Introduction

Like most everyone, S&P Global Ratings has been closely watching the trends within the retail mall sector. Far from the latest fashion developments, though, the trends we've been following concern retailer bankruptcies and store closures, shifts in consumer shopping preferences, and other developments that might have a direct bearing on mall performance. Take online shopping, which often serves as a substitute to traditional brick-and-mortar patronage--according to the third-quarter 2019 U.S. Census report, third-quarter 2019 e-commerce sales ($154.5 billion), adjusted for seasonal variation, accounted for 11.2% of total retail sales ($1,380.5 billion), an increase from 7% in first-quarter 2015 and a little over 4% in first-quarter 2010.

In examining the malls within our rated commercial mortgage-backed securities (CMBS) portfolio, we recognized that these trends are just that--trends--which, alone, may fail to tell the whole story for any particular mall. For example, while tough to discern from the abundance of negative news out there, like all other real estate, malls are inherently local, and each one should be examined within the context of the demographic trends of the geographic market it serves. A thorough assessment of any mall would also include a review of its historical rent and tenant sales performance (taken together, occupancy cost), tenant mix and lease rollover schedule, and the property's ability to attract consumers by offering a variety of shopping, dining, and experiential options. A few malls that seem to have bucked the negative narrative include Christiana Mall in Newark, Del; Fashion Show Mall in Las Vegas; and the Shops at Merrick Park in Coral Gables, Fla. These malls' strong performance illustrates the ability of high-quality malls to set the appropriate merchandise/demand driver mix that allows them to drive revenue and sales even in the face of the ongoing e-commerce threat. The fact that such malls are typically owned by deep-pocketed institutional investors and are situated in gateway markets with strong international/tourist presence further helps their resiliency.

All of this is to say that a particular mall's prospects for long-term success will hinge on factors not often highlighted in the splashy news headlines. However, there are a few observable trends, metrics, and property characteristics that can render a particular mall one worth watching.

S&P Global Ratings CMBS Mall Loan Exposure

For purposes of identifying malls, our initial screening utilized the various property type code indicators provided by Trepp, as well as the reported loan and property names. We further verified the identified properties by referencing site photos and online descriptions, as necessary. We estimate that there are 410 mall loans comprising $52.5 billion within the U.S. CMBS sphere. Of these, our currently rated U.S. CMBS portfolio contains 153 active loans, comprising $20.7 billion (reflecting November 2019 performance information) secured by mall properties (see Table 1). Roughly 60% of the $20.7 billion balance is held in single borrower/large loan transactions, with the remainder held in conduit/fusion deals. Twenty-four of the 153 loans, representing $1.9 billion in balance, are currently in special servicing, for a 9.4% balance-based special-servicing rate. In terms of vintage, an overwhelming majority of the mall exposure (133 loans, or $19.7 billion) reflects post-2009 originations, while just 20 loans, or $986.2 million, are CMBS 1.0 product. Despite its paltry representation within the S&P Global Ratings CMBS portfolio of mall loans, the CMBS 1.0 segment accounts for 40.3% of specially serviced mall assets by balance. This reflects the adverse selection pervading the CMBS 1.0 segment at this stage in its life, as we expect the better-performing mall loans with savvy sponsors to have already been refinanced.

As far as CMBS 2.0 is concerned, its presently specially serviced loans are all from the 2012, 2013, and 2014 vintages, the latter of which accounts for $1.0 billion of the segment's total $1.2 billion nonperforming loan balance (see Chart 1). To date, loans secured by Destiny USA (Syracuse, N.Y.), South Towne Center (Sandy, Utah), Colonie Center (Albany, N.Y.), and Yorktown Center (Lombard, Ill.), as well as the loan securing the SRPT 2014-STAR mall portfolio deal, have all defaulted at maturity. In terms of losses following a maturity default, just this year, as an example, saw the liquidation of the Independence Mall asset from WBCMT 2007-C33. The suburban Kansas City, Miss. asset, which transferred to special servicing in May 2018 for maturity default, resolved at a 75% loss to its $200 million trust balance, reflecting the size of the debt relative to the property's net operating income, and the tenants' inability to increase sales due to economic challenges. This historical record suggests that some of the CMBS 2.0 malls bear watching over the next few years as their associated loans hit scheduled maturity dates.

