Ratings Firms Issue Downgrades for Mall-Backed Debt

Bond rating companies are looking closer at securities tied to shopping mall debt, issuing downgrades for those backed by malls suffering from an anchor store closure and putting on watch malls with large stores such as Macy's Inc., J.C. Penney Co. and Sears Holdings, even if the stores remain open.

While anchor stores might not be part of the collateral of the mall loan or contribute much rent to the property owner, fluctuations in occupancy rates raise the probability of losses. Ratings firms also look at clauses that allow tenants to renegotiate for concessions such as early lease termination or rent relief from the landlord.

The rapid pace of store closures so far this year -- more than 3,000 to date -- has heightened concerns about mall owners' ability to repay their mortgages. The overbuilt retail real-estate market and the rising popularity of e-commerce have clouded prospects for many middling malls.

Cottonwood Mall in Albuquerque, N.M., for instance, is losing its Macy's anchor store. Fitch Ratings applied a 50% haircut to the most recent reported property cash flow to account for cotenancy clauses and predicted a 29% loss on the $101 million loan.

The loan, which was earlier bundled into a commercial mortgage-backed security deal, is still performing but Fitch recently issued negative ratings outlooks on two slices of the deal.

"Retail is back in the crosshairs of many market participants," said Fitch in a research note, adding the concerns about retail property, especially malls, aren't new.

During the last recession, retail landlords struggled as people curbed spending and unemployment rates shot up. Now, while consumer spending is much stronger, e-commerce and the oversupply of retail space are disrupting retail real estate, analysts said.

Since last August, Macy's, J.C. Penney and Sears have said they are closing as many as 390 stores in all, with Sears recently saying it is shutting pharmacies and auto centers.

Apart from metrics such as sales a square foot, the mix of anchor stores, and its cotenancy clauses, credit analysts also scrutinize a mall's performance compared with its competition, whether it is dominant mall in the market, and tenants' occupancy costs as a percentage of sales.

Kroll Bond Rating Agency, for its part, recently revised the performance outlook of the loan of Oglethorpe Mall in Savannah, Ga., to underperform from perform.

While the mall is 97% occupied and the loan remains above water, the lowered performance outlook has more to do with its exposure to the three department stores owned by J.C. Penney, Sears and Macy's.

"We are being proactive given the current volatility in the retail sector as well as the fact that there is a possibility of additional store closures in the future," said Keith Kockenmeister, managing director in the CMBS Group of KBRA.

Not all mall loans will be slammed with losses. E-commerce has weakened electronics and household goods retailers, resulting in the bankruptcies of HHGregg and RadioShack. But while electronics giant Best Buy was under pressure for a while, it has been relieved by the demise of its competition.

As the retail shakeout continues, "weaker malls will disappear and the remaining malls, offering a solid mix of retail, restaurants and entertainment, will be stronger as a result," Fitch said.

Write to Esther Fung at esther.fung@wsj.com

(END) Dow Jones Newswires

May 23, 2017 10:58 ET (14:58 GMT)