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Blackstone sale could be tip of the iceberg for Irish retail property

Retailers have been hit hard by Covid-19 and the two main banks have significant exposure to retailers and landlords, writes Dan White

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Both Francesca McDonagh at Bank of Ireland (pictured) and AIB’s Colin Hunt have seen an increase loans to retail and property that are now classified as riskier as a result of lockdowns. Photo: Fergal Phillips

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Ireland’s main shopping streets have been left hurting thanks to Covid and clicks online. Photo: PA
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Both Francesca McDonagh at Bank of Ireland (pictured) and AIB’s Colin Hunt have seen an increase loans to retail and property that are now classified as riskier as a result of lockdowns. Photo: Fergal Phillips

If you're a company hoping to get bad news out of the way with the least possible fuss, then by far the best time to release it is the Friday of a bank holiday weekend. Hopefully, public interest will have moved on to the next sensational news item by the time everyone heads back to work on Tuesday morning.

Last Friday week (October 23), as most of us were preparing for the oddest October bank holiday weekend of our lives, news broke that Blackstone, which paid €1bn for the Blanchardstown Centre in 2016, was preparing to offload the centre onto Goldman Sachs - it was Goldman which provided the mezzanine finance, the money ahead of the equity in the financial queue but behind the bank lending, for the 2016 deal.

With 1.2 million square feet of retail and leisure space, along with a further 1.6 million square feet of potential development space, Blanchardstown is the largest retail centre in Ireland. It has 180 stores, 7,000 parking spaces and was visited by 16.5 million people in 2019. Unfortunately, one of those stores was a large Debenhams outlet that shut its doors permanently in April. Despite apparently pulling out of Blanchardstown, Blackstone remains a major player in the Irish property market. With over $580bn of assets under management globally, it invested a further €600m in Irish office and warehouse property this year.

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Blackstone had been seeking a debt reduction from Blanchardstown's lenders, which apart from Goldman also includes AIB. The investment company had valued Blanchardstown at €900m - significantly less than the 2016 purchase price - at the end of 2019. This figure included borrowings of at least €735m.

This reduction in Blanchardstown's value shows that most categories of non-food retail were already under pressure from the relentless rise of the online retailers even before the pandemic. However, Covid-19 and its associated lockdowns have transformed what had been up to then a more or less orderly retreat into a full-scale rout.

And big funds such as Blackstone are not the only ones with an exposure to the most troubled sectors of the economy. At the end of June AIB had €7.1bn of loans to property and construction companies (including shopping centres) and a further €1.6bn of loans to retailers and wholesalers on its books. Bank of Ireland had €8.2bn of loans to property and construction companies and €2.4bn of loans to retailers and wholesalers on the same date.

How have these loans been affected by the pandemic?

Under the recently-introduced IFRS 9 financial reporting regulations, banks are obliged to include their loans in one of three categories. Loans categorised as Stage 1 are expected to be fully repaid with no loss to the bank while Stage 3 loans are impaired with the bank believing it is unlikely to be fully repaid.

Stage 2 loans are those where the bank has not yet decided if it will get all of its money back, but is starting to get worried. In the first half of this year AIB moved €1.9bn of its property and construction loans and €300m of its retailer and wholesaler loans from Stage 1 to Stage 2 while Bank of Ireland moved €1.9bn of its property and construction loans and €240m of its retailer and wholesaler loans in the same direction.

For AIB that means €2.7bn of its property and construction loans and €600m of its wholesaler and retailer loans (both about 38pc of the total) are now categorised as being either Stage 2 or Stage 3.

The situation is if anything even grimmer at Bank of Ireland, where €4.4bn of its property and construction loans (53pc of the total) and €716m of its wholesaler and retailer lending (almost 30pc of the total) are similarly categorised.

Based on those numbers it is clear that both of the major domestic banks are expecting bad news, lots of bad news, from the retail sector.

AIB and Bank of Ireland released their third-quarter statements last week. The good news - such as it was - things hadn't got any worse for their property and retailer loans since the publication of their half-year results in August.

