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Category ArchiveMorningstar Credit Ratings

Brian Grow Named President of Morningstar Credit Ratings

Following the departure of its ratings business’s previous leader, Vickie Tillman, at the end of last year, Morningstar has named Brian Grow the new president of Morningstar Credit Ratings.

Grow, 44, served most recently as the head of the firm’s asset-backed securities and residential mortgage-backed securities ratings practices. He joined the company in 2011 and presided over a period of growth in structured-finance ratings, as the firm’s trio of largest competitors—Standard and Poor’s, Moody’s and Fitch—drew scorn for their role in overrating the creditworthiness of debt securities in the years before the financial crisis.

“Brian has proven to be an extremely effective leader and has helped take Morningstar Credit Ratings from a single asset class to a full-service and diverse rating agency,” Haywood Kelly, the Morningstar Inc. executive to whom Grow will report, said in a statement. “His analytical and technical expertise, high-quality standards and history of strategic decision-making will support Morningstar in its mission to help investors reach their financial goals.”

Despite Morningstar’s recent growth, it remains a small player in a heavily concentrated industry. In March 2017—the date of its latest regulatory filing—the company employed 81 credit analysts, 17 of whom were supervisors. As of late last year, that staff was responsible for ratings on about three dozen banks, just over three hundred corporations, and around 3,600 structured finance transactions.

Standard and Poor’s, by contrast, rates about 60,000 banks, 50,000 corporations and about as many structured securities—not to mention nearly a million public-finance entities, its filings show. At the end of 2016, its workforce numbered just over 1,500 analysts, with more than 150 supervisors.

As of his third day on the job, at least, Grow said he sees advantages to helming a smaller vessel.

“I think of the big three [rating agencies] as big cruise ships,” he said. “Everybody knows them, but they’re not nimble. The smaller agencies are more like speedboats.”

Morningstar, Grow pointed out, is still majority owned by its founder, Joe Mansueto, an arrangement that the new president said helps the company maintain a long-term focus.

After a decade of regulatory challenges for the industry, as the ratings agencies labored to implement strict controls mandated by the Dodd-Frank Act, the focus is shifting back towards the fundamental business of understanding debt markets, Grow said.

“Regulatory [challenges] are kind of old news,” explained Grow, who studied economics at St. Lawrence University and holds a master’s degree in business from Yale University. Instead, his priority will be “staying on top of monitoring and surveillance. We’re very focused on that because there will be a down cycle at some point, and I want to be the first to come out and inform investors.”

Source: commercial

Toys ‘R’ Us Bankruptcy Could Risk $500M in CMBS

The announcement of the closure of 182 Toys “R” Us stores last week—part of the retailer’s Chapter 11 bankruptcy filing last fall—has put roughly $500 million in commercial mortgage-backed securities (CMBS) at risk, according to a report from Morningstar Credit Ratings.

Analysts at the rating agency identified 20 CMBS loans, with a combined balance of roughly $500 million, that could come under fire due to occupancy concerns following the closings.

The report, issued on Tuesday, indicates that there are 40 CMBS loans—with a combined balance of $1.47 billion—that are exposed to the recent Toys “R” Us store closures. While 20 of those loans—with a combined balance of $500 million—are of concern due to occupancy issues following Toys “R” Us’ departure, the remaining 20 loans haven’t raised red flags due to the fact that Toys “R” Us doesn’t represent a large enough portion of each asset’s leasable space. Of the latter population, the two largest are the $56 million loan backed by Akers Mill Square in Atlanta, Ga., and the $123 million loan on The Plant at San Jose in San Jose, Calif.

The loan on Akers Mill Square was securitized in the Deutsche Bank-sponsored COMM 2014-LC5 transaction and represents 6.31 percent of its roughly $695 million securitized balance. The loan on The Plant at San Jose in San Jose, Calif.—securitized in the Wells Fargo-sponsored WFRBS 2013-C14 CMBS deal—constitutes 8.8 percent of the deal’s roughly $1 billion balance.

In September 2017—prior to the bankruptcy filing—a Morningstar Toys “R” Us risk report highlighted two of the largest CMBS loans at risk, should the retailer file for bankruptcy. The $507.6 million loan securitized in the Goldman Sachs/ Bank of America-sponsored TRU 2016-TOYS deal is the CMBS loan with the largest exposure.

Although the loan is backed by a portfolio of 123 Toys “R” Us and Babies “R” Us stores, Morningstar analysts noted that just seven locations with an allocated property balance of $3.2 million are exposed to a closing store and that the stores’ geographic diversity and low loan-to-value ratio (56.6 percent) significantly mitigates loan default risk.

