CMBS Exposure to Distressed Retailers Grows

Although the number of distressed retailers will likely rise as the retail sector evolves, their credit effect on U.S. commercial mortgage-backed securities should remain limited, reported Moody’s Investors Service, New York.

Moody’s Sector-in-Depth report noted distressed retail tenants increase credit risks in commercial real estate mortgages. But the report cited several mitigating factors that should limit their credit effect.

“[One] mitigating factor for the CMBS we rate is the low overall exposure to distressed and defaulted tenants in the transactions,” the report said. “In addition, successful retail property owners will be able to adapt as the retail industry continues to evolve.”

Brian Olasov, Executive Director with Carlton Fields, New York, called the report a good counterweight to recent stories of retail hysteria. “There are three important takeaways that frequently get lost,” he said. “First, while the coverage is all on store closings, it often ignores the positive flip side that, across most retail sectors, store openings year after year are outpacing closings. Second, outside of obsolete malls, loss severities for other retail properties are on par with other asset classes. Third, even among the embattled malls, weak tenants–both anchor and in-line–are a manageable number.”

Olasov called these takeaways “slight consolation” for lenders with exposure to those weak anchors, but said it’s a manageable exposure across the CMBS universe. “Good retailers are constantly reinventing and reinvesting,” he said. The velocity may be accelerating, but the reinvention is happening and healthy.”

Exposure to distressed or defaulted retailers makes up a small share of the overall CMBS universe. “CMBS transactions benefit from a diversity of property types and tenants,” Moody’s said. “As a result, distressed and defaulted tenants contribute only a small portion of rent to the overall cash flow of the collateral backing CMBS loans.” The ratings agency said loans with exposure to distressed and defaulted tenants represent just 6 percent of all outstanding U.S. CMBS by balance.

Good property owners can easily counter the effect of distressed and defaulted tenants, Moody’s said. “Successful retail property owners will continue to replace departing tenants with tenants that are more suited to changing consumer preferences. While increased e-commerce competition has pressured traditional department stores and clothing retailers, demand has increased from other tenants such as off-price retailers, entertainment- and experience-oriented tenants and online retailers looking to expand their brick-and-mortar footprint.”

Fitch Ratings, New York, expressed more concern with mall exposure to distressed retailers. It reported 284 retail loans with a balance of $3.2 billion defaulted last year. By loan balance, retail defaults accounted for 40.5 percent of total defaults in 2017, up from 32.2 percent in 2016, and seven of the largest 10 retail defaults were regional malls or lifestyle centers.

“Fitch remains concerned with regional malls, particularly in non-primary markets with stronger competition and low or declining sales,” Fitch Ratings Director Roxanna Tangen said.