Hotel reservation books are filling up, but a profitable summer may not be enough to offset the ongoing challenges burdening the European hospitality sector. Lodging companies are facing continual supply-chain issues and inflationary pressures on the back of macroeconomic uncertainty and the current geopolitical context. These factors, matched with lower-than-anticipated GDP growth, will likely erode consumer confidence and discretionary spending. As a result, S&P Global Ratings believes many European lodging companies will experience slower post-pandemic recovery than previously expected, which could lead to a difficult year 2023 for European lodging companies.

Given the potentially challenging year ahead for the hospitality sector, revenue recovery in 2022 to approach 2019 levels is more crucial than ever, particularly in Europe. If the rebound lags our current base-case assumptions, lower-rated issuers--that is, those in the 'B-/CCC+' categories--could experience a liquidity squeeze and become dependent on additional cash injections to sustain their credit metrics. Also, the combined effect of a lagged revenue per available room (RevPAR) recovery with an increase in operating costs may pressure the ratings on commercial mortgage-backed securities (CMBS) transactions backed by U.K. hotels.

Table 1

Current Challenges For EMEA Lodging Companies

Macroeconomic and geopolitical uncertainty could jeopardize international travel, especially in Europe.   The Russia-Ukraine conflict could have indirect profound effects on macroeconomic prospects and credit conditions around the world. The highly uncertain and volatile situation is a particular threat to Europe in regards to energy security, further supply chain disruption, and amplification of existing inflation pressures. Additionally, a hike in fuel costs could cause international travel costs to spike, with potential ramifications for the hospitality sector.

High inflation will likely dampen consumer confidence.  The military conflict has exacerbated inflationary pressure across Europe, which will likely reduce consumer confidence further than initially anticipated, leading households to save more and spend less. As a result, consumers may curtail spending on discretionary products and activities, such as leisure travel, which would impede lodging operators' paths to recovery.

Although we expect business and leisure travel to continue to strengthen in 2022, we now project EMEA lodging companies' revenues to remain at least 10%-15% below 2019 levels.  We saw stronger leisure demand recovery than we initially anticipated during the second half of 2021. This was supported by pent-up appetite for staycations (that is, people holidaying in their home countries) in Europe on the back of tighter mobility restrictions and testing requirements for international travel. However, intermittent lockdowns in early first quarter and the second quarter of 2022, as well as the likely macroeconomic and geopolitical uncertainty related to the Russia-Ukraine conflict, could make this recovery bumpy especially from 2023. Under our revised base-case scenario, most lodging operators' revenue will likely remain at least 10%-15% below 2019 levels at year-end 2022. This RevPAR estimate could translate into next year's EBITDA being 20%-30% below 2019 levels for the overall sector. That said, each company's individual performance depends heavily on its price segment and location as well as its cash flow model; a hotel owner, for example, is subject to greater volatility than a franchisor due to its cost structure.

Financial policy decisions will weigh heavily on credit rating trajectories.   Despite uneven recovery, leisure companies with no immediate debt maturities and high cash positions will likely continue to focus on mergers and acquisitions (M&A). Domestic demand-driven hotels, holiday homes, and leisure operators will remain within the sweet spot as staycations will continue to be popular in 2022 and more importantly 2023. Some of these players already had high debt burdens that were subsequently extended during the pandemic as most companies received support from the government in the form of loans and furlough schemes. Furthermore, a large majority of these hotel operators are owned by private equity firms, which stepped in with additional debt or quasi equity injections to help keep these highly leveraged companies afloat. We believe that these companies are treading on thin ice as they continue with opportunistic M&A and sector consolidation in 2022 despite their heavy debt burdens. Financial policy decisions are therefore a crucial factor in our rating considerations.

The Good News

Summer 2022 is on track to boost hotels' performance.  Vaccination rates across Europe are high, and the COVID-19 Omicron variant has proved less disruptive due to its lighter symptoms, widespread booster campaigns, and some level of group immunity. Governments have now largely scrapped travel-related restrictions, including pre-departure testing requirements. As a result, we have witnessed lodging operators reporting high levels of advance bookings for summer holidays for their first-quarter results of 2022. This is despite consumers generally booking holidays later over the past two years due to the ever-changing restrictions related to the pandemic. Therefore, we see upside to our current base-case assumptions, and do not discount the possibility that lodging companies in Europe could recover faster than we currently anticipate.