Table 1

Chart 1

Net Cash Flow (NCF) Change By Market Type

By count, over half of these 153 outstanding loans are secured by malls that have exhibited a decline in NCF since securitization (see Chart 2), with an average decline of 23.1% since issuance (based on the later of 2018 or 2017 reported information). The market type distribution of these deteriorated malls aligns with conventional thought, with most (39 of 85 loans, or roughly 46%) located in tertiary markets, and the fewest (20 of 85, or approximately 24%) situated in primary markets. For further context, by loan count, tertiary and primary markets reflect approximately 36% and 26%, respectively, of our aggregate mall loan universe. Twenty-three of the 85 deteriorated mall loans are already specially serviced.

On the positive side, roughly one-third of these 153 outstanding loans are secured by malls that have exhibited NCF improvement since securitization, with an average improvement of 17.1% since issuance. Unsurprisingly, tertiary markets contributed the least here, accounting for just 13 of the positive category's 52 loans.

There are 16 loans that either lack 2018/2017 financial reporting or have exhibited no change in reported NCF, all of which are from the 2018 or 2019 vintage.

Chart 2

Maturity Schedule

The next six years look to represent a particularly busy stretch for mall loan maturities, with $14.3 billion of our $18.8 billion performing CMBS mall loan population (over 75%) coming due through 2025 (see Chart 3). In fact, each of these years sees over $1.8 billion in performing mall loan maturities, with 2021 and 2025 coming closest to the $3.0 billion mark. Annual scheduled maturities then drop to sub-$1.0-billion, before climbing to $1.5 billion and $1.1 billion in 2028 and 2029, respectively. The continued credit concerns around mall properties and uncertainty around when the market will turn (S&P Global Ratings sees overall recession risk between 25%-30% over the next 12 months), coupled with a potential dearth in mall-related liquidity, may make the successful refinancing of these loans difficult to ascertain.

As would be expected, the balance-based special-servicing rate amongst loans already past their maturity date is high, at 80.1% (which compares to the 1.2% rate for 2020-and-later maturities). In fact, the only performing loan amongst the post-maturity bunch is King's Plaza, a $427.4 million loan held in the GSMS 2013-KING transaction, which repaid in December 2019. The loan was secured by 872,741 sq. ft. of the 1.2-million-sq.-ft. Kings Plaza Mall in Brooklyn, N.Y.

Chart 3

Individual Mall Loans Worth Watching

While our review and analysis of individual malls is property-specific, as mentioned above, there are a number of observable trends, metrics, and property characteristics that we commonly key in on when monitoring the performance of any mall. The main barometers of mall health we consider include:

Property-Specific

• Tenancy/occupancy – We review the tenant roster, with particular attention paid to the anchor and major tenants, and the lease rollover schedule. We also examine the month-to-month/seasonal tenancy at a property, since we generally consider this a less-sturdy rental income stream. Anchor retailers who have recently announced store closures or declared bankruptcy are reviewed against chain-wide sales and the historical sales trend to determine if there is a heightened chance of store closing at the subject property. Reviewing the list of loans worth watching, it is worth noting that we observed that most of the anchors at these properties are the customary names we expect, such as Macy's, Lord & Taylor (Hudson's Bay), J.C. Penney, Burlington, Dick's, Dillard's, and Boscov's, although the occasional local retailer also pops up. Please see Appendix 1 for further information on S&P Global Ratings' credit opinion of, and outlook for, certain anchor retailers.
• Occupancy costs –For all tenants, we examine occupancy cost ratios to gauge whether an outsized portion of a tenant's sales goes toward covering its rent and expense reimbursement obligations (thus putting it at a higher closing risk, in our view).
• Net operating income (NOI) – We review the historical property NOI for any significant, persistent declines.

Market-Specific

• Market fundamentals – We examine market rents and occupancy levels, both historical and forecasted. We also examine the potential impact of any shifting demographic trends on a mall's customer base and its ability to capture its fair share of its trade area's retail spending. We would also consider the market type (primary, secondary, or tertiary), as well as any nearby competition.
• Market cap rates – Where available, we would review any updated property appraisal reports to understand the current market cap rate for the subject mall, as well as those for any comparable retail properties.

