Canary Wharf Group Credit Review for Full Year 2023

This document is provided for information purposes only. The information and analysis contained in this document were compiled or arrived at from sources believed to be reliable. It was prepared with the greatest of care and to the best of the author’s knowledge and belief. Any information is expressed as of the date and time of writing. The information may change without notice and the author is under no obligation to inform you of any such changes.  It is not a solicitation or an offer to buy or sell any security or other financial instrument.  Nothing in this document constitutes investment, legal, accounting or tax advice. This document is not investment research and should not be treated as such. The author has not independently verified any of the information provided and no representation or warranty, express or implied, is made and no responsibility is or will be accepted by the author as to or in relation to the accuracy, reliability or completeness of any such information.  This document may provide the addresses of, or contain hyperlinks to, websites. The author has not reviewed any such site and takes no responsibility for the content contained therein. Such addresses or hyperlinks provided are solely for your convenience and information and the content of any such website does not in any way form part of this document. Accessing such websites or following such links through this report shall be at your own risk.

Credit Summary

Performance Key Takeaways

• Revaluation of the property portfolio with a reduction of £1.2Bln across the estate.
• The Canary Wharf Portfolio Asset Value now at £6.9Bln at FY’23. The revaluation wiping off 18% of the Office Estate and 10% of Residential values.
• Critically, occupancy rates have been ticking up in the Office segment to >90%.
• Average rent up to £60p/sft, with a longer average lease term to expiry of 9yrs against 6.4yrs at FYE’22.
• Good revenue numbers overall, with £491m in Underlying revenue (£475m FY’22), With an increase in EBIT to £261m (£238m FY’22).
• Along with a prepayment of leases from Barclays of £310m (for 10 Cabot Sq) producing top line revenue on top of the £491m of £789m. With EBITDA of £582m, and adjusted for covenant purposes (removing the £310m form the Barclays transaction) to Adj EBITDA of £272m.
• The Fixed Charge covenant ratio has been met at 1.31x for FY’23.
• Net Debt reduced to £3.7Bln from £4.2Bln due to the stronger cashflow and the £310m prepayment from Barclays.
  

Operating Key Takeaways

• Canary Wharf (“CWG”) very much back to full operating capacity, with room to grow the area in residential and community areas. The CWG has had to pivot away from some longer term fixed tenancies and diversify their revenue generating schemes in retail, restaurants, residential buildings and leisure, allowing for more innovative and flexible leasing agreements.
• Record Footfall in 2023 with over 67m visitors.
• 37 new Retail and Leisure openings.
• 3.5k people living full time in Canary Wharf.
• Financing milestones included £300m from shareholders, plus £100m RCF.

Development News

• Wood Wharf development financing of £535m.
• Morgan Stanley removed the 2028 break clause to extend to 2038 for 20 Bank St.
• Barclays also extended to 2039 for 1 Churchill Place, but is now sub leasing 10 Cabot Sq and CWG is looking for a new occupant.
• 1 Cabot Sq was inhabited by Credit Suisse for 25 years, and is currently being marketed by JLL. There is 183k Sq Ft for them to lease. This is a significant undertaking and illustrates a flaw in CWG’s operating model. With significant sized buildings, there is clearly a significant concentration risk where one large client like Credit Suisse is suddenly out of business and vacates such a large space. Mitigating that is CWG’s attempt to adapt to a new in the office working practice, that is more flexible and with 10 floors available will operate as a multi Let instead. However, the idea is not as easy in practice, with letting office space to new companies a serious chore in London.
  https://property.jll.co.uk/rent-office/office-rent-london-e14-4qj-11307
  
• The 2023 results for Canary Wharf Group (CWG) show a mixed picture. On one hand, CWG has effectively utilized its space and demonstrated the value of the Canary Wharf area post-pandemic lockdowns, with numerous firms returning to the office and spaces being repurposed. However, asset revaluations have posed challenges and negatively impacted the CWG property portfolio. Critically, although CWG has seen a decline in its asset values, CWG financial metrics are still within the loan covenants, of <60% LTVs (50%) and <45% Priority LTVs (37.5%), with the fixed charge coverage ratio also at >1.31x.

Operating Performance

Rental income has increased in FY’23 to £349m. Top line revenue included the prepayment of leases from Barclays of £310m to record £789m for FY’23. Underlying revenue excluding the Barclays payment was £491m, still up £15m YoY.
The majority of the revenue is from rent along with service charge income of £106m, down £5m YoY.

