Expected cash flows too low to meet higher requirements from lenders
Almost 20% of the loans in European CMBS maturing this year and 2024 face very high refinancing risk as their expected cash flows are too low to meet higher expected requirements from lenders, according to Berlin-based ratings agency Scope. Another 14% of loans are facing high risk if swap rates rise by another 100 basis points.
Of European CMBS outstanding, 20 are maturing this year and a further 18 in 2024. Of this year's crop, 7% of those denominated in euros have a high refinancing risk, with debt yields less than Scope's estimated refinancing rate (defined as the relevant five-year swap rate plus the actual loan margins, with a 50 bps top-up to reflect ongoing debt repricing).
33% of CMBS loans maturing this year and 2024 facing 'high' or 'very high' refinancing risk represents €500m of euro-denominated notes and €1.2bn that are sterling-denominated. The sterling notes are at higher rise because of the faster rate rises in the UK, a problem likely to get worse in 2024. As many as one-third of sterling-denominated loans maturing this year fall into the 'very high risk' category, says Scope.
Today's difficulties have their roots in the last ten years of super-low interest rates and easy financing conditions, says Scope. The risks now facing CRE borrowers are threefold; tightening credit standards, rising debt costs and pressure on property values. Given time lags in revaluation and so-called anchor-value bias, property values have largely held up so far, but banks are pulling back from new lending, and the alternative lenders are tightening up their financing conditions.
As an example, Scope cites a 60% LTV loan with 2.0x interest coverage ratio (ICR) financing a prime Frankfurt office with a 2.0% coupon in 2020. This now looks very different against the backdrop of today’s financing conditions. A mere 30bp increase in the capitalisation rate combined with a 150bp increase in debt costs increases the LTV to 68% and reduces the ICR to a meagre 1.14x.
So far, borrowers in general are not yet in breach of their loan-to-value or interest-coverage covenants based on the latest valuations and low-interest-rate cap. They are largely holding back in wait-and-see mode or are seeking loan extensions, biding time before they are forced to either inject fresh equity or consider selling into a weak market.
But as transactional evidence increases and price visibility emerges from the mist, Scope expects valuation to gradually adjust. Property yields are slowly starting to widen, especially for non-prime and non-green assets, reflecting deteriorating market conditions and rental growth outlook.
On the positive side, Scope did add that "CMBS and CRE CLO noteholders tend to be better protected against liquidity and fire-sale risks due to mechanisms such as liquidity reserves, note protection tests, foreclosure periods and horizontal tranching, which help to limit imminent loss exposure and provide a buffer to navigate around troubled waters."
