The ability of a triple-net lease transaction issuer to refinance is dependent on benchmark interest rates, market conditions, and collateral performance. Historically, given the low interest rate environment in the last decade, all S&P Global Ratings-rated triple-net lease transactions have been able to refinance at their anticipated repayment dates (ARDs). However, the current environment is of higher interest rates, and considering that they may remain higher for longer due to the uncertainties in the capital market, we assessed how rated triple-net securitizations would fare in a hypothetical scenario of elevated interest rates.

ARDs Incentivize Refinancing

Triple-net lease securitizations are typically structured to have an ARD for each tranche that incentivizes refinancing. Although transactions are often refinanced at the ARD, failure to redeem the liability in full at the ARD is not an event of default under the transaction documents. ARDs in triple-net transactions typically range from five to 15 years from the issuance dates of the notes. Our ratings address the timely payment of interest and ultimate payment of principal by legal final maturity, typically 30 years for the rated transactions. Unlike commercial mortgage-backed securities (CMBS), where borrowers need to refinance or liquidate the properties to meet the bullet maturity payments, triple-net asset-backed securities (ABS) transactions are not subject to such timing constraints until the legal final maturity. However, post-ARD step-up interest will start accruing on the notes, and bond amortization will accelerate, shutting down payments to the equity holder. Refinancing the notes at a higher interest rate at the ARD would increase the overall cost of fund on the capital structure. Either scenario could lead to rating implications for the securitization or the corporate sponsor.

Given the current environment of higher interest rates, issuers with ARDs in the next 12 months will continue to face tougher refinancing conditions. Of the 103 triple-net ABS notes rated by S&P Global Ratings, one has an ARD coming up in December 2024, and seven have ARDs in 2025 (see table 1).

Table 1

Chart 1 shows the refinancing balance for triple-net notes with ARDs in the next 12 months versus the total capital stack balance.

Chart 1

Scenario Description And Assumptions

To test whether the transactions in table 1 have sufficient cushion to absorb elevated refinancing rates at the current rating levels on the notes with their existing collateral pools, we ran the assumed refinancing rates in table 2 on the notes and observed whether they passed their respective stress levels. For historical context, in 2024, six triple-net ABS notes that belonged to two master trusts--CARS-DB4 L.P. and STORE Master Funding I LLC--were refinanced at weighted average coupons of 4.75% and 5.76%, respectively. These refinancing rates, corresponding to notes rated at the 'A' category or above, represent an increase of 1.32%-1.69% from retired notes' coupons at issuance.

Table 2

We derived the hypothetical rates for testing from observations of the notes' coupon spreads above historical 10-year Treasury notes and S&P Global Ratings economists' forecast for the 10-year Treasury rate (see "Economic Outlook U.S. Q4 2024: Growth And Rates Start Shifting To Neutral," published Sept. 24, 2024). We applied the same hypothetical refinancing rate for the same rating category across all tested transactions and did not consider the sponsor-specific factors that could lead to pricing differentials.

We then applied the general framework as stated in our criteria "North American Real Estate Securitizations Backed By Triple-Net Leases: Methodology And Assumptions," published Aug. 24, 2023. For the purpose of this analysis, we made additional assumptions as listed below:

• The property pools are assumed to remain static, with no property substitution, disposition, or addition; no change in tenant composition or ratings on the tenants; and no change in lease terms.
• We assumed no change in utility scores or S&P Global Ratings' values assigned to each property within each master trust.
• For the notes listed in table 1, we assumed the new ARDs to be rolled forward by five years, with no scheduled annual amortization for the refinanced notes.

We did the analysis on all outstanding notes--51 in all--from the master trusts listed in table 1 above (CF Hippolyta Issuer LLC, NADG NNN Naperville LP, Oak Street Investment Grade Net Lease Fund LP, and STORE Master Funding I LLC).

Depending on the coupons at issuance, we found that the notes listed below in table 3 could experience incremental costs ranging from 1.83%-4.81%. On the master trust level, the weighted average cost could increase by 25-263 basis points.

