How Big Box Bankruptcies Would Impact CMBS

Concern over the fates of J.C. Penney and Sears Corp. has yet to blow out the spreads of commercial mortgage backed securities (CMBS) with exposure to the department store chains, but in light of their potential bankruptcies investors best be aware of the weakest links.

Spreads on bonds with exposure to J.C. Penney and at the bottom of the CMBS capital stack widened 10 or 15 basis points in the first few weeks of October, when the retailer’s stock price fell to a 13-year low and unsubstantiated tweets suggested it was moving closer to bankruptcy. The market quickly overcame its jitters and spreads have tightened since then, said Alan Todd, U.S. CMBS strategis at BofA Merrill Lynch Global Research. News pertaining to Sears Corp., such as the second quarter’s earnings and revenue shortfalls, has had a similar short-term impact on relevant CMBS.

Todd added that spreads widened on fairly limited selling, but he said that a trickle could turn into a flood should either company file for bankruptcy.

Spreads Could Widen on Uncertainty About Store Closings

“If we get an announcement that J.C. Penney has definitely filed, we’ll see spreads jump out, based on the uncertainty about what the restructuring will look like, whether stores will be closed, what it means for the malls they’re in, and the impact of things like co-tenancy clauses,” Todd said.

When such an announcement will arrive is anybody’s guess. Todd said Bank of America’s equity analyst covering the company forecasts that J.C. Penney will have sufficient cash to carry it through the 2014 holiday season. Others suggest one or both retailers could face fatal hurdles next year and perhaps sooner. Nevertheless, some investors have been paying close attention.

“Over the past couple of years we’ve been very focused on malls that have both Sears and J.C. Penney, and we’ve passed on deals that have had that exposure,” said Marc Peterson, a managing director at Principal Global Investors who is responsible for CMBS. He added that several CMBS deals in 2012 had exposure to regional malls and retailers such as J.C. Penney and Sears, but that’s been less the case so far this year.

Steve Jellinek, vice president at Morningstar Credit Ratings, said that Sears, including its Kmart division, has nearly twice the CMBS exposure as J.C. Penney in terms of square feet that may have to be filled should the company declare bankruptcy and vacate. The firm calculates that 182 CMBS deals have exposure to J.C. Penny, while 255 have exposure to Sears Corp. (Sears and Kmart stores), and 98 have exposure to both.

J.P. Morgan noted in a report published Oct. 4 that there are 68 loans where the two retailers are listed in the top three retailers at a property. “Direct exposure to either J.C. Penney or Sears is typically highest in seasoned deals where there are only a small number of loans remaining, and one is secured by a retail property,” the report stated.

Exposure to Sears, J.C. Penney Highest in Seasoned Deals

The data Morningstar uses to calculate its deal-exposure comes from the CMBS servicers, which do not distinguish when the retailers own the space or they lease or rent it from the shopping center owners that issue the CMBS. The latter can be more problematic for CMBS investors, since those payments are part of the deal’s collateral, and the issuer would be responsible for replacing that revenue stream.  

In strong markets, that replacement could actually be a higher end retailer and so benefit the bond deal, but in weaker markets the issuer may have difficulty finding a replacement or end up bringing in a lower-end retailer, such as a Bon-Ton or Boscov’s, for potentially less income. 

Sears and J.C. Penney typically are one of a shopping center’s anchors; the likelihood of finding a replacement tenant beneficial to bondholders depends in large part on the identity of the mall’s other one-to-three anchors. Retailers such as Lord & Taylors and Macy’s typically indicate stronger shopping centers, increasing the likelihood of drawing a healthy new tenant.

“Malls at the lower end would be those adding grocery stores … doing whatever they can to survive,” Jellinek said.

If Sears or J.C. Penney shut a store that it owns, the impact of their bankruptcies on a CMBS deal backed by loans on nearly properties would be lessened.

“It’s going to be the indirect impact on mall traffic, so the question becomes how big of a draw was the store?” Peterson said