Gross rental yield has increased to 5.7% in Office space, from 4.5% FYE’22 and 4.3% FYE’21. As a result of increased rent collections and essentially a devaluation in the asset prices. Whilst the Retail segment, seems a little more promising, with rental yields of 5.9%, up from 5.0% FYE’22, but still down from 6.5% FYE’21. As the Retail segment saw a positive revaluation to its property of £149m in 2022 and £19m in 2023 after the resumption of economic activity post the pandemic lockdowns.

Operating Profit has reduced to a negative £591m loss FY’23, mainly due to the investment property valuation writedowns of £1.2Bln.

Pre-impairment operating profit was c£566m, £339m higher than FY’22. Removing the £310m from Barclays, there was still an improvement in EBIT of £29m. Whilst adjusted Adj EBITDA of £272m is up 10% on FY’22.

The negative UK real estate sentiment is mitigated by Canary Wharf Management through their ability to pivot and repurpose some non performing real estate, and their strong Estate performance overall.

Estate performance is measured across their 3 key segments.

• Office Space – 6.9m Sq Ft. – 12 Sites
• Retail Shopping Space – 1.2m Sq Ft – 19 Sites
• Residential neighbourhood 0.8m Sq Ft – 4 main sites

Office Space Operating Performance

Key factors driving the Office real estate segment valuations at CWG, are the occupancy rate, which fell to 89.8% in 1H’23 but recovered by year end 2023 to 91%, also fell to 70% in multi-purpose space, before recovering to 81% at FYE. The weighted average lease life to break has also improved to 8.9 years, and the headline rent which has substantially improved to £60.8p/sq/ft. CWG achieved 10 new Office leases in 2023, against 20 in 2022. With 94k Sq Ft taken against 417k Sq Ft taken in 2022. With the difficulty of key tenants leaving the estate, including Credit Suisse, these factors combined have led to a revaluation of -18% of Office Real Estate.

CWG Retail

Key factors driving the Retail real estate segment at CWG, are the occupancy rate of the Office space and footfall in the Canary Wharf spaces. As mentioned occupancy rates have fallen in the office space, but footfall has increased by 30% in FY’23 to 67m people. The Group transacted 75 retail lettings (59 FY’22) including renewals in the period (172k sq ft). New lettings generated £3.0m of rent and renewals secured £1.3m. There have been 10 tenants enter liquidation and 3 administrations, 4 of these units were released to new shops with improved rents. Rent collection in 1H’23 was over 95.0% and negligible rent concessions being granted in the period.

The weighted average lease life to break has also increased to 7.7 years, and the headline rent which has increased to £63.4/sq/ft. These factors combined have led to a revaluation of 0.1% of Office Real Estate.

With just under 1m Sq Ft of Residential real estate, CWG achieved rental growth of 30% from £21m to £28m and is credit positive for CWG. The residential segment is seeing a stabilization in its rental income. The residential asset valuation declined 10% YoY. A fairly punitive reflection on the successful take up of residential units in Canary Wharf.

Asset Quality

Asset Valuations

As previously stated, the net asset value of CWG plays a vital role in the financial viability of the business. Consequently, with the current high-interest-rate environment, subdued UK GDP growth projections, potential recession, and the emergence of hybrid working models, CWG is particularly susceptible to fluctuations in the economic landscape.

Firstly, Revaluations have meant a contraction of £1.2Bln in asset values to £6.9Bln since FYE’22, and £2.4Bln since FYE’21. The Office space has seen over £1.7Bln in devaluation since FYE’21, to £4.4Bln. Office space is the key risk for CWG, as it makes up over 64% of total assets.

Repurposing space to mitigate risk

To mitigate this risk, CWG has identified various strategies, both operational and financial. Operationally, they have begun repurposing some of their space, subletting larger buildings to multiple companies and diversifying their tenant base to reduce concentration risk. Additionally, CWG is offering shorter and more flexible lease contracts, a departure from traditional practices in the commercial real estate industry, but deemed necessary to maintain occupancy rates and cash flow. Furthermore, CWG has repurposed some of its space, such as converting a car park into a go-kart center.

Financially, CWG could consider divesting some of their real estate assets to alleviate their debt burden and enhance their capital profile. While this option is not currently being pursued, continued economic shocks may compel CWG to explore asset divestment in the future.

Asset LTV

Covenant LTV is 51.9% which includes all assets. The loan covenants have headroom, including 75% for 25 Churchill Place. Headroom of 70% for 1 Bank Street; 65% for Quay Club Loan; 65% for Wood Wharf.

Events taken place after year end include the following:-

On 8 Jan’24, the covenant waiver extension expired on the Group’s 12 Bank Street facility and the commitment drawn and accrued interest, amounting to £19.5m, were repaid.

