The Trafford Centre Finance Limited — Moody’s downgrades six and affirms two classes of EMEA CMBS Notes issued by The Trafford Centre Finance Limited

Rating Action: Moody’s downgrades six and affirms two classes of EMEA CMBS Notes issued by The Trafford Centre Finance LimitedGlobal Credit Research – 06 Apr 2021Approximately GBP 661.8 Million of CMBS AffectedLondon, 06 April 2021 — Moody’s Investors Service (« Moody’s ») has downgraded the ratings of six classes and affirmed two classes of Notes issued by The Trafford Centre Finance Limited.Moody’s rating action is as follows:….GBP340M (Current outstanding amount GBP257.6M) Class A2 Notes, Affirmed Aaa (sf); previously on Jun 5, 2020 Affirmed Aaa (sf)….GBP188.5M Class A3 Notes, Affirmed Aaa (sf); previously on Jun 5, 2020 Affirmed Aaa (sf)….GBP120M (Current outstanding amount GBP56.2M) Class B Notes, Downgraded to Aa3 (sf); previously on Jun 5, 2020 Affirmed Aa1 (sf)….GBP20M Class B2 Notes, Downgraded to Aa3 (sf); previously on Jun 5, 2020 Affirmed Aa1 (sf)….GBP20M Class B3 Notes, Downgraded to Aa3 (sf); previously on Jun 5, 2020 Affirmed Aa1 (sf)….GBP69.55M (Current outstanding amount GBP29.1M) Class D1(N) Notes, Downgraded to Baa3 (sf); previously on Jun 5, 2020 Downgraded to A3 (sf)….GBP50M (Current outstanding amount GBP20.4M) Class D2 Notes, Downgraded to Baa3 (sf); previously on Jun 5, 2020 Downgraded to Baa1 (sf)….GBP70M Class D3 Notes, Downgraded to Baa3 (sf); previously on Jun 5, 2020 Downgraded to A3 (sf)RATINGS RATIONALEToday’s downgrade action reflects a re-assessment of the credit risks of the loan including property value and cashflow expectations given the immediate as well as enduring negative impact of the coronavirus pandemic on retail tenants and the implications for the retail real estate sector. The ratings on the classes B and D Notes were downgraded because of an increase in expected loss due to a higher risk of default and lower Moody’s property value as well as the capped Liquidity facility amount available to the Class D Notes. The ratings on the class A Notes were affirmed because they have sufficient buffer to absorb the expected deterioration in the market value of the collateral in addition to ample access to the cash reserve and liquidity facility.As of January 2021, the transaction’s loan to value (LTV) ratio was 42% based on a December 31, 2019 valuation. This compares to a Moody’s LTV ratio of 71.8% which reflects a Moody’s property value of GBP 925m, based on a net cash flow of GBP 57.6m and a cap rate of 6.25%.Moody’s rating action reflects a base expected loss in the range of 0%-10% of the current balance. Moody’s derives this loss expectation from the analysis of the default probability of the securitised loan (both during the term and at maturity) and its value assessment of the collateral.The coronavirus pandemic has had a significant impact on economic activity. Although global economies have shown a remarkable degree of resilience to date and are returning to growth, the uneven effects on individual businesses, sectors and regions will continue throughout 2021 and will endure as a challenge to the world’s economies well beyond the end of the year. While persistent virus fears remain the main risk for a recovery in demand, the economy will recover faster if vaccines and further fiscal and monetary policy responses bring forward a normalization of activity. As a result, there is a heightened degree of uncertainty around our forecasts. Our analysis has considered the effect on the performance of commercial real estate from a gradual and unbalanced recovery in the UK economic activity.We regard the coronavirus outbreak as a social risk under our ESG framework, given the substantial implications for public health and safety.DEAL PERFORMANCEThe transaction is secured by a loan backed by a single trophy asset, the Trafford Centre, a dominant, super regional shopping centre in Greater Manchester. The loan consists of eight tranches that mirror the note classes with five tranches (A2, B, B3, D2 and D3) paying a fixed rate and three tranches (A3, B2 and D1N) paying a floating rate. The floating rate tranches are fully hedged via interest rate swap agreements with Natwest Markets plc (A3). The deal benefits from schedule amortization with four tranches (A2, B, D1N, D2) fully amortizing and one (A3) partially amortizing. The remaining three tranches (B2, B3 and D3) pay interest only and repay in bullets. The legal final maturities of the notes range from 2022 to 2038.In December, 2020, Canada Pension Plan Investment Board (CPPIB Aaa, stable) acquired the ownership of the centre via enforcement of its GBP250 million subordinate debt following Intu’s administration and an unsuccessful sale process. We view this change of ownership as overall positive given CPPIB’s credit quality and its position as an experienced