Average daily rates (ADRs) are elevated and we anticipate they will remain so at least for 2022.   ADRs recovered faster than expected following the pandemic. At year-end 2021, lodging operators saw global ADR at around 8%-10% below 2019 levels, a much faster bounce-back than following previous downturns. We anticipate these will remain elevated during 2022 on the back of intensifying demand for leisure travel underpinned by ongoing remote working arrangements and extended weekend trips. We might witness a decrease in ADR as leisure demand normalizes in 2023, but we anticipate global ADR to remain higher than 2019 levels as the demand remains strong and consumers are willing to pay higher prices due to additional cost price inflation.

No maturity walls for most of the hospitality names within the sector.  During the pandemic, most lodging operators secured handsome packages in the form of furlough schemes and local government loans to support their liquidity positions. These included the prêt garanti par l'état in France and government subsidies in Germany. Many of these loans were repaid during 2021, freeing up lodging operators within our rated universe from significant upcoming debt maturities in 2022 and 2023. Furthermore, many lodging issuers were able to access the capital markets at low borrowing costs despite the pandemic-related stress. These debt issuances helped to bolster balance sheets and stave off defaults. As recovery continues to materialize, we expect future debt issuances will increasingly be motivated by lower-cost refinancing rather than liquidity constraints.

Risks To Recovery

Summer 2022 performance remains critical despite the recent positive actions on European-based lodgers.   We lowered our ratings on several European lodgers during the pandemic. Around 40% of EMEA-based lodging and hospitality companies remain on a negative outlook. The downward trend for ratings has resulted in most lodging issuers being downgraded by one or more notches, and a big increase in the number of 'CCC' category ratings. That said, we have taken some positive actions on EMEA-based lodgers over the past six months. On Oct. 20, 2021, we upgraded TUI, a Germany-based company providing fully integrated tourism services (see " TUI AG Upgraded To 'B-' On €1.1 Billion Equity Raise; Outlook Stable"). This was on the back of shareholder and governmental support sustaining the company's liquidity position during the pandemic, as well as our expectations that leisure travel has reached an inflection point after its period of stress. Likewise, we revised our outlooks on eDreams, the online travel agency (OTA), and InterContinental Hotels Group to positive from negative on similar grounds.

Our revised outlooks and credit ratings are largely based on the assumption that the travel sector will continue to recover smoothly in 2022. For many operators, particularly OTAs, where international travel plays a more relevant role, performance according to our base case will depend heavily on summer bookings.

Peers with higher exposure to domestic and regional travel will continue to benefit from swifter recovery.   People began travelling again during the second half of 2021, albeit generally staying within their own country or region due to stricter restrictions and testing requirements associated with international travel. We expect international leisure demand to pick-up during 2022 as restrictions are further eased but expect closer-to-home regional travel to be preferred due to health and safety and geopolitical uncertainties. As a result, we expect long-haul destinations or destination countries with lower vaccination rates to recover more slowly.

Chart 1

Real Estate Investment Trusts (REITs)

Hotel owners' revenues are on track to fully recover by 2023-2024

After a tough 2020, the rebound in revenues for 2021 was stronger than expected. Hotels variable leases and hotels under management heavy losses were partly offset by a strong tourism activity in the second half of last year. Overall, RevPAR in Europe increased by 42% in 2021 versus 2020, although remaining 54% below 2019 levels. We expect the rebound to linger toward 2022, as the first quarter (Q1) was robust, especially in France and in the U.K., after most pandemic-based restrictions had been waived since February 2022. The growth in revenues would likely moderate in 2023, as weaker purchasing power and consumer confidence could weigh more heavily on leisure tourism. Still, we assume hotel landlords, with variable leases and hotels under management, and high-quality assets in Europe, could recover their pre-pandemic EBITDAs in 2023-2024.

As expected, fixed leases have remained protective, with only moderate single-digit percentage rental income decreases in 2020-2021, due to rent discounts conceded to tenants during the pandemic, often in exchange for lease extensions and partly offset by rent indexations in 2021. We do not assume further concessions as earnings before interest, taxes, depreciation, amortization, and restructuring or rent costs (EBITDAR) remain acceptable and major European hotel operators' creditworthiness has proven relatively resilient to the pandemic, mostly due to government support packages (such as furlough schemes), COVID-19 loans, and liquidity built-up. We expect our rated hotel landlords' rent collection rates, even including potential rent discounts, to stabilize close to 100% for the coming years.