Analysts also noted that the largest asset within TRU 2016-TOYS accounts for only 2.4 percent of the securities balance and that a small number of stores closing is unlikely to have a significant effect on the deal.

On Sept. 18, 2017, Toys “R” Us filed for Chapter 11 bankruptcy, making the toy store chain the latest retailer to feel the pressures of operating brick-and-mortar shops in an age of dominance for e-commerce and online shopping.

In an effort to restructure and reorganize in bankruptcy proceedings, Toys “R” Us announced on Jan. 23 plans to shutter 182 stores—or 20 percent of its U.S. portfolio, with about half of the stores falling under the Babies “R” Us brand—that have failed to meet “performance standards,” as Commercial Observer reported on Jan. 24.

A spokeswoman for Toys “R” Us previously told CO that the company had until Feb. 6 for the court to approve its plan to shutter it’s targeted locations. If approved, the closures would have commenced in January, with “the majority” closing in mid-April,  according to a letter on the company’s website to customers and signed by company CEO Dave Brandon.

Toys “R” Us was able to extend its the court-imposed deadline to decide which stores to close to the end of August, as part of a deal with creditors, Bloomberg reported on Jan. 23. In exchange, the company agreed to pay landlords’ fees related to the bankruptcy case as well as finish this round of store closures by the end of August or it will be unable to close any of the stores on its list until after the 2018 holiday season.

A representative for Toys “R” Us could not immediately be reached.

Source: commercial

2018 CMBS: The Rating Agencies’ Predictions

After a stellar 2017, what’s in store for CMBS next year? We asked the industry experts to opine…


erin stafford 2017 06 27 dbrs 3455 2018 CMBS: The Rating Agencies’ Predictions
Erin Stafford. Jeff Wasserman/ For DBRS

Erin Stafford,  Head of North American CMBS at DBRS

What are your predictions in terms of 2018 CMBS issuance volume and what will be the key drivers of that issuance?

We are expecting volume to be flat compared to 2017. The lion’s share of the increase in U.S. CMBS volume in 2017 came from increased issuance in the single-asset, single-borrower (SASB) market, while the conduit market in 2017, after adopting risk retention, is likely to end up close to flat from the previous year. It is likely that the SASB volume could remain strong as many of those transactions are short-term in nature and may need to be refinanced into the CMBS market as interest rates remain low.

Are there any property types or regions that you are paying close attention to as we go into the new year? Why?

We are seeing some softening in certain markets. For instance, Houston was on our radar prior to Hurricane Harvey as office vacancies in the energy corridor had increased in addition to lower hotel occupancies and higher concessions at higher-end multifamily properties. There are markets where new supply may cause short-term disruptions; this is particularly noteworthy for hotels. Regional malls are something that we are watching very closely especially since last year retailers were quick to make store closure decisions following disappointing holiday sales, and we expect this again in 2018. We notice that some mall operators are making great strides to upgrade their offerings while others are lagging, seemingly awaiting more store closures. Other areas we are paying close attention to are suburban office projects and student housing properties.


James Manzi, Senior Director at S&P Global Ratings

jmanzi 2018 CMBS: The Rating Agencies’ Predictions
James Manzi. Photo: Standard & Poor’s

What are your predictions in terms of 2018 CMBS issuance volume and what will be the key drivers of that issuance?

We’re expecting about $85 billion in CMBS issuance next year, which is slightly lower than this year’s total, which we expect to be around $90 billion. Lower CMBS loan maturities are a headwind, while continued activity in the single-borrower space and the potential for more multifamily collateral making its way into conduits are tailwinds.

Are there any property types or regions that you are paying close attention to as we go into the new year? Why?

With offices taking a leading role in conduits in the 2017 vintage (at around 40 percent of collateral) and being second only to lodging in terms of volume securitized in single borrower deals, we’ll be closely watching performance in that sector. It will be interesting to see if companies (office tenants) choose to use smaller footprints over time, similar to the way retailers have reduced theirs.


zanda lynn 1 2018 CMBS: The Rating Agencies’ Predictions
Zanda Lynn. Photo: Stefan Falke/ For Fitch Ratings

Zanda Lynn and Huxley Somerville, Head of U.S. CMBS Business Development and Head of U.S. CMBS at Fitch Ratings

What are your predictions in terms of 2018 CMBS issuance volume and what will be the key drivers of that issuance?

