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CDS point to testing time ahead for UK REITs

Published 02/09/2009, 11:36 AM
Updated 02/09/2009, 11:40 AM

By Sinead Cruise and Daryl Loo

LONDON, Feb 9 (Reuters) - Capital-starved UK property companies face an uphill struggle to calm fears about possible default on billions of pounds of their debt as shown by the high cost of buying protection in the credit derivatives market.

The cost of buying debt protection on UK commercial real estate company is steeply rising, as the British economy buckles and the property downturn lurches from bad to worse, according to pricing from data provider Markit.

CDS spreads for Anglo-French property investor Hammerson tightened dramatically on Monday after it unveiled a debt-reducing rights issue. But, Hammerson's move failed to improve CDS market sentiments on relatively high protection costs across the broader sector, a trader said.

UK property company CDS have widened in the last 18 months by between 17-times to 20-times, since the peak of the UK property market at end-July 2007 through to end-January 2009.

This compares poorly with the investment-grade iTraxx Europe index, whose spreads have tripled to about 150 basis points, from about 50 basis points over the same period.

Debt held by industrial property specialists Brixton and Segro are the most expensive to protect in the UK sector, with CDS spreads now at 935 basis points and 892.5 basis points respectively, both up 20-times from 18 months ago.

In July 2007, Brixton's five-year CDS were trading at 46.5 basis points, which meant it cost 46,500 euros a year to protect 10 million euros of its debt against default. Now, the same level of protection costs 935,000 euros a year.

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Confidence in Hammerson's ability to pay back its bonds rebounded after the company unveiled a fully underwritten seven-for-five rights issue it hopes will raise almost 600 million pounds ($893 million) of new capital.

The credit trader said Hammerson's CDS price tightened by about 100 basis points from about 917 basis points late on Friday in response to the news, though some property analysts warned Hammerson's financing problems may not be over yet.

"Hammerson has been cornered into a deeply discounted rights issue to restore its covenant headroom, but in doing so has erased a decade of growth ... a further 25 percent fall in values puts it back in the danger zone on our calculations," Nomura said in a note to clients.

"We give them credit for having gone early and big in papering over the balance sheet cracks, but the strategy remains conventional in an unconventional cycle," the note said.

Credit spreads for the two biggest UK REITs, British Land and Land Securities, have eased by about a fifth since December 2008, when their CDS reached record wide levels in this cycle.

It now costs just under 732,000 euros a year to insure 10 million euros of Land Securities' debt against default, compared with around 721,000 euros to protect against the same amount of British Land debt, end-of-day Markit pricing on Feb. 6 showed. (Additional reporting by Natalie Harrison; Editing by Andrew Macdonald) (See www.reutersrealestate.com for the global service for real estate professionals from Reuters)

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