Overview

• We have reviewed Meadowhall Finance in light of an increasingly challenging environment for the retail sector, which continues to be exacerbated by the credit effects of COVID-19.
• Following our review, we have lowered our ratings on all classes of notes.
• Meadowhall Finance is a 2006-vintage secured U.K. CMBS transaction, which is secured by a single loan backed by Meadowhall Shopping Centre in Sheffield, South Yorkshire.

LONDON (S&P Global Ratings) Feb. 4, 2022--S&P Global Ratings today lowered to 'A (sf)' from 'AA- (sf)' its credit ratings on Meadowhall Finance PLC's class A1 and A2 notes. At the same time, we have lowered to 'BBB- (sf)' from 'A- (sf)', to 'B+ (sf)' from 'BBB- (sf)', and to 'B- (sf)' from 'BB (sf)' our ratings on the class B, M1, and C1 notes, respectively.

Rating rationale

Today's downgrades follow 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 and landlords, which has resulted in a continuing decline in property market values, has weakened the notes' credit metrics.

Transaction overview

Meadowhall Finance is a secured U.K. commercial mortgage-backed securities (CMBS) transaction that closed in 2006, with notes totaling £1.015 billion, which included £175.0 million in un-issued reserve notes. The single loan is secured on Meadowhall Shopping Centre, one of the U.K.'s largest shopping centers located in Sheffield, South Yorkshire. The center is owned by a joint venture between The British Land Company PLC and Norges Bank Investment Management. The current securitized loan balance is £519.3 million. At closing, two reserve tranches (the M1 and C1 reserve notes) were created, but remain unissued. While the issuance of these reserve tranches are subject to certain conditions, our analysis assumes a full issuance of the class M1 and C1 reserve notes, which currently total £137.3 million.

As of Sept. 30, 2021, the property's reported market value was £719.0 million, which reflects a 23% decrease from the valuation as of our previous review in September 2020. Consequently, over the last year, the whole loan-to-value (LTV) ratio has increased to 72.2% from 60.0% (or to 91.3% from 74.9% if including the reserve notes).

Over the same period, the annual gross passing rent has decreased by 13% to £64.8 million from £74.6 million, while the valuer's estimated rental value has decreased by 15% to £52.9 million from £62.2 million.

The tenant profile comprises a combination of internationally and nationally recognized retailers (such as Marks & Spencer, Primark, Next, Boots, Victoria's Secret, H&M Hennes, and Vue cinema). However, the shopping center remains exposed to significant ongoing challenges with regards to retailer occupier demand and performance. In the period since September 2020, we understand from the most recent reporting that overall passing rent has reduced by £9.8 million per year as a result of (i) lease surrenders, exercises of break clauses, and non-renewals, and (ii) administration and company voluntary arrangements.

In recent years, an increasing number of retailers have suffered 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. However, the risk is somewhat mitigated in the longer term by being among the prime super-regional shopping centers in the U.K.

Since April 2021, there has been considerable leasing activity with a mixture of short- and long-term leasing. The focus has been to maintain occupancy, optimize the customer experience when visiting the center. As a result, the property has experienced an increase in occupancy to 96.5% from 95.2% in September 2020. At the same time, the property experienced a reduction in weighted-average unexpired lease term until first break to 4.1 years (from 4.5 years).

The total amount of unpaid rent outstanding from tenants due to COVID-19 has decreased to £21.0 million at the end of November 2021 from £23.0 million in June 2021, and in addition there is approximately £4.0 million outstanding related to deferred rental amounts.

Funds in the excess cash flow reserve account from the Jan. 12, 2022 interest payment date are £11.6 million. These funds are available for debt service. The funds may be released if the LTV ratio is below 50%, and either (i) British Land holds at least 50% of the partnership interest in the borrower, or (ii) the net coverage ratio on the two preceding calculation dates has been at least 1.20x. The current LTV ratio is 71.1% and the net coverage ratio is 1.77x.

