More distress expected as office woes hit Canary Wharf

The news coming out of Canary Wharf in recent weeks has not been positive for the landlord of the 128-acre estate in London’s Docklands, nor those which own or have lent against office assets there.

It emerged this week that investment bank UBS could make 35,000 posts redundant as the bank merges with Credit Suisse – which has thousands of staff at its office at the estate’s One Cabot Square.

Also in recent days, on 26 June, UK bank HSBC confirmed it was leaving the estate, the home of its world headquarters for two decades, and was in the process of negotiating a smaller lease at Panorama St Paul’s, 81 Newgate Street – in the City of London.

The news follows  credit ratings agency Moody’s downgrade, in May, of Canary Wharf Investment Holdings – which owns most of the estate – the holding company of Canary Wharf Group, owing to “weak credit metrics” and a difficult funding environment.

Lenders with exposure to the estate are also feeling the impact of falling office values. UK high street lender Lloyds Banking Group appointed fixed charge receivers over 20 Canada Square following the failure of its borrower, Chinese property group Cheung Lei, to repay debt against it. Creditors of 5 Churchill Place, also owned by Cheung Lei, have also appointed administrators and receivers for the same reason.

HSBC’s exit comes as little surprise, given it has been touting its move since last September, but it will have surprised Canary Wharf Group the least.

The company’s strategy of diversifying the area away from financial services and re-shaping it as a mixed-used district has been underway for several years owing to changing patterns of occupational demand. But the departure underscores the much more immediate issues facing owners and lenders across the estate, created by the changes in the world of work exacerbated by the covid-19 pandemic and the space shrinkages undertaken by business occupiers as a result.

Asset sales

Canary Wharf Group, jointly owned by Qatar Investment Authority and Brookfield Property Partners, has £1.4 billion (€1.6 billion) of mostly secured – but also bond – debt that will mature in 2024 and 2025. The next major maturity to tackle is a loan held against One & Five Bank Street, which expires in November.

It also needs to improve its current credit profile. Its fixed charge coverage ratio, which measures a firm’s ability to cover fixed charges, such as debt repayments, is 1.33x – an FCCR of 1, for instance, means a company lacks sufficient profitability to cover its fixed charges.

The group has said it intends to use asset sales to help refinance debts maturing this year and next. In the shareholder presentation of its 2022 financial results, in April, the company’s chief financial officer Becky Worthington, outlined that it was relying on asset sales as a major strategy for raising capital. But as the value of its office portfolio declines – by £522 million to £5.3 billion in 2022 – and amid a potential further deterioration in market values, this is an avenue not currently open to CWIG.

Asked by a shareholder about what she intended to do to improve the company’s interest coverage ratio given higher for longer interest rates, Worthington replied: “This is just an issue we have to tackle, isn’t it? Really the only thing we can do to improve ICR in that context is to make sales… but only in stabilised market conditions. We are not a distressed seller and given the market is showing a real lack of liquidity, it is not sensible to take assets to market.”

Ramzi Kattan, vice-president and senior credit officer, Moody’s, which oversees the company’s ratings, said in an interview with Real Estate Capital Europe: “The recovery in investment volumes is going to be delayed but the company’s strategy is heavily reliant on the ability to sell these assets, and this is their best strategy due to the difficult funding environment. These assets are good quality but to sell them in the current market they would need to offer a significant discount.”

While the upcoming secured bank debt maturities are ringfenced in special purpose vehicles, leaving those lenders with no recourse to the company, walking away from the assets is not likely.

With property sales, for the short term, looking unachievable, and the bond markets remaining difficult for CWIG to access, repaying debts against assets on the estate will not be easy. But several factors are in its favour.

The group has a weighted average lease expiry of 10 years which, Kattan said, will enable the company to manage the assets on a case-by-case basis, gradually repurposing or selling them when market conditions improve: “They have a staggered and long-dated lease expiry profile, which means if tenants leave it won’t overwhelm them in any one particular year.”

More distress to come

However, CWIG is not the only owner on the estate – and the ability of other owners to repay debts or sell assets will be less feasible, some market participants believe.

At present, Canary Wharf’s vacant offices total 3 million square feet, 750,000 square feet of  which is owned by Canary Wharf Group. But across the total 3 million square feet of vacant space, only 250,000 square feet, according to the company, is of prime quality.

CWIG’s director of investment Andrew King explained to shareholders during the April presentation: “There is a lot of space on the estate and a lot of the space is at a lower quality – both in terms of physical quality and also available lease quality than the space CWIG itself has to offer.”

Over the next two years, therefore, market observers say owners and lenders invested in offices there are in for a tough time. “There will be more pockets of distress, where owners cannot refinance, and there will be instances where lenders will take a haircut,” said Jonathan Jay, partner at debt adviser, Conduit Real Estate.

“The estate as a whole is undergoing a transformation, just look at the number of residential properties – which have gone from close to zero to nearly 3,500. Clearly the management team have taken pre-emptive measures well in advance of recent events. I have no doubt in my mind that eventually it will succeed as a destination, but there is a difficult time in the near term,” he added.

Jay predicts senior lenders in these more distressed positions will not want to take keys on buildings that could be repositioned to fit the estate’s future as a mixed-use neighbourhood. Instead, he expects them to follow the strategy of Lloyds Banking Group.

“Senior lenders are not in the business of hoping things get better, they are in the business of getting repaid. For buildings that need to be repurposed it will require someone to take a view but it will cost money,” Jay explained.

Deepak Drubhra, co-founder at London-based debt advisory firm Westfort Advisors, said the office sector is in for a tough time, a problem magnified in Canary Wharf, given lenders want to fund long-term secure income, or owners with deep pockets that are able undertake significant capex to align buildings with the latest environment standards.

He added: “A lot of stock coming up for refinance will actually not be that old and could satisfy occupier demand. But most bank lenders only want to finance the best offices, with the highest ESG credentials, or private debt funds will finance value-add plays where the business plan is to deliver top quality space.”

The challenge, Drubhra adds, will be financing offices with short weighted average unexpired lease terms, which were last refurbished five or six years ago. These assets he said, are not financeable by banks and the cost of private debt is too high for borrowers, adding: “There will be many stranded assets across London and that will be the case at Canary Wharf, too.”