan-to-value (LTV) ratio of about 100% (see "Intu (SGS) Finance CMBS Notes Ratings Lowered Then Raised Following Change In Rateable Promise," published Sept. 11, 2020).
|European CMBS Rating Actions In 2020(i)|
|(i)As of Sept. 23. N/A--Not applicable.|
Retail Is Facing Historical Stress Levels On Both Sides Of The Atlantic
Before the government-mandated COVID-19 lockdowns, retail mall operating performance had already been declining in both the U.S. and Europe (see "Shop With Caution – CMBS Mall Loans Worth Watching," published Jan. 8, 2020, and "Various Rating Actions Taken On 24 U.S. CMBS Transactions Due To Exposure To Underperforming Retail Loans," published March 20, 2020). Retail malls have being facing significant challenges and deteriorating revenues for the past several years due to factors including the proliferation of retailer bankruptcies and store closures as consumer shopping preferences shifted to e-commerce from brick-and-mortar stores. For instance, pre-pandemic 2019 performance data for the retail properties collateralizing the eight U.S. CMBS retail mall-backed SASB transactions (which were all placed on CreditWatch negative) and the six U.K. retail-backed transactions we rate showed steeper-than-expected performance declines.
We expect retail mall performance deterioration to continue and/or accelerate in the U.S. and across Europe over the next year. The pandemic has resulted in accelerated bankruptcy filings from struggling retailers (J.C. Penney, Neiman Marcus, J.Crew, Brooks Brothers, etc. in the U.S.; and Debenhams, Laura Ashley, Monsoon, etc. in Europe) and/or store closures. And although retail malls have now generally reopened in the U.S. and across Europe, we expect their performance to rebound slowly, given the additional shopping restrictions, uncertainty regarding consumers' willingness to shop in person, and, in the U.S., the increase in COVID-19 cases reported in several states during recent weeks.
Furthermore, billed rent collection rates have declined sharply since the COVID-19 outbreak, while e-commerce has captured a greater market share in the wake of COVID-19 containment measures. Retail rent collection rates have declined to the low-teens to mid-20% range in the U.S. and the high-20% area in Europe because many tenants have not paid rent in recent months. In the U.S., e-commerce share of total sales increased 16% to $211.5 billion in the second quarter from 11% a year earlier, representing a 31.8% quarter-over-quarter and 44.5% year-over-year increase, according the U.S. Census Bureau's Quarterly Retail E-Commerce Sales report for second-quarter 2020. In Europe, e-commerce has a similar share of retail sales: its market share rose sharply to about 16% in second-quarter 2020 from 12% year earlier. In the U.K. and Germany, e-commerce has an even larger market share at 26% and 20%, respectively, whereas Spain and Italy each record less than 10% of retail sales online.
Our rating actions U.S. and European retail mall-backed CMBS transactions reflect our reevaluation of the retail properties securing the respective loans. In our current analysis for the aforementioned eight retail-backed U.S. SASB transactions, we lowered our expected case values to between negative 11% and negative 34%. This resulted in lower estimated recoveries on the retail malls than what we had derived in our last review or at issuance. Generally, we adjusted our sustainable net cash flow (NCF) down by 8%-16%, versus the NCF in the last review or at issuance, to account for increased tenant bankruptcies and store closures, as well as low-billed rent collections due to the pandemic. We also increased the capitalization rates by up to 200 basis points (bps) to better reflect the challenges retail malls and the overall retail sector are facing, and their increased susceptibility to NCF and liquidity disruptions from weakening retail trends, the COVID-19 pandemic, weak anchor and major tenants, and weak and declining in-line sales.
We undertook a similar analysis for the European CMBS we reviewed and widened our assumptions for vacancy and expenses in the respective retail properties. We also raised our cap rates within our published ranges, leading to revised S&P Global Ratings values, which are now 6%-26% below their equivalent 2019 levels. We will continue to evaluate the performance of retail-backed CMBS transactions we rate, including the impact of the pandemic-related conditions, and take rating actions as we deem appropriate.