Other

• Site visits - Where practicable, guided mall tours can provide a wealth of information not directly gleaned from reported statistics and figures. Site visits allow an analyst a feel for general mall foot traffic and activity, which can help with assessing the property's long-term prognosis. Site visits can also afford an analyst a feel for how any neighboring retail might affect a particular property's performance.
• Sponsorship commitment – We view sponsors with greater equity within and/or significant planned capital expenditures towards a particular mall as a positive sign. The cash infusions often go towards re-leasing efforts and/or property repositioning plans that, if successful, should be a net positive for long-term property performance. This was recently illustrated by Park City Center, an approximately 1.3 million-sq.-ft. super regional shopping center in Lancaster, Pa., where Brookfield re-tenanted a portion of the former Sears anchor space with Round1, and is also looking to re-demise the anchor space vacated by Bon-Ton.
• Appraisal values – Most relevant to defaulted mall assets where annual appraisals are generally ordered, we would consider the trend, magnitude, and velocity of any changes in value. As noted in Appendices II and III below, valuations of defaulted mall assets can drop quickly, and significantly.

In examining our rated book with the above considerations in mind, we have identified 39 mall loans, with balances greater than $25 million, as ones worth watching (see Appendices II and III). The list includes both specially serviced and non-specially-serviced assets, and represents the segment of mall loans we feel warrants closer ongoing scrutiny. We arrived at the list based on a review of several factors, such as special servicing status, in-place anchor tenancy, and demonstrated, or potential, performance deterioration.

Table 2 below provides a summary of the loans worth watching. The first group represents specially serviced malls, the second group are malls securing loans that will be maturing in 2019 through 2021 and have demonstrated a decline in performance, and the last group are malls maturing after 2021 that have demonstrated a decline in performance. In aggregate, these malls secure $6.5 billion of outstanding loans.

Table 2

Ongoing Surveillance Analysis

S&P Global Ratings continuously monitors the performance of the loans securing rated transactions. In particular, for mall loans, where we see year-over-year declines in property and/or market performance, we will revisit, and may revise, our NCF, cap rate, and valuation expectations.

Based on our review of this information, our analysis may entail:

• Forming a further-stressed projection of a mall's key performance metrics. For example, where we have observed significant, persistent declines in property cash flow, we may elect to revise our S&P Global Ratings NCF to a level reflecting the likelihood for further cash flow deterioration beyond that already observed. In cases where our calculated occupancy cost ratio is above the level we deem to be sustainable, we may perform a mark-to-market analysis.
• Increasing a mall's S&P Global Ratings cap rate above the baseline level if we determine that market dynamics have shifted and the risk premium is higher.
• For defaulted mall assets specifically, where appraised values have declined over time, baking into our selection of recoverable value an expectation of future value decline, particularly in cases where a distressed mall asset's liquidation timing is in question.
• Considering the impact of any revised mall loan expectations on the credit risk of a particular transaction (which would factor in the performance of other loans within the deal, as well as any amortization-to-date and structural features).

Conclusion

The next few years may prove even more challenging for the mall sector as consumer-shopping preferences continue to move toward e-commerce and retailer bankruptcies and store closures likely continue unabated. The S&P Global Ratings corporate team that follows retailers noted that competition within the retail sector will continue to intensify, putting pressure on margins. In addition, they expect vulnerable brick-and-mortar retailers to report flat or declining same-store sales and further store closures in 2020. For more information on our view for 2020 for retailers, please see "Industry Top Trends 2020: Retail And Restaurants," published Nov. 19, 2019.

In our opinion, the combined effect of these phenomena alone justifies a deeper analysis of mall properties that starts with the barometers cited above. While we recognize that it would be extreme to paint all mall properties with a broad brush of negativity, we feel that a cautious view towards particular malls is warranted at this time.

Appendix I

Burlington Stores Inc. (BB+/Stable)

On Dec. 2, 2019, we affirmed our rating on Burlington Stores Inc. at 'BB+' with a stable outlook. The stable outlook reflects our expectation for continued successful execution on real estate and merchandise strategies to support modest improvement in credit metrics. We expect shareholder initiatives to be funded with internally generated cash and anticipate share buybacks to be favored over debt reduction. Our forecast shows adjusted leverage in the mid-2x area over the next 12 months. Key strengths of the company include the company's ability to participate in the growing off-price retail segment, an improved merchandising strategy with a track record of growing profitability, and ample cash-flow generation that supports continued store growth. Key risks include intense competition from both online and traditional retailers, as well as productivity that lags its peers due to larger, inefficient legacy store formats.

For further detail, please see our research update from Dec. 2, 2019, "Burlington Stores Inc.".

