Balloon Repayments Pose Threat to European CMBS
Despite falling commercial property values across Europe, the number of loans in payment default remains extremely low across European commercial mortgage-backed securities (CMBS), according to Fitch Ratings. “This will inevitably rise in the coming year as economies slow and corporate insolvencies increase, but is still not expected to be the principal cause for concern for CMBS ratings across the continent,” Fitch says in a new report. “It is the risk that borrowers will be unable to make their balloon payments at loan maturity that represents the greater risk.”
The combination of declining property values with a restricted new lending market, means that borrowers facing loan maturity in the near future may well struggle to make expected balloon payments, at least in a timely manner.
“Declines in European commercial property values have been greatest in the UK, while other property markets that contribute significant collateral to European CMBS, including Germany and France, suffered relatively slight value declines. This reflects the strength of the preceding boom in capital values in the UK and is likely to bring greater downward rating pressure on UK CMBS than in other European countries. However, rating actions are likely to be restricted to the junior tranches, with most senior tranches still adequately covered.”
“The weakening performance of the UK property market will only fully translate into the performance of CMBS when properties have to be sold or refinanced to repay the loans,” says Euan Gatfield, Senior Director, in Fitch’s EMEA CMBS team. “This is unlikely to be the case for many loans in the near future as they are not scheduled to reach maturity and, unless tenant defaults result in reduced cash flow, interest service payments are likely to be made until then.”
The German property market appears to have shown relative resilience to the credit crunch. This, coupled with the fact that German banks continue to have access to wholesale funding via Pfandbrief issuance, allowing them to continue lending in significant volumes, is supporting property values. Fitch, however, cautions that although the multi-family housing market remains stable and is set to produce steady rental income in support of many loans, the costs required to effectively operate a portfolio of multi-family housing have increased in many cases, leaving several borrowers at increased risk of loan payment defaults.
French occupational markets remain close to equilibrium and so again overall valuation declines in France are expected to be relatively muted. Markets focused on the financial services sector are likely to be the first to suffer, including the La Defense district of Paris. However, new development has been muted across Paris, limiting the likely effects of declining demand.
For details see Fitch’s European Structured Finance CMBS Outlook - October 2008.
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