Overview

• We have reviewed Meadowhall Finance PLC as part of our regular surveillance process.
• Following our review, we have affirmed 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. 6, 2023--S&P Global Ratings today affirmed its 'A (sf)' credit ratings on Meadowhall Finance PLC's class A1 and A2 notes. At the same time, we affirmed our 'BBB- (sf)', 'B+ (sf)', and 'B- (sf)' ratings on the class B, M1, and C1 notes, respectively.

Rating rationale

Today's affirmations follow our updated review of the transaction's credit and cash flow characteristics. Although the property's estimated rental value has increased slightly since our previous review, retail tenants remain vulnerable to reduced consumer spending and higher operating costs, in our opinion. Our S&P Global Ratings value has declined because of a higher vacancy assumption, taking into account the physical vacancy at the property and the broader U.K. shopping center vacancy rate. At the same time, the transaction has deleveraged through scheduled amortization, and the assumed hedge break costs in our analysis are now lower due to the current higher interest rate environment. We have therefore affirmed all the ratings in this transaction.

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 £482.0 million. At closing, two reserve tranches (the M1 and C1 reserve notes) were created, but remain unissued. While the issuance of these reserve tranches is subject to certain conditions (including rating agency confirmation), our analysis assumes a full issuance of the class M1 and C1 reserve notes, which currently total £135.3 million.

As of Sept. 30, 2022, the property's reported market value was £707.0 million, which reflects a 1.7% decrease from the valuation as of our previous review in February 2022 (see "All Meadowhall Finance PLC U.K. CMBS Ratings Lowered On Worsened Performance," published on Feb. 4, 2022). The decline in market value over the last year has been offset by the £37.3 million amortization of the loan. Consequently, the whole loan-to-value (LTV) ratio has decreased to 68.2% from 72.2% (or to 87.3% from 91.3% if including the reserve notes).

Rental performance over the same period has improved. The annual passing rent has increased by 2.6% to £66.5 million from £64.8 million, contracted rent has decreased by 0.6% to £67.9 million from £68.3 million, while the valuer's estimated rental value has increased by 0.9% to £53.4 million from £52.9 million.

The tenant profile comprises a combination of internationally and nationally recognized retailers (such as Marks & Spencer, Apple, Frasers, Primark, Next, Boots, H&M, Goldsmiths, Zara, and Vue cinema). However, the shopping center remains exposed to significant ongoing challenges with regards to retailer occupier demand and performance.

In recent years, an increasing number of retailers have suffered financial difficulties, which was exacerbated by the effects of the COVID-19 pandemic. We believe the environment remains challenging for retail tenants, and with energy prices expected to remain high in the near term, this could put pressure on both retailers and consumers. The risk of increased vacancy levels and diminishing rental levels remains. However, this risk is somewhat mitigated in the longer term by the property being among the prime super-regional shopping centers in the U.K.

Since September 2021, there has been considerable leasing activity with a mixture of short- and long-term leasing. The focus has been to maintain occupancy and optimize the customer experience when visiting the center. As of September 2022, the property's reported occupancy decreased to 94.8% from 96.5% in September 2021. The reported occupancy could decrease further if the units previously occupied by Debenhams and Topshop (both in administration), which together account for 10.6% of the center's gross internal area, are not relet. At the same time, the property experienced a reduction in weighted-average unexpired lease term until first break to 4.0 years (from 4.1 years).

The total amount of unpaid rent outstanding from tenants has decreased to £9.0 million as of November 2022 from £21.0 million at the end of November 2021, as the economy reopened and tenants returned to trading.

Funds in the excess cash flow reserve account from the Jan. 12, 2023 interest payment date are £16.6 million, up from £11.6 million as of January 2022. 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, including funds in the reserve account, is 66.6% and the net coverage ratio is 2.02x.

Since our previous review, our S&P Global Ratings value has decreased by 5.1% to £588.5 million from £619.8 million. This is primarily due to a higher vacancy rate assumption of the property of 13.0%, which takes into account the current physical vacancy at the center and the broader vacancy rate at U.K. shopping centers. Our S&P Global Ratings net cash flow (NCF) has decreased to £41.8 million from £44.0 million. We have then applied a 6.75% cap rate against this S&P Global Ratings NCF, unchanged from our previous review, and deducted 5% of purchase costs to arrive at our S&P Global Ratings value.

The retail sector remains vulnerable to lower consumer spending and increased costs. Consumer confidence is low and inflation and household energy costs are affecting consumers' discretionary spending. At the same time, online shopping penetration has declined after the end of lockdown, showing that physical stores retain their appeal to consumers. Rents have rebased and stabilized over the last few years, but remain exposed to further declines due to the weak economic environment, in our opinion.

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, which remain unissued.

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.

The transaction's credit quality has been affected by the ongoing structural shift in the physical retail sector. The challenging environment for retail tenants has resulted in increased vacancy levels across the sector. Our opinion of the long-term sustainable value is now 5.1% lower than at our previous review, because of our higher vacancy assumption taking into account the physical vacancy at the property and the broader U.K. shopping center vacancy rate.

However, substantial amortization in the transaction since our previous review--approximately 7% of the securitized loan balance--has offset this risk, in our opinion. In addition, the assumed hedge break costs, which could reduce recovery from the property sale in our analysis, are now lower due to the current higher interest rate environment. This is credit positive, in our view.

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 63.4%, 81.9%, 95.1%, and 104.9% 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.

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, Feb. 4, 2022
• 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