The GBP 69.9m Maroon senior loan is one of two loans backing the Elizabeth Finance 2018 CMBS, which is secured by three UK secondary regional shopping malls. Maroon’s secured real estate portfolio was initially appraised at GBP 104.7m but declining rental income and rising yields had forced two reassessments, which wiped out roughly GBP 35.8m of market value in two years.

“The UK retail sector has been hit by Brexit uncertainty, the rise of e-commerce, a supply and demand imbalance and more recently the Covid-19 pandemic. This has led to growing pressure on rental income resulting from rising tenant credit risk and widening yields. This is especially true for regional secondary shopping centres, which had seen their credit risk worsening compared to other retail sectors,” said Florent Albert, associate director in the structured finance team of Scope and author of a report out today.

UK secondary regional retail yields have risen to 8.8% since bottoming at 6.0% in 2015 while their spreads have widened respectively by 75bp and 125bp versus secondary high street and secondary bulky goods.

“The Maroon default highlights the importance of key factors that are included in Scope’s approach to rating CRE loans,” said Albert. “These include sector specific stresses combining through the cycle observations and forward-looking assumptions like the disruption potential of general turmoil in the UK retail sector and secondary shopping centres; the importance of factoring tenant credit quality into net operating income; cautiousness around re-letting assumptions; and the sensitivity of appraised value to capitalisation-rate movements and net operating income projections.”

The 10 top tenants at closing of the Elizabeth Finance CMBS represented 40.4% of the rent of 131 in-place tenants with an eight-year weighted average unexpired lease to break (WAULB). This relatively long WAULB provided limited comfort, however, because the credit quality of the top 10 was weak: 76% of the rent was from non-investment-grade tenants. After year one, the 58% of top 10 in the highly-speculative rating bucket (B and below) rose to 74%. On that basis, the assumed average credit rating of the Top 10 tenants would have worsened to B+ from BB- by 2019, increasing lost rent because of defaults among those tenants.”

Applying a GBP 6.75m per annum Scope-projected NOI and the 8.2% capitalisation rate used by the valuer would have resulted in a Scope base-case portfolio value of GBP 82.3m and a 85% LTV. In 2018, the appraiser valued the portfolio at GBP 104m.

“We would have addressed the negative outlook on secondary UK shopping malls through sensitivity analysis,” said Albert. “This is typically factored in through an increase in the capitalisation rate.” Secondary shopping centre capitalisation rates widened by 100bp between the Maroon loan appraisal and issuance of the Elizabeth Finance CMBS. A 100% premium on the capitalisation rate would have resulted in a portfolio value of GBP 73.4m and a 95% LTV aligned with the recent collateral reappraisal. “Based on this analysis, the Maroon loan would have been perceived as risky from issuance and negatively impacting our view on the Elizabeth Finance 2018 CMBS,” Albert concluded.

The full case study can be downloaded here.