Overview
- We have reviewed Westfield Stratford City Finance No. 2 as part of our ongoing surveillance.
- 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) Aug. 19, 2022--S&P Global Ratings today lowered to 'AA- (sf)' from 'AA (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 the retail sector is still suffering from structural changes, and rising energy prices in the near term could put further pressure on retailers and consumers. The contracted rent for the shopping center has continued to decline further since our last review. Some tenants have had their contracted rental agreements reduced and other tenants that are on company voluntary arrangements have had their traditional rent-based lease agreement amended to a sales-based lease.
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 2.0 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 4 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 93% occupied and leased to over 269 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 3.9 years (down from 5.1 years at closing in July 2019 and marginally up from 3.4 years at our last review in March 2021), with a tenant profile generally incorporating internationally and nationally recognized retailers and food and beverage/leisure operators. The top 10 tenants combined represent approximately 30% of the contracted rent compared to 26% at our last review, with the largest tenant contributing 7.5% and no other tenant contributing more than 4.5%.
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. However, there is a shift in the retail sector where tenants are regearing leases at lower rents.
Some leases in the shopping center also include turnover rent, stepped rent, and index-linked rent clauses.
Based on the last reported market valuation (March 31, 2021) of £1,760 million (down from £2,332 million at March 31, 2020), the transaction has a reported loan-to-value (LTV) ratio of 43% compared to 32% at our last review. The servicer has confirmed that a new valuation will be completed and disclosed on the next payment date.
Retail assets are still recovering from the effects of COVID-19 and the change in customer habits. An increasing number of retailers are still suffering financial difficulties in the aftermath of the COVID-19 pandemic and this is further exacerbated by the change in consumer habits and the rise in inflation.
Vacancy rates at the shopping center have increased to 6.8% from 4.0% since our last review. Furthermore, there is a concentration of leases scheduled to expire in the next 48 months (approximately 50% 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 6% to £1,223 million from £1,304 million, primarily due to a lower rental income assumption of the property which we believe will continue in the near term due to the current economic climate. Having considered updated performance data together with comparable market evidence, we have reduced the S&P Global Ratings net cash flow (NCF) to £83.7 million from £89.2 million.
We have then applied a 6.5% capitalization rate against this S&P Global Ratings NCF (which is the same as at our last review) and deducted 5.0% of purchase costs to arrive at our S&P Global Ratings value.
Table 1
| Loan And Collateral Summary | ||||||
|---|---|---|---|---|---|---|
| Review | March 2021 (using data from February 2021) | August 2022 (using data as from July 2022) | ||||
| Securitized loan balance (mil. £) | 750.0 | 750.0 | ||||
| Securitized LTV ratio (%) | 32 | 43 | ||||
| Net operating income (mil. £) | 55.3* | 83.3* | ||||
| Vacancy rate (%) | 4.0 | 6.8 | ||||
| Market value | £2,332 million | £1,760 million | ||||
| Date of market value | March 31, 2020 | March 31, 2021 | ||||
| Equivalent yield (%) | 5.1 | 5.1 | ||||
| Interest coverage ratio | 4.68x | 7.83x | ||||
| *This figure reflects actual rents collected, rather than contracted rents due. LTV—Loan-to-value. | ||||||
Table 2
| S&P Global Ratings' Key Assumptions | ||||||
|---|---|---|---|---|---|---|
| Review | As Of March 2021 | As Of July 2022 | ||||
| S&P Global Ratings gross potential rent (mil. £) | 119.3 | 113.6 | ||||
| S&P Global Ratings vacancy (%) | 7.5 | 7.5 | ||||
| S&P Global Ratings expenses (£) | 22.3 | 22.8 | ||||
| S&P Global Ratings net cash flow (mil. £) | 89.2 | 83.7 | ||||
| S&P Global Ratings value (mil. £) | 1,304 | 1,223 | ||||
| S&P Global Ratings cap rate (%) | 6.50 | 6.50 | ||||
| Haircut-to-market value (%) | 44 | 30 | ||||
| S&P Global Ratings LTV ratio (before recovery rate adjustments; %) | 57.5 | 61.3 | ||||
| LTV--Loan to value. | ||||||
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 October 2021, January 2022, April 2022, and most recently July 2022, were £51.6 million, £68.1 million, £84.3 million, and £83.3, respectively. The reported trailing 12-month net operating income has increased since all the COVID-19 U.K. restrictions were lifted in February 2022 but has not reached the level of approximately £108.5 million per year as was seen before the onset of the COVID-19 pandemic.
The collection rates have increased since our last review in March 2021, and in turn the available cash flow generated from the property is sufficient to service the debt payments on its own. At the July 2022 interest payment date, the reported interest coverage ratio had increased to 7.82x compared to 4.68x at our last review.
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.
The contracted rental income decline reflects the ongoing structural shift in the physical retail sector, as well as the impact of the current economic climate on consumers' disposable income. We also expect vacancies to rise due to increased energy bills and rising inflation. We believe that these factors may continue to constrain the cash flows available to the issuer.
The increasingly challenging environment for retail tenants is affecting this transaction, which is reflected in 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 61.3% for the fixed rate notes. Together with transaction-level considerations, we have therefore lowered to 'AA- (sf)' from 'AA (sf)' our rating on the notes.
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
- Criteria | Structured Finance | CMBS: CMBS Global Property Evaluation Methodology, Sept. 5, 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 Q2 2022, July 19, 2022
- S&P Global Ratings Definitions, Nov. 10,, 2021
- Westfield Stratford City Finance No.2 U.K. CMBS Notes Rating Lowered, March 11, 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
| Primary Credit Analyst: | Carla N Powell, London + 44 20 7176 3982; carla.powell@spglobal.com |
| Secondary Contact: | Mathias Herzog, Frankfurt + 49 693 399 9112; mathias.herzog@spglobal.com |
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