The first default of bonds backed by commercial mortgages in Europe could be on the cards after Standard & Poor’s yesterday downgraded a securitisation backed by a loan to 28 hotels in the Thistle chain.

The £530m deal, called Hoteloc, passed its expected maturity date in May 2005 and reaches its final legal maturity in May this year when all note holders are due to be repaid.

S&P said a sale of the portfolio of hotels is in danger of not being completed in time to repay the loan backing the bonds, which would lead to the first European default of a commercial mortgage backed security (CMBS).

“The hotels are due to be sold and the rating action follows further delays in the exchange of contracts with a potential purchaser,” S&P said. “We now have material concerns that, even if contracts on this sale are eventually exchanged, the sale will not be completed in time to allow proceeds to be used to repay the notes before legal final maturity.”

If there is a default, some investors are understood to be considering legal action to recover their investments.

The deal was sold by Morgan Stanley, the pioneer in CMBS transactions in Europe, in 2002.

The investment bank had no comment yesterday on the chances of the notes being repaid.

Originally, three London hotels in the portfolio were to be sold off and redeveloped as residential property, but two did not receive planning permission to become residential properties.

These hotels were eventually sold, but achieved a lower value than expected.

S&P said this deal was the first European CMBS to have its most senior AAA-rated notes downgraded.

The ratings on these were cut by two notches to AA yesterday, while the most junior B-rated classes of notes were cut to CCC. All notes remain on negative watch with a view to further downgrades.

Moody’s downgraded some of the notes at the end of last month when it cut the most senior bonds from Aa3 to Baa1 and the second most senior from A3 to Baa2.

It also has the notes on a negative outlook.

A proposed buyer has been found for the hotels, but deadlines for exchanging contracts have passed without a deal being finalised.

S&P said yesterday that failure to conclude a deal with the current proposed buyer could severely hinder attempts to sell the properties at a price that would cover all the money owed to bond holders.

“Further delays, or a reduction in communication of decisions to us, are likely to result in further negative rating actions on all classes of notes as the legal final maturity date approaches,” S&P said.

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