Valuations may not recover to pre-pandemic levels

Most valuation declines among our rated REITs were contained below 10% during the pandemic, and even less for fixed-leased assets. We do not expect asset values to recover to pre-pandemic levels as rising interest rates, and potentially a more fragile growth in demand in 2023, will likely weigh on future revaluation assumptions by appraisers. On the other hand, indexed fixed lease revenues would likely benefit from the rising inflation in the eurozone (6.4% in consumer price index in 2022 and 3.0% in 2023 as per our expectations).

Moreover, investments in European hotels continue to significantly lag pre-pandemic levels. This could leave hotel REITs with limited potential for further capitalization rate compression based on benchmark transactions. We generally expect flat portfolio revaluations for the sector over the coming 24 months.

Chart 2

Elevated bond yields are a concern for capital intensive REITs, but the hotel REITs that we rate are currently safe

The current elevated credit spreads will likely affect hotel REITs' interest coverage and access to debt funding from capital markets. Since April 2022, credit spreads have significantly widened for European real estate companies. Given the capital intensity and refinancing needs in the sector, we think hotel REITs will likely refinance their existing debt at higher costs, and therefore raise their interest burden. Moreover, access to debt capital markets may be volatile. However, hotel REITs rated by S&P Global Ratings exhibit healthy EBITDA to interest coverage ratios and liquidity positions for the coming 24 months, which should allow them to either refinance debt at current conditions or cover their 12-month debt maturities with secured sources, without rating pressure.

Chart 3

Owners of hotels in countries where domestic tourism and infrastructure are stronger should continue to fare better

Leisure hotels, at affordable rates, located in countries that benefit from strong domestic demand and good infrastructure may remain more resilient. This is because the erosion of purchasing power and increasing travel prices will likely moderate the international tourism rebound from 2023. Moreover, increasing environmental awareness may see more tourists stay local rather than travelling long distances. In France and Germany, domestic tourism makes up 64.8% and 76.3% of total tourism, respectively, according to MKG Consulting. On the other hand, Spain and Greece rely more on international tourism. Finally, in a period of economic uncertainty, companies may also possibly contain business travel expenses and favor less expensive hotels.

What if the situation worsens beyond our expectation?

As the economic conditions remain volatile and uncertain, we have run a rating sensitivity analysis. In our downside scenario, we assume that RevPAR could stand at 75%, 80%, or 85% of its 2019 levels in 2023, which would lessen hotels landlords' variable portion of revenues by the same extent. In addition, our sensitivity analysis assumes that these landlords' cost structures could be 10% higher than in 2019, partly offset by potential end-customer price increases.

We forecast that most of our rated hotels REITs could absorb such scenarios over the next 24 months, at the same rating level.

CMBS

As for hotel operators and REITs, pressure on revenues would affect the net cash flow situation for CMBS loan borrowers and could subsequently impair their ability to make timely interest payments and refinance their loans when they come up for maturity. In July 2020, we took rating actions on our three European CMBS transactions backed by U.K. hotel properties (see "Various Rating Actions Taken In Three European Hotel-Backed CMBS Transactions," published on July 1, 2020). Two years later, we observe that, even though cash flows and valuations have not reached pre-pandemic levels, the hotels backing those transactions are gradually recuperating. We nevertheless recognize that recovery may be hindered by uncertainty on international travel and inflationary pressures. We therefore investigate the impact of lower RevPAR recoveries and increase in operational costs on our ratings.

Helios (European Loan Conduit No. 37) DAC

Helios is backed by a single loan, secured against a portfolio of 49 limited-service hotels, comprising 6,129 bedrooms, located across the U.K. The portfolio mostly comprises Holiday Inn Express Hotels plus the Hampton by Hilton in Liverpool, and Park Inn in York. The transaction closed in December 2019.

On July 1, 2020, we lowered our S&P Global Ratings RevPAR to £55.7 from £56.4, after which we lowered our S&P Global Ratings Value (see "CMBS Global Property Evaluation Methodology," published on Sept. 5, 2012) to £400.8 million from £414.9 million.

The loan was transferred into special servicing on Nov. 23, 2020, following a breach of the debt yield covenant, triggering a sequential payment event.

In January 2021, Cushman & Wakefield provided an updated valuation of the portfolio, decreasing it to £472.0 million from £561.1 million.

The class E notes started showing interest shortfalls from the February 2021 payment date, because of the special servicing fees that were now due. The class E notes do not benefit from access to the liquidity facility. According to the loan agreement, it is the borrower's obligation to pay these special servicing fees but based on our discussions with the special servicer, these fees were not received. On Sept. 30, 2021, we lowered our rating on the class E notes to 'D (sf)' following failure to pay full and timely interest.

