The problems in the wider CRE debt market are amplified by the sharp decrease in liquidity provided by banks in the wake of SVB’s failure and pressure in the financial system following UBS’s negotiated takeover of Credit Suisse.

“Maturity extensions or extension attempts highlight the difficult underlying conditions facing European commercial real estate,” said Florent Albert, a senior director in Scope’s structured finance team. “Factors include deteriorating financing conditions and cautious underwriting; challenging cashflow and value projections after a decade of accommodating monetary and fiscal policy; and deteriorating secondary market liquidity and overvalued assets.” Cautious lenders are demanding wider margins to finance CRE assets.

“On valuation, we don’t believe retail and office yields have decompressed enough to reflect the interest-rate increases and ongoing structural changes. On refinancing, the risks are high for retail and shopping centre loans and certain single-office loans maturing in 2023-2024,” said Benjamin Bouchet, director in Scope’s structured finance team.

Maturity profile of European securitised CRE loans (EUR m equivalent)

Source: Scope Ratings, Investor reports

Early-stage conclusions for CMBS

Three takeaways here. First, maturity extensions come at the expense of senior noteholders. Most CMBS 2.0 documentation has embedded unilateral rights for servicers to extend loan terms to prevent a default if it is deemed to be in the interest of all noteholders. “We generally view loan extensions without enhanced protective terms as credit negative for senior and mezzanine tranches, which represent the largest portions of CMBS investors,” Bouchet said .

Second, refinancing planning is once again paramount. “In recent years, accommodating financing conditions have enabled borrowers to draw up refinancing plans months or even just weeks before loan maturities. Reverting to longer refinancing planning periods and/or proactive deleveraging are necessary to ease refinancing discussions and avoid last minute distressed exchanges,” Albert said.

Third, shorter workout periods increase fire-sale risks for noteholders as it leaves less time to implement business plans and ultimately maximise value for noteholders and minimise losses.

Some CRE loan holders will be even more concerned than noteholders about recent developments. Misalignment of interests is not an issue in the CRE loan market because servicers act principally on behalf of pari-passu lenders, unlike CMBS where senior, mezzanine and junior noteholders have divergent interests. That said, holders of loans do not benefit from CMBS work-out periods so pretend and extend is lenders’ only solution to prevent refinancing defaults.

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Related research

• A third of commercial real estate loans in European CMBS face significant refinancing risk.
• Scope assigns preliminary unsolicited ratings to notes issued by CASSIA 2022-1 S.R.L. – Italian CMBS
• A primer on European CRE CLOs: same foundations as US CRE CLOs. Same success?
• European CMBS: stellar valuations but mixed operating performance; refinancing risks lurk
• Investors should assess debt yield alongside traditional financial covenants to capture CRE risk
• European real estate grapples with inflation, higher yields: assessing challenges for debt holders (webinar)
• European real estate grapples with inflation, higher yields: assessing challenges for debt holders (slides)

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