Lodging Is Facing Challenges Too
The lodging sector is one of those hardest hit by the pandemic. Government travel restrictions and state-mandated closures have resulted in significant declines in corporate, leisure, and group lodging demands. There has also been a dramatic decline in airline passenger miles for both international and domestic travel.
In an effort to curtail the spread of the virus, most group meetings and travel have either being cancelled (corporate and SMERF [social, military, education, religious, and fraternal]), restricted (corporate transient travel), or slowed (leisure travel) due to fear of travel, the closure of demand generators such as amusement parks and casinos, and the cancellation of concerts and sporting events. In response, many hotels that were not mandated to close, closed voluntarily because the revenue generated would not be sufficient to cover operating expenses or fixed costs. These actions resulted in U.S. revenue per available room (RevPAR) declining 80%, 71%, 61%, 52%, and 47% in April, May, June, July, and August, respectively, reflecting historic U.S. lodging industry performance declines. In addition, many U.S. lodging properties had minimal or negative NCF during this four-month period.
We expect a choppy recovery in the U.S. lodging sector, depending on both hotel type and location. Luxury and upper upscale hotels in dense urban/infill locations and those dependent on corporate, group, and international demand are the most negatively affected. These hotels will take the longest to recover because corporate and group meeting needs and travel protocols may evolve significantly going forward, and international demands will likely take some time to return to previous levels. On the other hand, economy and midscale hotels, particularly in smaller towns, highway locations, and suburban markets have fared better and have largely remained open. Extended stay hotels within these lower chain scales have also demonstrated stable performance. We expect most hotels to break even or attain some profitability at an occupancy level of about 40%. As of August, the U.S. average hotel occupancy rate was approximately 50%, but it remained below 40% on average for luxury and upper upscale hotels and those in urban markets.
Many European hotels managed to generate some business during lockdowns by, for example, agreeing to provide temporary housing for repatriated citizens or agreeing contracts with local governments and charitable organizations and making rooms available for medical staff or as a quarantine center. On the expense side, most operators made use of local government-sponsored short-time work schemes, such as in the U.K., where the government also provided relief from business rates. Otherwise, hotel operators generally would not have reopened their hotels unless they expected an at least 30% occupancy rate. Toward the end of the summer school break, European domestic holiday-makers generated some additional hotel demand, given that international travel was still restricted. This increase in demand predominantly benefited smaller drive-to, limited-service hotels, as opposed to the larger convention hotels or city-center lodging offerings.
Adjustments to our analytical assumptions
In our analysis for lodging-backed CMBS transactions in the U.S. and Europe, instead of adjusting our sustainable NCF assumption (since NCF was significantly strained or negative in many cases), we typically increased our capitalization rate between 50 bps-125 bps from issuance, reflecting our view that travel, particularly to urban areas and hotels that rely on corporate, group, and international demand will remain tempered for several quarters. Many industry participants do not expect overall RevPAR levels to return to 2019 levels until at least 2023. However, lower tier chain scale properties and hotels in less densely populated locations will likely recover sooner.
Nevertheless, S&P Global Ratings' RevPAR and NCF assumptions from issuance are significantly below 2019 NCF levels for most loans, as we generally underwrite to levels that were achieved two to three years prior to (and lower than) the levels at issuance. Also, since many of these deals are from 2016 and 2017, S&P Global Ratings' NCFs are at 2013-2014 levels.
Due to our lower NCFs and higher stressed capitalization rates, the S&P Global Ratings values are significantly below market levels and are able to withstand large declines in performance before rated classes are affected. Further, most U.S. CMBS SASB transactions have an eight-year tail period beyond the loan's extended maturity date, while most European CMBS transactions have at least a five-year tail period. This provides servicers with flexibility and adequate time to orderly liquidate the asset to maximize recovery. We also note that many transactions have unrated first loss classes/HRR (subordinate) classes to help absorb losses. These factors partially explain why our rating actions on U.S. and European SASB transactions were not as severe as their retail mall counterparts.
The Future Of Office
There is much debate about the future of office markets globally, especially in central business districts (CBDs), and whether there will be a population shift away from large cities that ricochet into multifamily properties, and so on. We believe the future of office remains uncertain and will gradually unfold over time at a relatively slower speed of change than those of retail malls and lodging. For now, our focus remains on sectors where forbearance agreements and delinquencies/distress are centered.