Zanda Lynn: Our projection for non-agency CMBS is approximately $75 billion for 2018. We expect the slowdown in commercial real estate activity to contribute to a decline in overall volume, though the single-borrower market looks strong.


huxley somerville 3 2018 CMBS: The Rating Agencies’ Predictions
Huxley Somerville. Photo: Stefan Falke/ For Fitch Ratings




Are there any property type or regions that you are paying close attention to as we go into the new year? Why?

Huxley Somerville: Hotels, while continuing to perform, are showing signs of slowing revenue growth especially in New York City where new construction is adding to underperformance. We do not believe current revenue levels are sustainable over the longer term.


larry kay kbra senior director 2018 CMBS: The Rating Agencies’ Predictions
Larry Kay. Photo: KBRA

 Larry Kay and Eric Thompson, Managing Director and Senior Managing Director at KBRA

What are your predictions in terms of 2018 CMBS issuance volume and what will be the key drivers of that issuance?

While we are forecasting that CMBS private label issuance will decline from 2017 levels, there is still good support for new issuance as many positive CMBS and CRE underpinnings remain intact. Interest rates are still historically low, CRE provides favorable returns compared to other asset classes, CRE capital flows while slightly down are still strong, and credit performance remains stable. However, a potential market disruptor could be if the market believes that the Federal Reserve’s balance sheet unwinding is taking too much liquidity out of the system; this could trigger a jump in, or more volatile, interest rates. In addition, investors may be more cautious in their CMBS and CRE allocations in 2018 as property values are beginning to feel stretched, and a decline in scheduled maturities may limit refinancing opportunities. As a result, we are forecasting $65 billion of private label issuance in 2018, which could end up being 25 to 30 percent lower than 2017 levels.

eric thompson kbra senior managing director 2018 CMBS: The Rating Agencies’ Predictions
Eric Thompson. Photo: KBRA


Are there any property types or regions that you are paying close attention to as we go into the new year? Why?

In addition to concerns regarding full-price department stores, in 2018, we will be watching their off-price formats very closely. Chains that report sales with off-price department store offerings include Nordstrom Rack, which just reported fiscal 3Q 2017, and Saks Off Fifth with reported fiscal 2Q 2017 numbers. Both experienced declines in same-store sales performance for each respective quarter and through the nine and six months ending October and July 2017. Declining sales in what has been a high-growth segment leads us to believe there could be sales cannibalization and brand dilution taking place.

Historically, the underlying assertion was that department store retailers would not open off-price stores close to their full-line brand if it cannibalized sales. Based on KBRA’s analysis, which used Nordstrom financial disclosures, the distance between Nordstrom Rack and the retailer’s full-line offerings will increase in the future. Of the existing stores, approximately 42 percent of the off-price locations were situated within five miles of the nearest full-line store—the comparable figure for scheduled openings is just 17 percent. Perhaps this has to do with the availability of real estate. However, it could also signal that the retailer is trying to mitigate the potential for cannibalization and brand dilution.

img 1976 edit 2018 CMBS: The Rating Agencies’ Predictions
Lea Overby. Photo: Kaitlyn Flannagan/ For Commercial Observer

Lea Overby, Head of CMBS Research and Analytics, Structured Credit Research and Ratings at Morningstar Credit Ratings

What are your predictions in terms of 2018 CMBS issuance volume and what will be the key drivers of that issuance?

We expect 2018 nonagency issuance of $70 billion to $75 billion, down slightly from this year’s full-year total of around $85 billion. We are also likely to see another $100 billion in agency issuance next year. The volume of maturing loans that must be refinanced in 2018 will be far lower than in 2017, and most maturing loans are with portfolio lenders, rather than in CMBS. In fact, only $24 billion in CMBS will mature next year, down from over $80 billion that matured in 2017.

Despite the dip in maturing loan volume, we believe that lending may remain relatively constant. We expect transaction volume to remain steady, and borrowers may prepay loans to get ahead of potential interest rate increases. Also boosting CMBS issuance, conduit lenders may become more competitive with balance sheet lenders because conditions in the capital markets remain favorable with tighter CMBS spreads and low volatility. 

Are there any property types or regions that you are paying close attention to as we go into the New Year? Why?