"Nobody was prepared for the first lockdown," says Davy Stockbrokers financial analyst Diarmaid Sheridan. "This time more retailers are doing things like click and collect and operating their own websites".

"The initial reaction [of the banks] was to provide payment breaks across the [retail] sector. That bought landlords and tenants space. Landlords were able to offer rent breaks. We are now coming to the end of these [payment break] periods".

Unlike the post-2008 crash, where banks attempted to assess their likely loan losses on the basis of what was happening in the present, IFRS 9 forces them to look forward and provide now for future loan losses. The hope is that this will prevent unpleasant surprises where shareholders and regulators are suddenly confronted by unexpected losses.

AIB set aside €1.2bn to cover such expected credit losses in the first half while Bank of Ireland took a €937m hit. Even after these charges both of the Irish banks remain well-capitalised with Davy predicting a year-end CET 1 capital ratio of 14.5pc at AIB and 13.2pc at Bank of Ireland.

Will these provisions be enough? Only time will tell.

"It will be first or second quarter of next year before we see the areas that are in the most difficulty in these business [property and retail]", says Sheridan.

With offline retailers and the shopping centres and main streets that house them in seemingly long-term decline as more and more purchases migrate online, the banks are discovering that lending to retailers and their landlords is becoming an increasingly risky proposition.

When governments throughout the developed world shut down their economies last spring, traditional brick and mortar retailers suddenly found all of their worst nightmares coming true simultaneously.

At the same time as they were forced to shut in order to protect public health, business boomed for online retailers with sales at Amazon jumping by 40pc to almost $89bn in the three months to the end of June.

Amazon's gains were traditional retailers' losses. In April UK retailer Debenhams called in the administrators across the water and pulled the plug altogether on its Irish operation, triggering a bitter dispute with its former workers. Fashion chains Oasis and Warehouse have also exited the Irish market.

Even those retailers, both indigenous and foreign-owned, that managed to survive the initial Covid-19 tsunami were confronted by an existential threat as online retailers grabbed a massive 39pc of non-food, motor and bar sales in April and 29pc in May during the depths of the first lockdown.

So just how bad are things for the country's retailers?

"The second lockdown is bad news for most of the [retail] sector, particularly for businesses that are closed or partially closed. A lot of our members have not resolved issues arising from the first lockdown. The second lockdown is going to create acute challenges", says Arnold Dillon of IBEC's Retail Ireland.

"Transactional activity in the retail property market remains largely paralysed", wrote Marie Hunt, head of research at property consultants CBRE, in a recent report. "Most retailers are focussed solely on the survival of their core businesses at present".

With their shops closed, most retailers have found it extremely difficult to pay their rents. While hard numbers are difficult to obtain, there are a number of straws in the wind.

UK property firm Hammerson owns several major retail centres in this country including the Dundrum Centre, the Ilac, the Pavilion and the Kildare Outlet Village. When it reported its half-year results on August 6th Hammerson revealed that it had received only 46pc of the rents due from tenants at Dundrum, ILAC and the Pavilion for the three months to the end of June and just 25pc for the three months to September.

Hammerson published a rent update on October 15 in which it disclosed that just 33pc of the fourth quarter rent due on its Irish properties (including Kildare) had been collected so far. The only consolation Hammerson could offer to its shareholders was that the proportion of fourth quarter rents collected was higher than at the same stage for the third quarter.

Meanwhile UK pharmacy chains Boots, which has 87 stores in Ireland, has stopped paying rent on several of its outlets and is being sued by some of its landlords for unpaid rents. Other Irish-based retailers in dispute with their landlords include Schuh, Heatons and Topman.

"We are hearing mixed stories from across the sector. In some cases we have seen landlords recognise the challenge and engage with their tenants. While there have been some positive stories, unfortunately some landlords have shown no willingness to engage", says Dillon.

Such unwillingness is not exclusively the product of bloody-mindedness on the part of landlords, many of whom have large bank borrowings.

Sunday Indo Business

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