Dillard's Inc. (BB+/Stable)

On Dec. 9, 2019, we affirmed our rating on Dillard's Inc. at 'BB+' with a stable outlook. The stable outlook reflects our belief that the company's operating performance will remain relatively flat, including free operating cash flow (FOCF) generation of about $220 million annually and adjusted leverage of less than 2x over the next 12-24 months. Dillard's operates in the highly competitive department store industry as a smaller, regional chain. Despite the demise of competitor Bon-Ton and the bankruptcy of Sears, we expect that the conditions in the department store industry will remain challenging as competition from online retailers and value-oriented apparel operators (such as off-price and mass merchants) cause the company to sustain elevated promotional spending amid volatile consumer apparel spending. Key strengths of the company include low balance sheet debt, consistent FOCF generation of about $220 million annually for the next 12-24 months, and substantial real estate ownership of about 89% of stores. Key risks include the competitive nature of the industry, as well as Dillard's omni-channel capabilities lagging those of its competitors.

For further detail, please see our research update from Dec. 9, 2019, "Dillard’s Inc.".

J.C. Penney (JCP; CCC/Negative)

On Aug. 28, 2019, we lowered our rating on JCP to 'CCC', with a negative outlook, to reflect greater risk for debt restructuring. The downgrade reflects our view of the growing risk that JCP will pursue a debt restructuring over the next 12 months because its capital structure appears unsustainable and its progress on management's business improvement initiatives has not been sufficient to reduce the likelihood of a distressed exchange. Our expectation for an increasingly difficult macroeconomic environment and a still highly competitive department store sector facing secular demand trends, contribute to our assessment. The company's near-term maturities are manageable as it has about $150 million of senior notes maturing between 2019 and 2020. Still, JCP's $2.35 billion asset-based lending revolver expires in June 2022 and its $1.6 billion term loan matures in June 2023.

For further detail, please see our research update from Aug. 28, 2019, "J.C. Penney Corp. Inc. Lowered To 'CCC' On Greater Risk For Debt Restructuring On Industry Headwinds, Outlook Negative".

Lord & Taylor (Hudson's Bay) (not rated)

On Nov. 26, 2019, we discontinued our 'B' rating on Hudson's Bay Co. (HBC) because there is no rated debt outstanding. Prior to the rating discontinuance, we placed Hudson's Bay 'B' rating on CreditWatch Negative in October 2019, which reflected the higher-than-expected cash outflow for the business reflecting both the reorganization changes and the proposed transaction. Our rating action incorporates HBC's expected cash outflow resulting from dead rent obligations and reorganization (about C$715 million net of cash distributions from real estate joint ventures) over the next three years that will likely lead to additional cash calls on the company. At the same time, the company's definitive agreement with a group of HBC majority shareholders (collectively owning about 57%) to purchase the minority equity interest for about C$1 billion, funded with existing cash on the balance sheet and additional debt, will materially reduce funds available to support the company's turnaround.

The combination of these factors along with the company's strategy to invest in its remaining banners could lead to significant cash outflows at a time when HBC is facing secular headwinds in its retail operations, thereby reducing its financial flexibility.

For further detail, please see our research update from Oct. 23, 2019, "Hudson's Bay Co. Placed On CreditWatch Negative Following Expected Reorganization Charges And Agreement To Go Private".

Macy's Inc. (BBB-/Negative)

On Nov. 26, 2019, while we affirmed our 'BBB-' rating on Macy's Inc., we revised the outlook to negative due to soft operating results and weaker performance expectations. The outlook revision reflects Macy's recent underperformance and the risk that operating performance could remain under pressure. We previously anticipated a modest improvement in Macy's performance in fiscal-year 2019 with flat same-store sales growth and modest margin deterioration. However, the company reported a 3.5% drop in same-store sales for third-quarter 2019 and lowered its guidance to reflect a 1%-1.5% contraction in same-store sales this year. The company cited lower mall traffic, weaker spending by tourists, and warmer weather that dampened demand for cold-weather clothing as reasons for the poor third-quarter sales performance.

We see heightened risks that Macy's operating initiatives, such as its loyalty program and efforts to grow its off-price Backstage business, may not be sufficient to navigate secular headwinds in the department store sector. We also believe a decline in discretionary spending given the slowing macroeconomic environment could amplify consumers' preference for bargain prices, portending continued challenges for Macy's.

For further detail, please see our research update from Nov. 26, 2019, "Macy's Inc. Outlook Revised To Negative On Soft Operating Results And Weaker Performance Expectations; Ratings Affirmed".

Appendix II

Appendix II

Appendix III

Appendix III