Even though we believe that talk of the retail apocalypse is overblown, we do have concerns for this sector. We expect to see another round of bankruptcies and store closures after the holiday shopping season, and this will likely result in higher vacancy rates in 2018. We will also be keeping a close eye on grocery-anchored space. We believe this sector will see further consolidation, as Amazon’s purchase of Whole Foods and the U.S. expansion of discounters, such as Aldi and Lidl, affect traditional grocers.  Aside from the retail sector, we are also watching the multifamily and hotel sectors. Both have done extremely well during this economic cycle, but the party might not last too much longer. We are seeing signs of overbuilding in certain markets, which may leave multifamily properties and hotels more vulnerable to changes in the economic cycle. There are indications that the stable economy may at last be leading to rising homeownership rates, which may hurt apartment performance. On the other hand, the hotel sector is always vulnerable to economic downturns, and this is exacerbated by increased supply.

Keith Banhazl, Managing Director, Moody’s Investors Service

keith banhazl moodys 2018 CMBS: The Rating Agencies’ Predictions
Keith Banhazl. Photo: Moody’s Investors Service

What does 2018 hold in store for CMBS?

The credit quality of newly originated and outstanding commercial mortgage-backed securities conduit and fusion loans will remain steady in 2018. Rising interest rates and a cyclical inflection point in the commercial real estate cycle pose some challenges to CMBS collateral performance, but declining leverage and increasing coverage in conduit loans provide some degree of protection. Further, the wave of maturing and aggressively underwritten loans from the 2006 and 2007 vintages has mostly come and gone, and we expect the overall delinquency rate to improve as the volume of newly issued CMBS 2.0 loans outweighs that of delinquent CMBS 1.0 loans.

Source: commercial

Chicago Office—Suburbs’ Losses Are Downtown’s Gains

Chicago, America’s third-largest office market with over 470 million square feet, exemplifies the nationwide trend of companies relocating to urban areas from the suburbs as young people and knowledge workers congregate in city centers. The Windy City is the largest in the Midwest and differs from its smaller neighbors with its vibrant central core, strong public transportation network and amenities that are attractive to younger residents. Despite population losses in the metro area, downtown Chicago gained over 42,000 residents between 2010 and 2015, according to the U.S. Census Bureau. Some of these gains, however, have come at the expense of its suburban neighbors. In fact, the city reports stable office vacancy of around 13 percent since 2015, but vacancy in the suburbs is much higher.

Beam Suntory, one of the world’s largest spirits producers, and Sara Lee Corp. have traded in their suburban offices for downtown Chicago, and McDonald’s and Motorola Solutions are following suit with planned moves in the next year. The biggest blow outside of the city was dealt to the Schaumburg area, which saw AT&T surrender 1.3 million square feet. The former AT&T campus in Hoffman Estates is a real estate-owned asset of two CMBS trusts, MSC 2006-T21 and BSC 2006-PW11, with a forecast loss of over $70 million. Average vacancy in the Schaumburg area was 21.1 percent as of November, according to CoStar Group. The only major gain for the suburbs in this time was when Caterpillar, which spent over 100 years in downstate Peoria, Ill., moved its operations north to suburban Deerfield in early 2017.

In the other large suburban office markets, Central North and Western East/West Corridor, the average vacancy rate is nearly 16 percent, up from a pre-crisis low of 9.2 percent, with high four- and five-star sublease availability of more than 25 percent between the two. In addition to ConAgra, a number of companies either moved their headquarters or relocated a significant portion of their work force from the Central North submarket to Chicago, including Walgreens, Allstate and Sterling Partners.

In addition, since 2009, many companies have relocated to Chicago from out of state, bringing thousands of jobs and increasing the demand for office space. These include ConAgra Brands, a packaged-food giant that moved its headquarters from Omaha, Neb., in 2016, and the Kraft Heinz Co., which shuttered the Madison, Wis., headquarters of its Oscar Mayer division and established a co-headquarters arrangement between Pittsburgh and Chicago.

Rising demand has led to an increase in office construction in the city. Developers delivered two office towers of over 1 million square feet each in early 2017, River Point and 150 N. Riverside Plaza, and the John Buck Co. is building an 820,000-square-foot office tower for CNA Financial. With its size, Chicago is unique for the region in that the addition of two 1-million-square-foot office towers will have a relatively modest effect on vacancy and rent. In fact, CoStar forecasts a vacancy rate of 13 percent for 2019 for the metro area, 100 basis points lower than at the start of 2017. .

The West Loop could be the greatest beneficiary of growth in downtown Chicago. With technology employers including Google, Gogo and Glassdoor taking space in the area and the nearby Fulton Market’s transformation from a meatpacking district to a restaurant mecca, millennials have made the West Loop one of Chicago’s trendiest neighborhoods.