investor in UK shopping centres. The new sponsor is a professional investment management organization that owns a number of the UK’s largest and most popular retail destinations, including three of the Top-10 centres in the UK as ranked by GlobalData: London’s Westfield Stratford City, Manchester’s Trafford Centre, and Birmingham’s Bullring. The new owner has continued to support the income shortfall through equity injection in Q4 2020.Former Intu property and asset management teams at the centre have been transferred to Savills and CBRE, who have been retained to provide property and asset management services respectively. We view this as positive as it ensures a smoother operational transition.A year of social restrictions and governmental measures to fight the pandemic have not only accelerated the structural shifts in the UK retail industry and retail real estate, but also significantly deteriorated the centre’s rental income.Despite all non-essential retail stores set to re-open on 12 April 2021, and the good progress of the government’s vaccination program, the business operating environment will remain challenging for a while. Footfall will remain below pre-pandemic levels for a certain period due to limits on the number of people allowed into the centre at a time. Also the increasing number of retailers entering administration and likely not to re-open at all will lead to increasing vacancy levels and downward pressure on rental levels. Higher unemployment in the economy will hurt retail sales generally and the accelerated growth in online shopping puts further stress on ‘bricks-and- mortar’ retail sales. According to the ONS, internet sales of textile, clothing and footwear segments reached an all-time-high proportion of 57.6% of all retail sales in February 2021. Although we expect that the operating performance of the centre will remain stressed in the short to medium term, we consider the centre’s strong location and positioning as a destination venue, with a large catchment area of 4.8 million people within a 45-minute drive and over 9.3 million within a 70 minute drive, as well as diversity of tenant mix as supportive of a future performance recovery. The centre’s dominance in the North will enable it to bounce back quicker than less dominant and smaller centres, as highlighted by John Lewis & Partner’s latest store rationalization announcement in March 2021, where three of the eight stores to close are less than 70 miles from the property. The centre’s John Lewis store was not included on the closure list. We expect secondary and tertiary quality shopping centres to be at greater risk of obsolescence.Government measures focused on protecting tenants from enforcement actions for late or missed payments, three successive lockdowns in addition to the social restrictions have resulted in massive decline in the centre’s cashflow performance. On the Q4 2020 payment date (28 January 2021), the quarterly net cash flow decreased sharply to GBP 5.6m in Q4 2020 from GBP 21.2 million in Q4 2019 — a 74% drop. On a full-year basis, net cash flows were 80% lower compared to 2019 (from GBP 86.82m to GBP 17.25m). It was mainly driven by a 54% decrease in rental income to GBP 41.3m in 2020 from GBP 90.2m in 2019. Non-recoverable costs increased four folds to GBP 23.6m reflecting a one-off fee paid to KPMG for handling Intu’s administration, an increase in vacant units and the growing impact and use by retailers of company voluntary arrangements (CVAs). The tenants are still contractually obliged to pay their rent however the UK government announced a further extension of the moratoriums that prevent landlords from acting against commercial tenants for non-payment of rent. The Trafford Centre collection rate in 2020 averaged 61% of rental and service charge income. Early in 2020, Intu reported that they were offering monthly rents to tenants (instead of quarterly), and we expect the new asset manager to continue negotiating rent relief in exchange for either longer lease terms or stronger lease covenants.At the prime end of the market, property values of large stores and department stores are under increasing pressure, and yields have rocketed through their peak of 2009. Yields on super prime shopping centres have increased to 7.0% in Q4 2020[1], 275 basis points (bp) above the historically lowest yields observed in 2015 – it is a 150bp increase over a year and 275bp over five years. Cushman & Wakefield’s five-year yield expectation[2] is 7.0% for prime assets in the Manchester area. At the other end of the market, yields on secondary shopping centres sharply increased to 17% in Q4 2020, a 500bp increase over one year and 925bp over five years.In assessing a Moody’s medium-term view of value, we considered a stabilized vacancy rate of 13% and a cut to ERV of 25%, resulting in a net