Credit rating agencies are warning of a risk of further deterioration in the market for commercial real estate-backed debt.

Fitch Ratings said on Wednesday that deteriorating loan credit quality is creating downward pressure on ratings and highlighted uncertainty over whether loans could be refinanced when they matured. About 41 per cent of all Fitch’s publicly-rated European CMBS tranches – bonds secured against pools of commercial real estate mortgages – are at risk of potential rating cuts.

“Some of the largest loans in European CMBS are scheduled to mature in the next two to four years and it remains questionable whether markets will have improved enough by then to allow for orderly refinance,” said Euan Gatfield, a senior director at Fitch.

The constriction in new lending is contributing to breaches of covenants in a small but growing number of European CMBS loans. Fitch analysts said many more loans would be in default were it not for decisions by primary servicers to forgo testing loan-to-value covenants. At the start of this month, three issuers – Epic, Gemini and Plantation Place – were in breach of covenants, according to Fitch.

The agency warned investors, which include banks and insurance companies, of mounting problems for occupiers of commercial property. And while rental income on properties was allowing borrowers to service their debt, the threat of more tenants defaulting “cannot be ignored”.

Mario Schmidt, associate director at Fitch, said that while the impact of tenant defaults on European CMBS transactions had been muted so far, “as indicators of corporate distress ratchet up, the balance of power will continue its shift from landlord to tenant, an indicator of coming falls in market rents.”

Moody’s noted last week that the performance of a number of CMBS deals in Europe, the Middle East and Africa had deteriorated in the last quarter of 2008. It said it expected the performance of loans to deteriorate further and negative rating actions to increase significantly. Standard & Poor’s said this week it may cut the rating on more than 703 US CMBS transactions.

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