On 22 Jan’24, the Group repaid £71.5m of the A1 notes and £192.0m of the A3 notes of the securitisation. Together with a spens payment of £40.6m. The repayment released security over 10 Cabot Square.

Water Street Facility

On 7 March’ 24, the 15/20 Water Street facility reached expiry and the Group fully repaid £84.8m of principal amount drawn and £0.8rm of associated interest.

On 15 March’ 24, 2 new Green Loan facilities in respect of 15/20 Water Street for a value of £132.2m. The facilities of £118.5m term facility and a £13.7m fit out facility, both 5yr terms with interest payable at 3.0% aver SONIA. There is a requirement to hedge 190.0% of the term loan with no requirement to hedge the fit out facility. The Group has entered into 4 five year swaps in respect of this to fix the interest rate at 6.8%. The loans are subject to covenants on debt yield, interest cover and LTV. On 20 March 2023, £118.5m was drawn on the facilities.

Morgan Stanley

On 27 March’24, the Group agreed revised terms with Morgan Stanley on 15 Westferry Circus. CWG recognised £27.5m lease termination income upon the property being returned to the Group on 31 March 2024.

On 27 March 2024, a deal was agreed with Morgan Stanley UK Group for a deed variation in regard to their lease.

of 20 Bank Street. Under the deed of variation, Morgan Stanley has extended its tenancy to 2038 by removing

the break clause in 2028.

On 23 April 2024, the Group secured a new two year £80m construction finance facility, with two 12 months extension options, secured on the serviced apartment buildings at 3 and 15 West Lane. Interest is payable on the facility at 2.95% over SONIA, with a margin step down at PC to 2.15%, with a requirement to hedge 50.0% of the facility. At the date of signing, £51.2m was drawn on the facility.

On 24 April 2024, the Group agreed an amendment and restatement to the senior and mezzanine facilities on 25 Churchill Place, extending the maturity of both facilities for 5 years to July 2030. The senior £282.6m loan has a margin of 1.7%-2.25% over SONIA and the mezzanine £58.1m loan has a margin of 4.90%-5.90%. The caps on the orginal facilities remain in place until expiry in July 2024. Both facilities have no default covenants but are subject to cash trap covenants on debt yield, interest cover and LTV.

Cashflow, liquidity and capex

Starting with £351m in cash, CFO was £623m, driven by strong pre impairment operating profit of £566m. a reversal of working capital requirements in the past year of £57m, and considerable CAPEX expenditure of £132m, unleveraged Free cashflow was £491m. With higher interest payments to £233m Free cashflow was £258m positive for the first time since 2018. Further financing of net £174m brought year end cash to a substantial £840m.  

Cash in bank of £840m along with an unutilized RCF of £100m, gives CWG total liquidity of £940m.

leverage, interest and asset coverage

Leverage is measured in terms of LTV as mentioned above. Of which the total look-through LTV is currently 51.9%. And the priority LTV is 40%, both within LTV Covenants of <60% and <45% respectively.

CWG have a Fixed Charge Coverage Ratio, as measured by Adjusted EBITDA / Adjusted Interest. The current FCCR is 1.31x, which is just above the minimum covenant FCCR of 1.3x. Although there are remedies in place.

Additional Research 

CAP Table

• The commercial property market has faced challenges, with rising interest rates and concerns about office market health impacting property values. Canary Wharf, in particular, has encountered tenant departures while striving to diversify its estate. With £3.7bn of net debt, the group’s efforts to refinance loans highlight the global challenge for property owners amidst higher borrowing costs and diminished property values.
• Canary Wharf recently announced the extension of loans tied to the 25-30 Churchill Place office building, home to EY, by five years, alongside two other debt deals. Negotiations with lenders are ongoing to extend or refinance an additional £900mn of debt by year-end.
• While Canary Wharf benefits from long leases on key office assets and strong shareholder backing, the departure of major tenants like HSBC and Clifford Chance has raised concerns about its core office portfolio. Renovations may be needed for older office buildings to attract new tenants or repurpose them.
• Like other real estate investors, Canary Wharf has had to downsize loans for refinancing against depreciated properties. Shareholder support, exemplified by a recent £300m equity injection and extension of a £100mn loan, is crucial amidst market downturns. Recent debt deals, including those tied to residential portfolios and development projects, demonstrate proactive financial management.
• Despite challenges, Canary Wharf’s estate continues to draw significant foot traffic, with underlying profit before tax declining due to increased financing costs. Negotiations are underway to address upcoming loan maturities, including £564m tied to 1-5 Bank Street and a £350m tranche of green bonds maturing in April 2025

Appendix

For other interesting Credit Views please read about on EHYO:- https://www.europeanhighyield.online/pizza-express-fy23-credit-summary/