Table 3

Chart 2 shows a comparison of coupon at issuance versus hypothetical refinancing rate at each master trust level.

Chart 2

Scenario Analysis Results

Our testing result indicated that only one out of the four master trusts was able to absorb the higher coupons with the existing collateral. Out of 51 notes tested, 22 notes (43.1% of sample size) still passed at their current rating levels, while the other 29 notes (56.9% of sample size) showed model-implied ratings lower than their current rating levels.

Despite the weaker cash flow results in our analysis, many factors could affect the financial environment between now and the ARDs of the notes. If the Federal Reserve continues to cut interest rates, the actual refinancing rates could be lower than the hypothetical rates used in this test. Alternatively, the issuers could find other financing channels to pay down the notes while waiting for a lower leverage point to reenter the ABS market. Still, under our scenario analysis, the three master trusts that show shortfalls would need a debt reduction of approximately 20.0%-25.0% across the entire capital structure to maintain their current rating levels.

It is worth noting that issuers are aware of the ARDs and relevant economic implications. Historically, all triple-net lease transactions were able to refinance at ARD. Programmatic issuers usually prefer to access the public ABS market on a regular basis to maintain their reputation and investor base, while weighing the cost of financing against alternative funding sources such as bank loans or private lending. In a high-interest-rate environment, issuers will need to contribute additional properties to the collateral pool or plug the capital structure with equity to counter the impact from the higher cost of funds. Issuers that routinely accumulate collateral in the warehouse may have more flexibility; otherwise, the equity injection will have to come from the sponsor's balance sheet. Either case will require issuers to have long-term financing plans in place. If not, refinancing will be challenging if the public market dries up in a downturn.

ARD structures in triple-net lease securitizations vs. CMBS

The ARD structure in triple-net lease securitizations differs from those found in CMBS transactions, which rely on the refinancing of the mortgage loans to pay down the debt. A recent trend in CMBS transactions offers a contrast: many office loans with maturities in 2023-2024 defaulted, as borrowers failed to get refinancing or sold properties at much lower reappraised values, causing significant distress in the CMBS transactions. In triple-net lease ABS, the collateral's cash flows do not change when a tranche reaches the ARD, and step-up interest is typically subordinated to debt service payments on the notes. Property values are not subject to immediate mark-to-market because there's no mandatory requirement to sell, giving sponsors some wiggle room to wait out the stressed market conditions if needed. In addition, triple-net lease ABS portfolios are typically diversified by property count, tenant base, and geographies, limiting exposure to idiosyncratic risks.

Scenario Analysis Limitations And Caveats

• The stressed scenario is hypothetical and not meant to be predictive or part of any outlook statement.
• Operational risk, counterparty exposure, and legal considerations were not part of this analysis.
• The assumptions included in this analysis do not imply any changes to how S&P Global Ratings will apply the criteria to rate new transactions or to monitor the outstanding transactions.

Surveillance

In our periodic surveillance analysis of rated in triple-net lease securitizations, we may adjust our stress scenarios to incorporate transaction performance, including lease-rate declines and utilization rates. Additionally, we may recognize the decreasing tenor of the liabilities by adjusting our property-value haircuts if transactions are not refinanced at the ARD. For example, if a 30-year liability structure does not refinance at its seven-year ARD, then we may revise our liquidation assumptions, informed by the utility score, as the transaction's remaining life approaches the typical lifespan of a CMBS structure (that is, 10 years). After the ARDs, triple-net lease transactions typically accelerate amortization, which reduces leverage across the master trust. We may limit upgrades in such cases to recognize the structural subordination of existing classes of notes.

S&P Global Ratings will continue to monitor these notes and take appropriate rating actions based on their performance.

Related Criteria

• North American Real Estate Securitizations Backed By Triple-Net Leases: Methodology And Assumptions, Aug. 24, 2023

Related Research

• Economic Outlook U.S. Q4 2024: Growth And Rates Start Shifting To Neutral, Sept. 24, 2024
• North America Triple-Net Lease ABS Newsletter March 2024, March 28, 2024