cashflow of GBP 57.6m. We applied a cap rate of 6.25% which resulted in a value of GBP 925m and a Moody’s LTV ratio of 71.8%.Based on Moody’s cashflow assumption and the debt service payment, the average Moody’s DSCR is 0.96x over the next ten years.There is no financial covenant but some restrictions apply when the Debt Service Coverage Ratio (DSCR) falls below certain thresholds. These have all been reached pre-coronavirus and the transaction must comply with the restrictions and in particular on the nature, scope and amount of developments (such as material refits, material redesigns, or material reconfigurations of units) which may be undertaken. In Q4 2020, the DSCR on the relevant 12-month period was reported at 0.27x[3], down from 1.23x in Q4 2019 and 1.41x in Q4 2018.Neither the cash reserve nor the liquidity facility were used to make note payments to date as the sponsor injected equity to cover for the rental income shortfalls. The transaction benefits from a GBP5.0 million cash reserve and a further GBP80.0 million liquidity facility covering both the principal and interest payments of the Notes with the amount available to the Class D Notes limited to GBP15.0 million which, in the case of the Class D2 Notes, may be made to cover a shortfall in interest and/or principal, and in respect of the Class D1(N) Notes and the Class D3 Notes, may be made to cover a shortfall of interest only.Methodology Underlying the Rating Action:The principal methodology used in these ratings was « Moody’s Approach to Rating EMEA CMBS Transactions » published in October 2020 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBS_1243194. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.Factors that would lead to an upgrade or downgrade of the ratings:Main factors or circumstances that could lead to an upgrade of the ratings are generally (i) an increase in the property value or (ii) a decrease in default risk assessment.Main factors or circumstances that could lead to a downgrade of the ratings are generally (i) a decline in the property value backing the underlying loan or (ii) an increase in default risk assessment which also considers the new owner’s willingness to continue to support the transaction.REGULATORY DISCLOSURESFor further specification of Moody’s key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody’s Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.The analysis relies on a Monte Carlo simulation that generates a large number of collateral loss or cash flow scenarios, which on average meet key metrics Moody’s determines based on its assessment of the collateral characteristics. Moody’s then evaluates each simulated scenario using model that replicates the relevant structural features and payment allocation rules of the transaction, to derive losses or payments for each rated instrument. The average loss a rated instrument incurs in all of the simulated collateral loss or cash flow scenarios, which Moody’s weights based on its assumptions about the likelihood of events in such scenarios actually occurring, results in the expected loss of the rated instrument.Moody’s quantitative analysis entails an evaluation of scenarios that stress factors contributing to sensitivity of ratings and take into account the likelihood of severe collateral losses or impaired cash flows. Moody’s weights the impact on the rated instruments based on its assumptions of the likelihood of the events in such scenarios occurring.For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody’s rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider’s credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. 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Please refer to Moody’s Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.Moody’s general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1243406.At least one ESG consideration was material to the credit rating action(s) announced and described above.The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody’s affiliates outside the EU and is endorsed by Moody’s Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody’s office that issued the credit rating is available on www.moodys.com.REFERENCES/CITATIONS[1] Cushman & Wakefield Retail data detailed Europe – Q4 2020 Release 1 20/01/21[2] Cushman & Wakefield Research European Forecasts 2020 Q4[3] The Trafford Centre Limited — Investor Report December 2020Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody’s legal entity that has issued the rating.Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating. Benjamin Bouchet Asst Vice President – Analyst Structured Finance Group Moody’s Investors Service Ltd. One Canada Square Canary Wharf London E14 5FA United Kingdom JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454 Andrea M. 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