Overview

• We have reviewed Westfield Stratford City Finance No. 2 in light of an increasingly challenging environment for the physical retail sector, which continues to be affected by the credit effects of the COVID-19 pandemic.
• Following our review, we have lowered our rating on the sterling-denominated fixed-rate notes.
• Westfield Stratford City Finance No. 2 is a U.K. CMBS transaction that closed in July 2019 and is secured on Westfield Stratford City shopping center in east London.

LONDON (S&P Global Ratings) March 11, 2021--S&P Global Ratings today lowered to 'AA (sf)' from 'AAA (sf)' its credit rating on Westfield Stratford City Finance No.2 PLC's sterling-denominated fixed-rate notes.

Rating rationale

Today's downgrade follows our updated review of the transaction's credit and cash flow characteristics. We believe that a continued decline in cash flows from the property combined with our view of an increasingly challenging environment for retail tenants has worsened the notes' credit metrics.

Transaction overview

The transaction is secured on Westfield Stratford City shopping center and associated car parks (Westfield Stratford), which is located in east London adjacent to Queen Elizabeth Olympic Park.

The shopping center comprises approximately 1.97 million square feet (sq. ft.) of retail, food and beverage, and leisure space. Westfield Stratford is one of Europe's largest covered shopping and leisure destinations.

In this transaction, a newly incorporated issuer on-lent the note proceeds to the borrower (Stratford City Shopping Centre (No.1) L.P.) through an issuer/borrower loan. Payments due under the issuer/borrower loan primarily fund the issuer's interest and principal payments due under the notes.

The transaction is structured with a single class of interest-only fixed rate notes with an expected maturity in 5.5 years, followed by a five-year tail period.

Westfield Stratford, which opened in 2011, is part of a large-scale regeneration project called Stratford City. Stratford is now east London's primary retail, cultural, and leisure center and has become the second-most significant business location in the east of the capital, after Canary Wharf.

The property is currently 96% occupied and leased to over 280 retailers with John Lewis (including Waitrose) and Marks & Spencer anchoring the shopping center. The property has a weighted-average unexpired lease term to break of 3.4 years (down from 5.1 years at closing in July 2019), with a tenant profile generally incorporating internationally and nationally recognized retailers and food and beverage/leisure operators. The top 10 tenants combined represent approximately 26% of contracted rent, with the largest tenant contributing 7% and no other tenant contributing more than 3%.

While lease structures can vary within the shopping center, they are typically based on a 10-year term with five yearly upward-only rent review cycles and five yearly break options. Some leases also include turnover rent, stepped rent, and index-linked rent clauses.

Based on the last reported market valuation of £2,332 million (March 31, 2020), the transaction has a loan-to-value (LTV) ratio of 32%. Based on comparable evidence of updated valuations for similar shopping centers in the U.K., reported valuations have decreased by approximately 35% over the last 12 months.

An increasing number of retailers are suffering financial difficulties, which continue to be exacerbated by the effects of the COVID-19 pandemic in the short to medium term, and the risk of increased vacancy levels and diminishing rental levels remains. Furthermore, given the property opened in 2011, with most leases signed on 10-year terms, there is a concentration of leases scheduled to expire in the next 12 months (44% of rental income).

While there is a risk of a periodic peak in vacancy levels in the short term, the risk remains somewhat mitigated in the longer term by Westfield Stratford being one of the prime super-regional shopping centers in the U.K., a desirable location for new and existing occupiers, strong sponsor support with a track record of managing lease renewals, and the potential to create value through future asset management initiatives. Our analysis has considered these risks when arriving at our long-term vacancy and rental assumptions.

Since our previous review, our S&P Global Ratings value has declined by 30% to £1,304 million from £1,875 million, primarily due to a lower rental income assumption of the property, which we believe will be re-based over the long term. Having considered updated performance data together with comparable market evidence, we have reduced the S&P Global Ratings net cash flow (NCF) to £89.2 million from £114.5 million.

We have then applied a 6.5% capitalization rate against this S&P Global Ratings NCF (which is an increase from the 5.8% previously used) and deducted 5.0% of purchase costs to arrive at our S&P Global Ratings value.

Table 1

Table 2

Other analytical considerations

Our ratings analysis also includes an analysis of the transaction's payment structure and cash flow mechanics. We assess whether the cash flow from the securitized asset would be sufficient, at the applicable rating level, to make timely payments of interest and ultimate repayment of principal by the legal maturity date of the fixed rate note, after taking into account available credit enhancement and allowing for transaction expenses and external liquidity support.