Following an amendment and waiver letter dated Sept. 28, 2021, the lenders waived the loan-to-value (LTV) and debt yield loan events of default on the test dates falling in October 2020, January 2021, April 2021, and July 2021. The loan returned to primary servicing in April 2022.

On Oct. 29, 2021, the borrower prepaid the senior loan by £30.0 million, and deposited £13.5 million into the debt service account in accordance with the terms of the amendment and waiver letter to be applied on the January, April, July, and October 2022 payment dates.

The U.K. government lockdown restrictions ended on July 19, 2021, allowing all hotels in the portfolio to fully open.

Chart 4

The COVID-19 pandemic and the U.K. government lockdown restrictions significantly affected the Helios portfolio in the first half of 2020, as hotels were only open for key workers or as quarantine hotels. Occupancy remained low throughout 2020, allowing for a brief increase during the summer. Occupancy started to recover in the spring of 2021 as lockdown restrictions had been easing. By May 2021, all hotels in the portfolio were allowed to open, albeit with certain restrictions on household mixing and the number of guests allowed in a group. Most restrictions were lifted in July 2021.

As of December 2021 (last reported data), the 12-month average ADR had fully recovered to its pre-pandemic level (that is, the 12-month average reported in June 2019), while 12-month occupancy had recovered to 80% of its pre-pandemic levels and RevPAR to 84%.

On July 1, 2020, we lowered our RevPAR assumption to £55.7 from £56.4. As of March 2022, the 12-month average RevPAR was 86% of our RevPAR assumption.

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Magenta 2020 PLC

Magenta 2020 is backed by one loan, which was raised in December 2019 to facilitate the acquisition of 17 full-service hotel properties in the U.K. The £270.9 million securitized loan is backed by seven Crowne Plaza hotels, three Doubletree by Hilton, three Hilton Garden Inns, one Holiday Inn, one Hotel Indigo, and two AC Hotel by Marriott branded hotels spread throughout the U.K. The transaction closed in March 2020.

On July 1, 2020, we lowered our S&P RevPAR to £65.3 from £68.4. We then lowered our S&P Value to £323.7 million from £352.0 million.

In August 2021, Savills provided an updated valuation of the portfolio, decreasing it to £384.4 million from £435.6 million.

The senior debt yield test had been in breach since September 2020. In December 2021, the noteholders agreed to waive the senior financial covenants and to extend the loan maturity date to December 2024.

The senior loan has started to amortize by £1.4 million per quarter since the December 2020 payment date.

Chart 7

The hotels in the portfolio were compelled to close in March 2020. Performance remained limited between July 2020 and May 2021 due to restrictions on corporate and international travel or hotels being limited to only housing vital personnel. As the hotels reopened to the public, spring and summer 2021 saw a pick-up in domestic U.K. leisure demand as well as some corporate travel. In Q3 2021, ADR ranged between £77 and £131, with occupancy ranging from 69% to 93% across the portfolio. The winter months saw weekend leisure demand in the larger cities and an increase in small corporate meetings and events. However, since the outbreak of the Omicron variant, the borrower saw bookings decline.

Whilst ADR is at 106% of its November 2019 level, occupancy only stands at 69% of November 2019 level. As a result, RevPAR is at 78% of its November 2019 level.

On July 1, 2020, we lowered our S&P RevPAR to £65.3 (90% of the pre-pandemic level) from £68.4. Last reported RevPAR is 86% of S&P RevPAR.

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Ribbon Finance 2018 PLC

Ribbon Finance 2018 is backed by one senior loan, which was originated in April 2018 to facilitate the acquisition by the borrower sponsor of 17 Holiday Inn hotels and three Crowne Plaza hotels throughout the U.K. The transaction closed in June 2018. Two Holiday Inn hotels have been sold since closing.

On July 1, 2020, we lowered S&P Global Ratings RevPAR to £66.2 from £67.5, after which we lowered our Value to £452.8 million from £481.0 million.

In July 2020, the servicer agreed to certain waivers, consents, and amendments in response with the COVID-19 epidemic and the resultant temporary closure of certain hotels, with the goal of allowing the senior obligors to manage their immediate liquidity and operations without breaking their obligations under the senior finance documents. The sponsor promised to cover any shortfalls in operating expenditures and debt servicing with proceeds from subordinated debt or equity until July 13, 2021. In exchange, the senior loan facility agent has agreed to waive any senior loan event of default.

