U.K. care home operator Southern Cross is in the middle of a financial restructuring that could affect several U.K. CMBS structures, according to a Barclays Capital report.

The CMBS are tied to Ashbourne Group, which was acquired by Southern Cross in 2005.

According to Barclays, the Ashbourne Portfolio whole loan defaulted and was transferred into special servicing, because of the borrower being in breach of certain clauses in the credit agreement.

Half of the Ashbourne Portfolio Priority A loan (Ashbourne loan) with a securitized balance of ₤73.3 million ($118.4 million) is securitized in Equinox Eclipse 2006-1 (27.8% of the portfolio). The remaining 50% of the Ashbourne loan is securitized in Hercules Eclipse 2006-4 (9.3% of the portfolio).

In addition to the Ashbourne Portfolio Priority A loan, there are four junior loans, bringing the current whole loan balance to ₤330 million.

The whole loan is secured by 91 care homes throughout the U.K. that were valued at ₤261 million as per 4Q10 (whole loan LTV of 126% and Ashbourne Priority A loan LTV of 44.4%).

According to the Barclays report, at closing, the single tenant of the care homes was the Ashbourne Group. The sponsor of the non-recourse Ashbourne loan is London & Regional.

The investor notice does not state which clause of the credit agreement the borrower is breaching because the credit agreement is not public.

"Given that Southern Cross recently unilaterally decided to defer 30% of its monthly rental payments from June 1, 2011 to  September 30, 2011, we believe the event of default could be related to either a default of the tenant under its lease or a payment default under the loan which has its next interest payment date on  June 15, 2011," Barclays analysts said.

They explained that a re-negotiation of the Southern Cross lease would also have a particular effect on the Ashbourne loan because the lease is linked upward only to the U.K. retail price index (RPI).

"To hedge the risk associated with unknown future inflation, the borrower entered at loan closing into a RPI inflation swap," they said. "Therefore, even disregarding potential rent reduction, if following the lease re-negotiation the terms of future rent adjustments are delinked from the terms of the LPI swap, the borrower faces basis risk that could result in a loan interest payment default."

In addition to the Ashbourne loan that is securitized in two Eclipse CMBS and Titan Europe 2007-1 (NHP), a fourth transaction could be affected negatively by the events surrounding Southern Cross.

According to Barclays, in the Deco 11 - UK Conduit 3, Southern Cross Healthcare contributed 5.5% to the total rent of the transaction. Southern Cross is tenant in seven of the nine nursing homes securing the Holmes Care Portfolio loan (₤23.8 million or 5.9%), contributing 82% to the loan's rent.

The latest investor report showed that the current interest coverage ratio (ICR) of the loan is 1.47x, and the debt service coverage ratio is 1.0x. The borrower's excess rental cash flow is used to repay the loan in accordance with the loan agreement.

"Given the high ICR, the loan could withstand a Southern Cross rent reduction, in our view; however, such a reduction would negatively affect the amount of amortization that can be expected until loan maturity in April 2013," explained analysts.   


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