Morningstar believes that Chicago’s ongoing migration of younger residents to the central core will continue to attract employers to the area. While there will still be a need for suburban office space, the lack of construction in those areas and weaker access to public transit may dampen growth. Consequently, we expect growth in these areas to be more modest.

Steve Jellinek is a vice president of CMBS research and Edward Dittmer is a senior vice president of CMBS credit risk services at Morningstar Credit Ratings. They can be reached at steve.jellinek@morningstar.com and edward.dittmer@morningstar.com.

Source: commercial

Regional Malls Look to Reposition as Retail CMBS Space Sweats

The e-commerce contagion has pulled brick-and-mortar retailers, regional malls and shopping centers under the weather, resulting in tenant bankruptcies and mass store closures that have, in turn, put pressure on maturing retail commercial mortgage-backed securities loans predominantly those issued in 2006 and 2007, prior to the financial crisis—and created refinancing hurdles for borrowers.

“The concern is everywhere, and in some cases, it’s a surprising reality,” said Manus Clancy, a senior managing director at Trepp. “Because of the outlook for retail in general, a lot of borrowers are struggling to refinance. The problems are across the sector.”

From November 2016 to October 2017, roughly $29.3 billion in securitized mortgages backed by retail properties were paid off or liquidated, 12 percent of which was disposed with losses, according to data from Trepp. The disposed loans were written off at an average loss severity of just under 55 percent, up from around 47 percent in 2016, while overall CMBS loss severity for all loans disposed within the same time frame fell to just under 43 percent. This year, there have been 244 retail loans—totaling $3.4 billion—that have been resolved with losses at around $1.8 billion, according to data from Trepp and Morningstar Credit Ratings.

“If I had to guess, [retail loss severities] are in excess of 50 percent,” said Andrew Hundertmark, a managing director at CWCapital Asset Management. “In my opinion, a mall was never worth what it was when the loan was made. There were assumptions made to rent growth and tenant strength that didn’t turn out to be true, and 10 years ago then these loans were made, no one saw Macy’s as a troubled retailer. J.C. Penney showed some cracks but wasn’t a concern. People underwrote loans thinking everything was going to stay as it was.”

The rest is history. Retail giants such as J.C. Penney, Sears and Macy’s have closed hundreds of stores as they try to shift investment focus to e-commerce, technology and the use of delivery services. On Nov. 2, Sears announced that it plans to close more than 60 locations by late January 2018, marking 243 total closures since January 2017. The retailer will be left with around 680 stores operating in the U.S., down from 3,500 locations in 2010.

What impact have these closures had on maturing retail CMBS? These loans have been made vulnerable, in part, because they’re propped up by leases from major anchor retailers. When anchor boxes come under increased stress or shutter, it creates a vicious cycle for the mall owner or landlord that can negatively affect overall consumer traffic to small- and midsized in-line retailers such as Radio Shack or Bon-Ton Stores—both of which have recently closed stores—who fill out the mall and benefit from a strong anchor presence.

“The best we can do [as servicers] is try to stabilize tenancy and get them in longer-term leases,” Hundertmark said. “We want leasing arrangements with tenants who can take advantage of co-tenancy if anchors close. Just because you have a mall that’s troubled, it doesn’t mean there aren’t retailers ready to come in. They’re all about traffic counts, and they don’t care so much if Sears is open for business or not.”

Chattanooga, Tenn.-based REIT, CBL Properties’ Mall of Acadiana in Lafayette, La., may be a transitionable survivor. Its debt was originated by Bank of America in 2007, and the loan comprises 63 percent of the roughly $196 million BACM 2007-2 CMBS transaction. The enclosed mall at 5725 Johnston Street was previously anchored by the usual suspects: Sears, J.C. Penney, Dillard’s and Macy’s. According to Trepp watchlist commentary, Sears will shutter its location at the mall by the end of the year, and “there are significant co-tenancy implications tied to the two anchors closing, which may have a significant negative impact on cash flow and potentially collateral occupancy.” The mall is buoyed by its collection of noncollateral tenants such as a Carmike movie theater, which occupies 247,072 square feet—or roughly 81 percent —of usable space, an Old Navy, a Barnes & Noble, an Olive Garden and a Taco Bell. As of November, Trepp commentary indicated that the borrower is “self-managing and leasing the mall and continuing to make monthly payments” despite the mall’s status as nonperforming beyond maturity.

Some major high-end national mall landlords, such as Washington Prime Group or GGP, look to reposition retail space to include entertainment and lifestyle services and national restaurants. Washington Prime has even moved to use online competitor Amazon’s fulfillment lockers to help draw consumers.

