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Investors in European commercial mortgage bonds, which were initially sold with the highest ratings, are set to suffer losses, analysts say, marking the first time the safest tier of bonds has been hit since the global financial crisis.
Investors facing losses include holders of the top notes in commercial mortgage-backed securities that were originally lent to Oaktree Capital Management to finance three U.K. shopping centers. A recently agreed sale of the underlying assets is expected to raise less than the value of the outstanding debt.
Meanwhile, ratings agency Fitch predicts that investors in the safest tranches of two more CMBS deals, including one set up to lend to Brookfield, are also facing losses.
“As an investor, you're not expecting losses at the triple-A level. It's not good news,” said Elena Rinaldi, a portfolio manager on the asset-backed securities team at TwentyFour Asset Management.
Rising borrowing costs over the past two years have sparked the worst commercial property slump since the 2008 global financial crisis, with values of office, retail and other assets in Europe falling by a third to a fifth from their 2022 peaks.
Signs of distress among real estate investors have emerged slower this time around, as borrowing levels are currently more conservative than in the period leading up to 2008. But the latest loss forecasts suggest that the real estate market pain is reaching even the most protected segments of real estate-backed credit investors.
The loan was transferred to Mount Street, a “special servicing company” that seeks to maximise investors' recoveries, in 2020 due to breach of contract and has been in default since.
Elizabeth Finance 2018 DAC, the CMBS vehicle set up to issue the bond, said last week that Mount Street had accepted a £35 million bid for King's Lynn, Dunfermline and Loughborough shopping centres, known as Maroon Properties, which it said would generate net proceeds of around £31.5 million for bond investors.
Holders of the first-priority notes are owed £33.6m and would lose 6.3% under the proposal, according to Bank of America.
“The biggest issue is interest rates, quite simply,” said James Bannister, head of special services at Mount Street. “We don't have any money left to do anything with the assets so we've had to be honest with investors and say 'we can't do this any more, now is the time to sell these assets.'”
The highest-priority debt issued by Elizabeth Finance originally held two loans, one of which has been repaid. It was rated triple-A by S&P and Morningstar DBRS in 2018. Oaktree, one of the world's largest investors in distressed debt, was the original borrower.
Last week, DBRS downgraded the credit ratings of these senior bonds to junk status for the first time, and on Wednesday S&P did the same.
In 2018, Fitch expressed concern that the bonds did not justify the triple-A ratings given by other rating agencies due to risks related to asset quality.
UK non-large retailers are “not an unexpected credit risk. They've been in a bubble for a long time. [coronavirus] “The pandemic has obviously dealt a further blow to the sector and has been quite tough on these asset types,” said Euan Gatfield, head of EMEA CMBS at Fitch.
Following last week's Elizabeth Finance announcement, Fitch predicted losses could follow for top-tier bondholders of two other European CMBS, House DAC and River Green Finance 2020 DAC.
Holders of the top debt of Haus CMBS, which is secured by 6,281 apartment buildings across 92 locations in Germany, are also at risk from falling property values due to high vacancy rates, the bank said.
The lead borrower on the House CMBS is Brookfield Property Group Inc. Brookfield declined to comment.
Moody's downgraded all of HausDAC's debt, including top-tier bonds worth more than 200 million euros, in March last year, saying the properties had average occupancy rates of around 58 percent and planned renovations were facing significant delays.
“Without immediate improvement in sales performance, [capital expenditure] “We believe all bond types will suffer losses as the program is mired in delays and cost overruns,” Fitch analysts wrote, adding that without the additional payments from Brookfield, Mortgage House “will likely post negative net operating income.”
Another CMBS, Rivergreen Finance 2020 DAC, is Europe's first sustainability-focused CMBS and is secured by an office campus outside Paris that is largely leased to struggling tenant Atos.
Last year, Moody's downgraded all of River Green's bonds and raised its expected losses on the underlying loans because they were not repaid on time. River Green currently has €98 million of top-class bonds outstanding.