The HOTELoC structure found itself in the headlines again last week after the trust breached its interest cover ratio (ICR).

The transaction has been performing below expectations since early 2004.

Both Standard & Poor's and Moody's Investors Service downgraded classes of HOTELoC last week.

A breached ICR is a technical default in the transaction, the rating agencies noted. A draw was made from the minimum EBITDA guarantee during the first quarter of this year, following continued delays and a questionable outlook concerning the redevelopment process for several of the underlying hotel properties.

The terms of the loan agreement backing the HOTELoC CMBS deal require the borrowers in the transaction (Hotel Portfolio II U.K. Ltd and Hotel Portfolio II Jersey Ltd.) to maintain ICRs above 1.10X. The first quarter ICR figures came in at 1.6X.

Moody's placed all classes of HOTELoC on watch for downgrade (after downgrading several classes in March), whereas S&P has decided the ICR breach over the last quarter is not enough to substantiate a ratings change at the moment. S&P believes that the ICR breach over the past two quarters is due to the cyclical performance of the hotel sector. The agency has decided to take a long-term view on the transaction performance.

Moody's also notes that despite the technical breach, all required payments have been made on time. In March, Moody's downgraded the class B, C, D and E notes. The class B and C notes were lowered one notch to Aa3' from Aa2' and to A3' from A2', respectively. The class D and E notes received a two-notch downgrade to Ba2' from Baa3' and to B3' from B1', respectively.

The earlier rating was associated with litigation and allegations of fraud tied to the Orb Group (see ASR 3/17/03), which held the hotels securitized in HOTELoC. Moody's warned that the ratings would depend on the sale of the Hotel properties by the Orb Group, which announced that it intended to get out of the business.

Atlantic Hotels Group bought the hotel portfolio for just over GBP700 million last May, five months after the Serious Fraud Office (SFO) said it was investigating the alleged misappropriation of GBP33 million from Izodia, a software company in which Orb owned a 27% stake. Although the litigation proceedings did not affect the security or the priority of the mortgages, Moody's believed that it might affect the refinancing of the properties.

Following last week's action, the rating agency said it would continue to monitor further deterioration in the financial performance of the hotels, the implications of ICR breach and how the outstanding litigation issues will impact the hotel performance and capital expenditure utilization.

CMBS in distress

After downgrading U.K. super market retailer J. Sainsbury's long-term debt rating to Baa1' from A3', Moody's announced that it would follow by downgrading the retailer's sale/lease-back deals. Last week the agency lowered the ratings on Highbury Finance. Moody's also lowered class A and B notes of Dragon Finance to Baa1' from A3'.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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