“Often, the property will be sold at auction for a discounted price, and now, at lower basis, the new owner can invest and turn them around. It’s a mixed bag,” said Edward Dittmer, a senior vice president of CMBS at Morningstar Credit Ratings.

Smaller entities may not be so lucky or may not have the capital necessary to make a change, being that repositioning an anchor into an entertainment venue or fitness center can be a daunting task. It can sometimes be an even harder challenge as malls in metro areas and gateway cities are just simply outdated and face competition from newer facilities complete with more modern amenities.

westside pavilion interior 2008 Regional Malls Look to Reposition as Retail CMBS Space Sweats
Interior view of West L.A.’s Westside Pavilion mall. Photo: Wikipedia Commons

Los Angeles’ Westside Pavilion is one recent victim of an oversaturated market. The future health of the three-story, 766,608-square-foot mall at 10800 West Pico Blvd. in the suburbs came into question in August after its debt service coverage ratio fell below 1.10x as it faced hurdles with lease terminations—major tenants have begun moving just a few miles away to the Westfield Century City mall.

“West L.A. has too many malls chasing the same customer and it was due for consolidation,” said Macerich Chief Executive Officer Art Coppola—Westside Pavilion’s owner—in the company’s third-quarter earnings call. In October, Macerich, announced its search for a buyer. The $142 million, post-crisis era loan was transferred to special servicer Rialto Capital Advisors for the first time in September due to imminent monetary default. The note comprises just under 13 percent of the remaining collateral in the roughly $700 million WFCM 2012-LC5, Wells Fargo-sponsored CMBS transaction.

“[Many borrowers] view retail as undervalued and come in at a good basis with a plan and some money and an opportunity to make some good return,” Hundertmark said. “In general, people are out there trying to sell the troubled stuff. Regional malls attract a much different buyer set. Strip malls or shopping centers tend to bring in more local buyers, those who know the market and may have owned the property next door and can bring some synergies there with repositioning. The buying universe really differs, and there are a couple names in almost all sales.”

CMBS retail issuance has climbed while delinquencies have fallen 16 basis points to 6.47 since August, Trepp data shows. Changes in the way retail space is being modeled and used have most certainly spurred new investment into the sector and enabled many operators to thrive despite widespread concerns over the performance of the physical retail environment.

“A lot of the new delinquencies we’ve seen have been maturity defaults in 2017 as a result of the 2007 issuance,” Dittmer said. “Some of those loans have not been liquidated yet and are going to take some time to work through. It may take a year or two to see what will be the ultimate resolution.”

Retail delinquencies recovered more quickly than other major property types after the most recent financial crisis, according to Trepp analysts. Special servicers acted more swiftly to foreclose on distressed retail collateral to cut losses, in contrast to the “extend and pretend” approach more commonly employed with other property types, analysts said.

“We’ve talked to a lot of landlords, and most of them are scratching their heads because every location is different,” Hundertmark said. “If we can get a gym in here and a couple of nice, national restaurants, the community is strong enough, so we can keep this moving. But, retail has moved away from us, so what can we do? We can partner with or sell to a multifamily developer to put up a new development. The old retail paradigm has been shattered. There is no one size fits all.”

GGP, a Chicago-based publicly traded owner and operator of high-end malls, has sought to survive retail market headwinds by renovating former department store boxes into restaurants, supermarkets and movie theaters. Meanwhile, GGP is considering a takeover bid by Brookfield Property Partners.

“[Landlords] have got more flexibility and more options than a servicer, and [they’re] definitely getting more creative and more aggressive, taking steps they’d never dreamed of 10 years ago,” Hundertmark said. “The model was you build the mall, and the anchors stores build around you.” That’s no longer the norm as landlords can no longer rely on anchors and must take matters into their own hands.

Some analysts argue that yield can be mined easily in the right market with the right strategy. “The bright side is pruning season is ending,” Clancy said. “Sears and Macy’s have been pruning and closing stores, but what’s left in their portfolio they’re confident in. Simon Property Group and GGP and others who provide experience can still make the business model work. The headlines have outpaced reality. People can still make a good buck with the right strategy, market and tenants. What’s disastrous is older malls, sagging demographics and newer competition.”

National mall landlords who can reposition these assets may be the future of regional malls as they’ve been able to exhibit the clout and capital needed to entice bondholders and take on such projects. And, these companies, like GGP, have seen its stock price climb in recent months.

