On the surface, the May bankruptcy filing of J.C. Penney was a minor event in the universe of commercial mortgage-backed securities.
According to a report from Moody’s Investors Service, only 13 stores among the 161 closures announced by J.C. Penney for June and July were located in properties backed by loans held in CMBS deals. And those loans impact only 4.4% of CMBS collateral rated by Moody’s.
But the J.C. Penney reorganization is still emblematic of a troubling future for many department stores and regional malls — most of the Class "B" and "C" variety — already dealing with systemic declines in retail brick-and-mortar shopping trends. And these malls anchored by department stores such as J.C. Penney, Neiman Marcus and Macy's carry loans held in dozens of conduit/fusion CMBS transactions with increasingly troubled performance outlooks.
"The groundwork was already set for retail to enter any shock like this without a lot of bandwidth to maneuver," said Keith Banhazl, a managing director with the structured finance group with Moody's.
The J.C. Penney bankruptcy was the second major mall-based retailer (after Neiman Marcus) to file for Chapter 11 since the onset of the COVID-19 pandemic in the U.S.
J.C. Penney had been in a good financial position with $1.6 billion cash on hand and no near-term maturities on debt “had not the pandemic crisis not emerged so swiftly and virulently," Moody’s report stated. But mandatory lockdowns and pandemic-related store closings crushed revenues and ate away the company’s liquidity, Moody’s report stated.
Now, the company’s current woes expose the increasingly poor prospects for department stores, many of which take up anchor locations in lower-tier mall properties. Declining tenancy and foot traffic trends that might have played out two to four years “accelerated dramatically due to COVID-19. Add it all up and it doesn't bode well for the [retail] sector," said Banhazl.
In regions where department stories have been hit the hardest, a sub-sector of the retail sector among tenants has been hit asymmetrically due to the economic shock of the pandemic, said Kevin Fagan, vice president and senior credit officer within the agency’s structured finance group. "That makes malls that rely on department store anchors uniquely susceptible to [a Covid-19] disruption, particularly if they are not in a strong position in a market," Fagan said.
The report stated that struggling malls are often more “deeply hurt” by anchor closures that newer regional malls and shopping centers located in denser populations with strong income demographics.
For example, a 2016 J.C. Penney anchor-store closure kickstarted a “value death spiral” of an aging mall in Dewitt, N.Y., that went bankrupt in January this year to avoid a county tax foreclosure. But a Brookfield Property REIT-owned mall near Boston successfully re-purposed a former J.C. Penney store, thanks to its location in a dense trade area “with strong population and income demographics” that made it a stronger competitor. “Upper-tier regional malls … are more likely to weather store closures or the loss of an anchor, while weaker malls' sponsors are less likely to be able or willing to invest capital,” the report stated.
Moody's report also noted that weaker mall loans also have the highest loss severity rates among commercial real estate property types in CMBS deals, Moody’s report stated. The agency noted 52 loans included in U.S. conduit/fusion CMBS loans backed by regional malls have been liquidated since 2017 with an average loss severity of 77%. Excluding regional malls, average loss severities were around 49% in that time frame.
The same trends favoring newer centers in more favorable demographic areas could apply to the upward trajectory of e-commerce. "We’ve published that we expect the e-commerce share to plateau at 20%-25% of retail sales, but over about a decade. Now that timeframe may shorten significantly," Fagan said. "More people are likely to get accustomed to a broader use of e-commerce, as the pandemic has forced online shopping for items that may have been more typically purchased in stores.”