In April 2021, the servicer, senior loan facility agent, and borrower agreed to extend the in-place waiver term until July 13, 2022. The backward-looking covenants (ICR and debt yield) were waived in exchange for, among other arrangements, a £58 million paydown of the loan at the April 2021 payment date.

In July 2021, Savills updated its valuation of the 19-hotel portfolio, decreasing it to £528.1 million from £618.1 million.

The Best Western Ariel hotel was sold in November 2021.

Chart 10

In March 2020, the U.K. government ordered all hotels to close. Three were rented to the government and six others remained open for key workers. In July 2020, the government announced that all hotels were able to reopen, with social distancing rules in place. Except for the HI Heathrow Ariel, all hotels were open as of October 2020, with two of the open hotels having a sole use agreement until mid-November 2020. The government announced a new nationwide lockdown in January 2021. The borrower kept all hotels open (except for the Heathrow Ariel) for key workers or special circumstances. In May 2021, the U.K. relaxed restrictions, allowing hotels to open to the public. All restrictions were lifted in July 2021 allowing the hotels to be fully utilized for events with no limit on guest numbers.

Chart 11

Total portfolio revenue was reduced by the sales of Holiday Inn Bloomsbury in December 2019 and Best Western Heathrow Ariel in November 2021.

Revenue has been increasing since Q2 2021 due to the U.K.'s easing of restrictions in June 2021 and improvements in the hotels operations.

Chart 12

Since the outbreak of COVID-19 and the related challenges, the hotel's management has been steering the performance by taking steps to reduce costs, such as furloughing employees, reducing casual/agency employees, or negotiating with suppliers to get discounts and to rebate some invoices.

Scenario analysis

In our view, RevPARs have recovered to 65%-85% of their pre-pandemic levels. We note, however, that it may drop in 2023 once the surge in leisure occupancy stabilizes. We are also mindful of inflationary pressure and a possible increase in operating costs. In our view, our current base cases for the three U.K. hotels' CMBS transactions encompass those risks. We still expect those transactions to recover to RevPAR and net operating income (NOI) levels in line with our July 2020 analysis over the long term. However, we have performed a stress scenario analysis to determine, on an indicative basis, our ratings' sensitivity to a recovery at lower RevPAR and NOI levels than our current assumptions by modeling a decrease in our RevPAR assumptions, coupled with an increase in our operating cost assumptions. These scenarios assume that such levels of RevPAR and costs represent the new norm applicable over several property cycles and are not just a temporary stress. These levels do not represent our expectations, but rather a hypothetical sensitivity range to gauge the ratings movements and changes in the S&P values.

• Scenario 1: We lower our S&P RevPAR by 5%.
• Scenario 2: We lower our S&P RevPAR by 5% and increase our operating costs assumptions by 5%.
• Scenario 3: We lower our S&P RevPAR by 5% and increase our operating costs assumptions by 10%.

Table 3

Since our last review in July 2020, the total number of rooms increased to 6,129 from 5,972. Therefore, even a decrease in our RevPAR assumption may lead to a higher total revenue.

Table 4

Table 5

Since our last review in July 2020, the senior loan has amortized by £100.5 million. As a result, our adjusted LTV ratio decreased to 62% from 85%.

Conclusion

We note that since our last review in July 2020, U.K. hotel CMBS transactions have seen some positive developments (namely an increase in the number of rooms and leverage reduction of the securitized loan following covenant waivers). Despite the good news, however, we did not judge that a rating action was warranted. If the sector recovery occurs in line with our current assumptions, or if hotel management teams succeed in containing the increase in operational costs, we may see potential for positive rating actions.

However, if we saw increased levels of operating costs, coupled with lower RevPAR than we currently expect, we may see downward pressure on the ratings.

Related Research

• InterContinental Hotels Group PLC, April 25, 2022
• Industry Top Trends 2022: Real Estate, Jan. 25, 2022
• Accor S.A., Dec. 21, 2021
• Helios Finance DAC Class E U.K. CMBS Rating Lowered Following Nonpayment Of Interest, Sept. 30, 2021
• As European Hotels Grapple With Prolonged Restrictions, Are Operators And Landlords Sharing The Pain? Feb. 24, 2021
• Various Rating Actions Taken In Three European Hotel-Backed CMBS Transactions, July 1, 2020
• Presale: Magenta 2020 PLC, Feb. 12, 2020
• New Issue: Helios (European Loan Conduit No. 37) DAC, Dec. 19, 2019
• New Issue: Ribbon Finance 2018 PLC, June 8, 2018