Examining The State Of Mall-Backed CMBS

Sears' plans to close 150 stores and Macy's to close 100 could have a dramatic effect on the billions in CMBS loans backed by regional malls. More than one-third of all securitized mall loans have exposure to Macy’s, JCPenney and Sears, while another third are exposed to two of the three anchors. With data from Morningstar Credit Ratings, we look at how the evolving retail landscape in regional malls will buoy some loans while sinking others.

Specially Serviced Mall Loans

Since 2010, liquidations amounting to $3.89B led to $2.88B in CMBS losses, a 74% loss severity. Despite the landscape, the picture is complex. Properties in secondary and tertiary markets, anchored by department-store chains that have shuttered locations, such as Macy’s, Sears and JCPenney, are particularly susceptible to dramatic devaluation. The closure of an anchor tenant often triggers co-tenancy clauses that allow other mall tenants to exercise the right to terminate their leases or renegotiate the terms, typically with a period of lower rents, until the co-tenancy issue is resolved.

Morningstar predicts about $1.88B in losses on 53 specially serviced mall-backed loans with an unpaid principal balance of $3.4B, suggesting a 55.3% loss severity. Many of these properties are lesser quality Class-B or C malls in markets lacking a sufficient customer base to support ongoing operations. Other loans are backed by properties underwritten at the peak of the market with high debt leverage and little to no amortization. Morningstar forecasts that three of these loans will incur losses of more than $100M. 

$2.8B of mall loans were made between 2006 and 2007, many of which are aggressively leveraged and hampered by lax underwriting and lackluster cash flow. They'll likely struggle to refinance when they mature this year and next.

Since May, six mall loans with a combined balance of $652.8M were transferred to special servicing, and Morningstar projects losses on four of them. In total, there are 24 master serviced mall-backed loans totaling $1.38B on the Morningstar Watchlist. The list, which evaluates loan and property-level credit risk, assesses cash flow, occupancy, tenant-related concerns and other issues. Many of these properties generate enough cash flow to cover their debt payments; however, high leverage and previous modifications could lead to a transfer to special servicing, especially as these loans approach maturity.

The top five mall-backed CMBS loans Morningstar is watching: 

• Franklin Mills in Philadelphia
• Wolfchase Galleria in Memphis
• Montehiedra Town Center in San Juan, Puerto Rico
• Central Mall Portfolio, various locations
• Rushmoore Mall, Rapid City, SD

In the Houston area, Morningstar is keeping an eye on the Killen Mall, which is sitting at an LTV of 144%. 

Post-crisis Securitized Mall Loans

Since the restart of the CMBS market in 2010, 357 loans with an outstanding balance of $40.5B on 320 malls have been securitized. Morningstar expects mall loans originated since 2010 to perform better than pre-crisis loans, as most post-crisis loans exhibit more conservative underwriting, with roughly 96% having LTVs less than 70% at issuance. Even more striking, Morningstar found the weighted average LTV declined to 56.3% for mall loans originated since 2010, much improved from 69.8% for those originated before 2010.

Only three mall-backed loans issued since 2010 are specially serviced: the $49.1M Hudson Valley Mall loan in CFCRE 2011-C1, the $17.6M Wausau Center loan in WFRBS 2011-C4, and the $13.2M The Crossings loan in COMM 2013-CR12.

Losing Your Anchor Can Be A Blessing

A mall's ability to repurpose a bix-box space largely comes down to location and traffic at the mall. Morningstar equity analyst Edward Mui noted that, “All the qualities that make a mall successful also help mitigate the inevitable tenant bankruptcies; if the space is desirable, malls will be able to lease it up.”

Top-tier malls tend to have more successful department stores, including Neiman Marcus, Bloomingdale's and Nordstrom, compared with Sears, JCPenney and Kohl's stores, which bring in lower sales per square foot and typically pay lower rent.

Finding retailers large enough to fill these spaces can be tricky, but owners can get creative. “Mall REITs have had success breaking the spaces up and leasing them out like in-line stores, or even nontraditional anchors like grocery stores or Tesla dealerships,” Mui said.

The King of Prussia mall in Philadelphia replaced a Sears with a Dick's and Primark, increasing rents and bringing in more traffic from two successful retailers instead of one lagging retailer.

General Growth Properties has spent $1.4B since 2011 to carve up more than 80 vacant department stores into smaller spaces.

According to research firm Green Street Advisors, about 300 of the country's 1,100 malls generate sales of more than $470/SF. For these properties, getting rid of underperforming big-box stores will be a boon for business.