The risk of interest shortfalls is mitigated by a £13.82 million facility that provides liquidity support to service any expense shortfalls or interest shortfalls on the notes, and to remedy property protection shortfalls.

The reported trailing 12-month net operating income for March 2020, June 2020, September 2020, and most recently December 2020, were £106.6 million, £91.2 million, £86.7 million, and £55.3 million, respectively. This compares with approximately £108.5 million per year before the onset of COVID-19.

Although the collection rates have lowered over the last four quarters, the available cash flow generated from the property remains sufficient to service the debt payments on its own. At the February 2021 interest payment date, the reported interest coverage ratio was 4.68x.

Our assessment of the payment structure and cash flow mechanics does not constrain our rating in this transaction.

Our analysis also included a full review of the legal and regulatory risks, operational and administrative risks, and counterparty risks. Our assessment of these risks remains unchanged since our previous review and is commensurate with the assigned rating.

Rating actions

Our rating in this transaction addresses the timely payment of interest, payable quarterly in arrears, and the payment of principal no later than the legal final maturity date in August 2031.

In our view, the transaction's credit quality has declined further due to the ongoing structural shift in the physical retail sector, as well as the continued operational disruption resulting from the spread of COVID-19. We believe this may continue to negatively affect the cash flows available to the issuer.

The increasingly challenging environment for retail tenants is affecting this transaction, which is shown by the continued decline in reported operating performance and estimated rental values.

The combination of the above factors results in a reduced assumption of the long-term sustainable cash flow for the property and, in turn, a lower S&P Global Ratings value. This results in a S&P Global Ratings LTV ratio of 57.5% for the fixed rate notes. Together with transaction-level considerations, we have therefore lowered to 'AA (sf)' from 'AAA (sf)' our rating on the notes.

S&P Global Ratings believes there remains high, albeit moderating, uncertainty about the evolution of the coronavirus pandemic and its economic effects. Vaccine production is ramping up and rollouts are gathering pace around the world. Widespread immunization, which will help pave the way for a return to more normal levels of social and economic activity, looks to be achievable by most developed economies by the end of the third quarter. However, some emerging markets may only be able to achieve widespread immunization by year-end or later. We use these assumptions about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Environmental, social, and governance (ESG) credit factors for this credit rating change:

• Health and safety.

Related Criteria

• Criteria | Structured Finance | General: Global Framework For Payment Structure And Cash Flow Analysis Of Structured Finance Securities, Dec. 22, 2020
• Criteria | Structured Finance | General: Counterparty Risk Framework: Methodology And Assumptions, March 8, 2019
• Criteria | Structured Finance | General: Incorporating Sovereign Risk In Rating Structured Finance Securities: Methodology And Assumptions, Jan. 30, 2019
• Legal Criteria: Structured Finance: Asset Isolation And Special-Purpose Entity Methodology, March 29, 2017
• Criteria | Structured Finance | General: Global Framework For Assessing Operational Risk In Structured Finance Transactions, Oct. 9, 2014
• Criteria | Structured Finance | CMBS: European CMBS Methodology And Assumptions, Nov. 7, 2012
• Criteria | Structured Finance | CMBS: CMBS Global Property Evaluation Methodology, Sept. 5, 2012
• Criteria | Structured Finance | General: Criteria Methodology Applied To Fees, Expenses, And Indemnifications, July 12, 2012
• General Criteria: Global Investment Criteria For Temporary Investments In Transaction Accounts, May 31, 2012
• General Criteria: Principles Of Credit Ratings, Feb. 16, 2011
• Criteria | Structured Finance | General: Methodology For Servicer Risk Assessment, May 28, 2009
• Criteria | Structured Finance | CMBS: Methodology For Analyzing Loan-Level Limited Purpose Entities In European CMBS, Sept. 1, 2004

Related Research

• European CMBS Monitor Q4 2020, Jan. 20, 2021
• S&P Global Ratings Definitions, Jan. 5, 2021
• European CMBS: The Lowdown On Liquidity Support, Oct. 28, 2020
• 2017 EMEA CMBS Scenario And Sensitivity Analysis, July 6, 2017
• Global Structured Finance Scenario And Sensitivity Analysis 2016: The Effects Of The Top Five Macroeconomic Factors, Dec. 16, 2016
• European Structured Finance Scenario And Sensitivity Analysis 2016: The Effects Of The Top Five Macroeconomic Factors, Dec. 16, 2016