In the U.S., retail and lodging account for over 80% of delinquent CMBS loans and loans that are in (or have requested) forbearance agreements as of August. These loans represent about 8% of total U.S. CMBS securitizations (for more information on these delinquencies and forbearance, see "SF Credit Brief: U.S. CMBS Delinquency And Forbearance Rates Decline To 8.29% And 8.54%, Respectively," published Sept. 11, 2020). In Europe, we believe office-backed CMBS tranches in the 'AAA' and 'AA' rating categories can withstand increasing vacancy rates with little risk of downgrade, while lower-rated tranches are more vulnerable in higher vacancy stress scenarios (see "Vacancy Up, Ratings Down? European Office CMBS Transactions After COVID-19," published June 29, 2020). However, it remains uncertain how new behavioral patterns, social distancing measures, lower desk densities, and post-pandemic and pandemic-related corporate cost reductions will affect occupational demand and corporate real estate strategy. These changes could lead to higher longer-term vacancy levels in both the U.S. and European office markets.
S&P Global Ratings acknowledges a high degree of uncertainty about the evolution of the coronavirus pandemic. The current consensus among health experts is that COVID-19 will remain a threat until a vaccine or effective treatment becomes widely available, which could be around mid-2021. We are using this assumption in assessing the economic and credit implications associated with the pandemic (see our research here: http://www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.
- Intu (SGS) Finance CMBS Notes Ratings Lowered Then Raised Following Change In Rateable Promise, Sept. 11, 2020
- SF Credit Brief: U.S. CMBS Delinquency And Forbearance Rates Decline To 8.29% And 8.54%, Respectively, Sept. 11, 2020
- Various Rating Actions Taken On Morgan Stanley Capital I Trust 2011-C1, Aug. 27, 2020
- Various Rating Actions Taken On COMM 2012-CCRE4 Mortgage Trust, Aug. 24, 2020
- Various Rating Actions Taken On J.P. Morgan Chase Commercial Mortgage Securities Trust 2013-LC11, Aug. 24, 2020
- U.S. CMBS Conduit Update Q2 2020: COVID-19 Impact Still Emerging; Questions Remain, July 16, 2020
- Vacancy Up, Ratings Down? European Office CMBS Transactions After COVID-19, June 29, 2020
- U.S. CMBS Conduit Update Q2 2019: 'BBB-' Levels Remain Too Low, July 10, 2019
- Ratings On 96 Classes From 30 U.S. CMBS Conduit Transactions Placed On CreditWatch Negative, June 3, 2020
- Ratings On 123 Classes From 22 U.S. CMBS SASB And Large Loan Transactions Placed On CreditWatch Negative, May 6, 2020
- Various Rating Actions Taken On 24 U.S. CMBS Transactions Due To Exposure To Underperforming Retail Loans, March 20, 2020
- Shop With Caution – CMBS Mall Loans Worth Watching, Jan. 8, 2020
This report does not constitute a rating action.
|Analytical Contacts:||James M Manzi, CFA, Washington D.C. (1) 202-383-2028;|
|Dennis Q Sim, New York (1) 212-438-3574;|
|Natalka H Chevance, New York (1) 212-438-1236;|
|Mathias Herzog, Frankfurt (49) 69-33-999-112;|
|Gregory Ramkhelawan, CFA, New York (1) 212-438-3041;|
|Della Cheung, New York (1) 212-438-3691;|
|Edward C Twort, London (44) 20-7176-3992;|
No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.
Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.
To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw or suspend such acknowledgment at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.
S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process.
S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.
Any Passwords/user IDs issued by S&P to users are single user-dedicated and may ONLY be used by the individual to whom they have been assigned. No sharing of passwords/user IDs and no simultaneous access via the same password/user ID is permitted. To reprint, translate, or use the data or information other than as provided herein, contact S&P Global Ratings, Client Services, 55 Water Street, New York, NY 10041; (1) 212-438-7280 or by e-mail to: firstname.lastname@example.org.