There’s an interesting variety of players at auction for distressed regional malls, ranging from major national mall landlords to development firms looking to use the typically stellar locations where malls have been built to construct lifestyle centers full of national retail brands and restaurants, along with a residential building to help drive foot traffic and spark cash flow.

“First things we look for from a borrower is do they have the desire and the capital to reposition this mall, and three, do they have a plan?” Hundertmark said. “If they don’t know what they’re doing with the capital, they’re wasting everyone’s time. More and more we’re seeing them come in with a plan and turn it into a discount strip center or what have you.”

With approximately 25 percent of the CMBS arena being retail and roughly $3.1 billion in retail CMBS set to mature in the next 12 months, many borrowers may be done wiping their noses and ready to lick their chops.

Source: commercial

Closing 40 Stores, Bon-Ton Sets Off CMBS Alarm Bells

Fittingly, Cyber Monday brought yet another downbeat omen for nationwide retail tenants.

The Bon-Ton Stores announcement this month that it will close 40 stores—15 percent of its total portfolio—could imperil a swath of more than a dozen securitized commercial mortgage deals, according to a report yesterday by Morningstar Credit Ratings.

Bon-Ton, a Milwaukee and York, Pa.-based company that operates department stores under six brands primarily in the Northeast and Midwest, announced the closures in its lachrymose third-quarter earnings call. Same-store sales fell nearly 7 percent compared with the prior year, and the company posted a net loss of $45 million.

“While results in the third quarter fell short of our expectations, we are taking more aggressive actions to fuel improved performance as well as strengthen our financial position,” William Tracy, Bon-Ton’s chief executive officer, said in a statement.

The retailer, which runs stores under names including Boston Store, Younkers and Bergner’s, has not yet announced which of its 260 stores will be shut down by the end of next year. According to Morningstar, 59 commercial mortgage-backed securities deals have exposure to one of Bon-Ton’s locations. Fourteen of those deals are now especially concerning, said Morningstar vice president Steve Jellinek, an author of the report.

“For a couple of these loans, Bon-Ton’s leaving is going to mean that multiple anchor stores have vacated” recently, Jellinek said. “That pretty much spells the death knell for the property—especially if you’re not in a prime location.”

That would mean trouble is ahead for the malls that led Morningstar to sound the alarm. Located mainly in small cities far from major metropolises, like Norfolk, Neb., Alexandria, Minn. and Genoa Township, Mich., some of the shopping centers that host a Bon-Ton store would see occupancies drop to troubling levels in the event of a closure. Without its Bon-Ton anchor, for example, the Schaumburg Mall in Schaumberg, Ill. would be only two-thirds leased. At the Wausau Center in Wausau, Wis., occupancy would drop to 53 percent if Bon-Ton closed its store there.

The concerns highlight the disconnect between how malls were originally designed and the preferences of modern shoppers.

“When malls were initially conceived and built, the thought was, ‘Let’s build them around the anchors. They’ll feed shoppers to the in-line tenants,’” Jellinek said. “Over the past five or 10 years, with increasing competition from a multitude of other shopping options, the anchors became less and less important.”

As multiple anchors close at a single mall, property managers may face a spiraling crisis of declining rent rolls.

Non-anchor “tenants have lease provisions that if one or two anchors close, the tenant has discounted rent for a period of time,” Jellinek said.

If the anchor spot isn’t filled, smaller tenants may even have the option to vacate their lease early, without penalty.

Some of the embattled CMBS transactions seemed doomed from the start. As its largest source of concern, Morningstar pointed to University Mall in South Burlington, Vt., which secures 44 percent of the Lehman Brothers-sponsored LBCMT 2007-C3 transaction. At underwriting, its scant debt service coverage of 1.14x “left it unable to withstand tenant turnover and declining rents,” Morningstar noted in the report.

Appraisers valued the shopping center at $44.8 million in July, down over 50 percent from the value allocated to the CMBS transaction.

But even deals underwritten in the more risk-conscious atmosphere that swept in after the financial crisis face a bleak path forward.

If the Boston Store at Southridge Mall in suburban Milwaukee were to close, it would be the third anchor tenant the site has lost in a year. Sears closed shop there in September, and Morningstar expects Kohl’s to wind down its location in the mall by the end of 2018.

Such closures can lead to a vicious cycle of decline for retail properties, according to Morningstar. Without much surplus lease income to speak of, managers have to put off re-investing in improvements to bring their properties up to 21st century standards.

“There’s often barely any profits to put back into the property,” Jellinek said.

