Deutsche Konsum REIT Faces Further Downgrade After Failing to Impress at Deutsche Börse’s Equity Forum

Deutsche Konsum REIT-AG (DKR), a German commercial real estate company, is grappling with a challenging financial situation, prompting Scope Ratings GmbH to downgrade its issuer rating from BB+/Stable to B. The recent disappointing performance at Deutsche Börse’s equity forum has exacerbated the company’s troubles, and the latest message from Scope further underscores the severity of DKR’s predicament.

Rating Downgrade and Rationale:

Scope Ratings GmbH has downgraded DKR’s issuer rating to B from BB+/Stable, along with downgrades for its EUR 40m bond and senior unsecured debt rating. The downgrade is a response to DKR’s announcement of significant write-downs on property values and shareholder loans. This has led to various negative outcomes:

1. Increased Leverage and Liquidity Concerns: DKR’s recent impairments have caused a sharp increase in loan-to-value (LTV) to over 60%, exceeding its binding financial policy limits. The rise in leverage, as measured by Scope-adjusted debt/EBITDA, and a deterioration in EBITDA interest cover have raised concerns about the company’s ability to handle upcoming refinancing needs.
2. Write-downs and Losses: The company’s decision to write down property values and impair shareholder loans, totaling EUR 125m, has resulted in a substantial loss of EUR 203m under IFRS for FY 2022/23. DKR’s loss under German GAAP also means no proposed dividends for the fiscal year.
3. Uncertainty in Tax Dispute: The derecognition of tax receivables and recognition of deferred taxes due to an ongoing legal dispute regarding its G-REIT status has added further uncertainty to DKR’s financial outlook, resulting in EUR 72.5m in tax expenses.

Financial Metrics and Impact:

The significant write-downs have significantly impacted Scope’s credit metrics for DKR. Leverage, as measured by Scope-adjusted LTV, has surged to 62%, well above the previous rating downgrade trigger of 55%. Scope does not anticipate a substantial deleveraging in the short-to-medium term.

Scope-adjusted debt/EBITDA has risen to 14.7x for FYE 2022/23, up from 11.6x, and EBITDA interest cover has decreased to 2.4x from 3.7x last year. The company’s liquidity is also a concern, as unrestricted cash and forecasted free operating cash flow do not cover short-term debt.

Business and Governance Profiles:

Despite its financial challenges, DKR’s business risk profile is assessed at BB+, supported by its status as one of the largest landlords in Germany, focusing on food-anchored retail. However, negative governance issues, particularly a perceived conflict of interest related to a shareholder loan provided to Obotritia, have resulted in a negative one-notch adjustment to DKR’s standalone rating.

Outlook and Potential Developments:

Scope will closely monitor DKR’s refinancing efforts, potential asset sales, and capital raises. A prerequisite for an upgrade would be an orderly refinancing that addresses liquidity concerns. Conversely, a downgrade could be triggered by deteriorating liquidity or insufficient progress in refinancing upcoming maturities.

Deutsche Konsum REIT’s recent struggles, highlighted by Scope’s downgrade, reflect a challenging financial landscape. The company’s efforts to address its liquidity concerns and navigate upcoming maturities will be closely watched, with the outcome determining its credit rating outlook in the coming months.

The close relationships between the main shareholder and the board of directors of Deutsche Konsum REIT-AG (DKR), as well as the shareholders of the Scope Group, raise significant concerns regarding the independence of assessment in the context of the company’s financial standing and potential consequences of a delayed downgrade.

Independence of Assessment:

1. Conflict of Interest: The perceived conflict of interest arising from the main shareholder’s close ties to the board of directors, particularly the previous CEO and Chairman of the Board, Rolf Elgeti, who is also the General Partner of Obotritia, creates a challenging situation. This relationship may compromise the objectivity and independence of the assessment process.
2. Governance Issues: The negative governance issues, including the continuation of the conflict of interest despite Rolf Elgeti stepping down as Chairman of the Supervisory board, further underscore the governance challenges within DKR. Such issues can erode trust in the integrity of the decision-making process.

Consequences of a Delayed Downgrade:

1. Investor Confidence Erosion: Excessive delays in downgrading a company facing financial challenges can erode investor confidence. If a downgrade is not promptly executed in response to deteriorating financial conditions, investors may question the effectiveness and independence of the credit rating agency, potentially leading to skepticism about the reliability of credit ratings.
2. Market Distortions: Delayed downgrades can distort the market’s perception of a company’s true risk profile. Investors rely on credit ratings to make informed decisions, and a delayed downgrade may result in a misalignment between the assigned rating and the actual risk, leading to market distortions.
3. Impact on Financing Costs: A delayed downgrade can impact the company’s ability to access financing at reasonable terms. If the credit rating does not accurately reflect the heightened risk, lenders may not appropriately price the risk, potentially exposing investors to higher-than-anticipated losses.
4. Regulatory Scrutiny: Regulatory bodies may scrutinize credit rating agencies for delayed downgrades, particularly if it is perceived that conflicts of interest or other non-independent factors influenced the timing of the downgrade. This scrutiny can lead to regulatory interventions and reputational damage for the credit rating agency.

Mitigation Strategies:

In conclusion, the close relationships between a main shareholder and the board, coupled with potential governance issues, pose challenges to the independence of assessments in the case of Deutsche Konsum REIT-AG. Timely and transparent actions by both the company and the credit rating agency are essential to maintain investor confidence and market integrity. Addressing these concerns is critical to ensuring the accuracy and credibility of credit ratings in the dynamic landscape of financial markets.