Since our previous review, our S&P Global Ratings value has declined by 18% to £619.8 million from £757.1 million, primarily due to a lower rental income assumption of the property, which we believe will be re-based over the long term, and an increase in the capitalization (cap) rate. We have reduced the S&P Global Ratings net cash flow (NCF) to £44.0 million from £51.8 million. We have noted an increase in the cap rate used by the valuer. We also believe that the retail sector will continue facing further declines in valuations. Once COVID-19 restrictions ease, recovery will still take some time and continuing pressure from growing online shopping will likely weigh on rental values and consequently property values. Therefore, we have applied a 6.75% cap rate against this S&P Global Ratings NCF (which is an increase from the 6.5% previously used) and deducted 5% of purchase costs to arrive at our S&P Global Ratings value.

Table 1

Table 2

Other analytical considerations

We also analyzed the transaction's payment structure and cash flow mechanics. We assessed whether the cash flow from the securitized asset would be sufficient, at the applicable rating, to make timely payments of interest and ultimate repayment of principal by the legal maturity date of the fixed and floating-rate notes, after considering available credit enhancement and allowing for transaction expenses and external liquidity support.

The risk of interest shortfalls is mitigated by a £75 million facility that provides liquidity support to service interest on the notes and scheduled principal repayments on the class A notes, if needed. The amount of the facility available is restricted to not greater than 70% of the facility for the class B notes, 45% for the class M1 notes, and 10% for the class C1 notes. However, interest does not accrue on the reserve tranches, the class M1 and C1 notes.

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 closing and is commensurate with the ratings.

Rating actions

Our ratings in this transaction address the timely payment of interest, payable quarterly, and the payment of principal no later than the legal final maturity date in July 2037.

In our view, the transaction's credit quality has declined further due to the on-going 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. We have factored this into our analysis when we calculated our S&P Global Ratings recovery value, together with other supporting features, such as the availability of the liquidity facility.

The combination of the above factors results in an S&P Global Ratings LTV ratio of 65.7%, 83.8%, 96.6%, and 105.9% for the class A1 and A2 (pari passu notes), B, M1, and C1 notes, respectively. Together with transaction-level considerations, these translate into 'A (sf)' ratings for the class A1 and A2 notes, a 'BBB- (sf)' rating for the class B notes, a 'B+ (sf)' rating for the class M1 notes, and a 'B- (sf)' rating for the class C1 notes.

S&P Global Ratings believes the omicron variant is a stark reminder that the COVID-19 pandemic is far from over. Uncertainty still surrounds its transmissibility, severity, and the effectiveness of existing vaccines against it. Early evidence points toward faster transmissibility, which has led many countries to reimpose social distancing measures and international travel restrictions. Over coming weeks, we expect additional evidence and testing will show the extent of the danger it poses to enable us to make a more informed assessment of the risks to credit. In our view, the emergence of the omicron variant shows once again that more coordinated and decisive efforts are needed to vaccinate the world's population to prevent the emergence of new, more dangerous variants.

Environmental, social, and governance (ESG) credit factors for this change in credit rating/Outlook and/or CreditWatch status:

• Health and safety.

Related Criteria

• General Criteria: Environmental, Social, And Governance Principles In Credit Ratings, Oct. 10, 2021
• Criteria | Structured Finance | General: Global Framework For Payment Structure And Cash Flow Analysis Of Structured Finance Securities, Dec. 22, 2020
• Criteria | Structured Finance | General: Methodology To Derive Stressed Interest Rates In Structured Finance, Oct. 18, 2019
• 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
• General Criteria: Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings, Oct. 1, 2012
• Criteria | Structured Finance | CMBS: CMBS Global Property Evaluation Methodology, Sept. 5, 2012
• General Criteria: Principles Of Credit Ratings, Feb. 16, 2011
• Criteria | Structured Finance | CMBS: Methodology For Analyzing Loan-Level Limited Purpose Entities In European CMBS, Sept. 1, 2004

Related Research

• All Meadowhall Finance PLC U.K. CMBS Ratings Lowered On Worsened Performance, Dec. 22, 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
• New Issue: Meadowhall Finance PLC, May 29, 2007