Southern Cross restructuring triggers CMBS default crisis

Equinox, Hercules and DECO deals may be hit, Barclays Capital warns

The restructuring of struggling care homes operator Southern Cross could hit several European CMBS deals, according to a Barclays Capital report. Southern Cross has agreed with its lenders and landlords to work towards a solution to the company’s financial problems in the next four months. But a potential renegotiation of a Southern Cross lease could affect the £146m of securitised debt linked to 91 care homes leased by its subsidiary, Ashbourne Group, because the lease is linked upward only to the UK retail price index (RPI).

To hedge inflation risk, the borrower entered into an RPI inflation swap when the loan closed, BarCap said. “Even disregarding potential rent reduction, if, following lease renegotiation, the terms of future rent adjustments are delinked from the terms of the RPI swap, the borrower faces basis risk that could result in a loan interest payment default,” the report added. Southern Cross asked its landlords to defer 30% of its monthly rent until the end of September, following a drop in fees from local authorities due to government cuts.

The loans have already gone into default and been transferred to special servicing. BarCap said this could be down to a default of the tenant under its lease or a payment default under the loan. The Ashbourne loan is securitised in two separate Barclays Capital CMBS deals – Equinox Eclipse 2006-1 and Hercules Eclipse 2006-4. Four junior loans totalling £184m are also secured against the homes, taking the total debt to £330m. London & Regional is the landlord.

The £23.8m Holmes Care Portfolio loan within the DECO 11-UK Conduit 3 CMBS is also exposed to Southern Cross, which contributed 5.5% to the deal’s total rent. It is tenant to seven of the nine homes securing the loan, contributing 82% to its rent. The loan’s interest coverage ratio (ICR) is 1.47x; the debt service coverage ratio is 1.0x. The borrower’s excess rental cash flow is used to repay the loan, as stipulated under the loan agreement.

“Given the high ICR, the loan could withstand a Southern Cross rent reduction,” BarCap noted. “But this would negatively affect the amount of amortisa-tion that can be expected until loan maturity in April 2013.” Southern Cross is also the main tenant of the £610m Libra loan in Titan Europe 2007-1
(NHP), which is in special servicing after maturing last year.

The borrower, Nursing Homes Properties, has the biggest exposure to Southern Cross of the 20 landlords working on the restructuring, with about 265 homes. Other landlords include Bond Care and Four Seasons, which own 85 homes; Prestbury; and Quintain’s fund Quercus, which has eight.