The Morningstar analyst said he’ll be keeping a close eye on securitized shopping center loans as Bon-Ton announces its specific closures.

“We’ll be watching for same-store sales,” Jellinek said. “They haven’t been growing—in fact they’ve been negative—for a long time. The final shoe dropping would be [Bon-Ton’s] filing for bankruptcy.”

Source: commercial

The Amazon Effect: Warehouses Become Prime Target for CMBS

In regions across the country, the rise of e-commerce is bringing industrial warehouses to burgeoning prominence in commercial mortgage-backed securities transactions, according to a report from Morningstar Credit Ratings. The report, prepared by analyst Jennifer Jones, notes that in the first half of 2017, logistics and distribution facilities outperformed all other major real estate categories in supply, demand, occupancy and rent growth.

Amazon in particular has grown in importance as a backer of securitized commercial mortgages. As the company continues its nationwide search for a second headquarters, investment banks have wrapped loans tied to seven of the company’s warehouses, totaling nearly $2.1 billion, into outstanding transactions—a development that Morningstar views favorably, given Amazon’s balance-sheet strength.

“With warehouse space, one of the big differences [from office buildings] is that you’ll just have only one or two tenants,” said Edward Dittmer, a senior vice president at Morningstar. “We look through the credit at the underlying tenant. If you’ve got a 10-year lease, the cash flow is going to come from the tenant, [affecting how] the credit is going to perform over time.”

Amazon remains secretive about its logistics network. Publicly, it has stated only that it maintains more than 70 sorting and distribution centers in the U.S., but Morningstar estimates the current number at more than twice that sum. In September, Gov. Andrew Cuomo announced that the company would open its first New York-area fulfillment center, on Staten Island, in 2018.

Despite Amazon’s opacity, however, Morningstar has found compelling evidence for its strength as a tenant.

At one Amazon warehouse that the agency examined, in Charlton, Tenn., employment has grown by 300 percent over the last six years, rising to 1,200 today from 300 in 2011. Other sites, like a fulfillment center in Chattanooga, Tenn., have taken advantage of artificial intelligence to increase productivity: algorithms provide that facility’s 3,000 workers with precise directions for how to navigate the 1-million-square-foot storage building in order to use their time most efficiently.

The internet commerce giant has made a strong push into artificial intelligence in recent years, most notably with its 2012 purchase of robotics firm Kiva Systems for $775 million. Tens of thousands of Kiva robots now ply Amazon’s warehouse floors, according to Business Insider. The robots can traverse the shelves at five miles per hour, hauling 700 pounds of goods at a time.

More broadly, though, the Morningstar analysts said that Amazon’s most transformative effect on CMBS has come from its nationwide push for two-day delivery through its Amazon Prime service, which they said has fundamentally altered the way that warehouses are used.

“Traditional retailers had a network of stores, with a more rigid view of how goods should be distributed,” Dittmer said. “Because of the growth of Amazon and two-day shipping, I think there has to be a more robust logistics network behind that.”

As online retail sales grew 15 percent year-over-year as of early 2017, reaching more than 10 percent of the total in all sectors excluding autos and gasoline, Jones said she is bullish on the permanence of the sector’s import.

“I think that there’s more to come,” Jones said. “It’s a very strong sector. And we’re continuing to watch it evolve.”

A representative for Amazon declined to comment.

Source: commercial

Morningstar’s Lea Overby on the ABCs of CMBS

It’s been a busy year for commercial mortgage-backed securities. The wall of maturities may be behind us now, but there’s plenty of new issuance to keep those in the sector busy, including Lea Overby. Overby joined Morningstar Credit Ratings last August and was appointed head of CMBS research and analytics in June. In her new role, Overby is responsible for the ongoing management and development of the rating agency’s CMBS business, including new issue and surveillance ratings, research and analytical products. Overby may have fallen into CMBS “somewhat randomly,” by her own account, but she already has 15 years of experience under her belt. Before Morningstar, Overby was the head of CMBS and asset-backed securities (ABS) research at Nomura Securities and, before that, a CMBS portfolio manager for BNY Mellon Treasury.

Commercial Observer: Tell us about your new role.

Lea Overby: Well, I have two groups that report up to me now. We’re branding one group as research—it’s client focused and produces a for-sale product for the investor community. That team is 15 people. The other piece is the rating agency business, which has two parts: the new issuance business and the surveillance piece of it, which surveils things we’ve already put a rating on.

Will you be adding to your teams?

I certainly hope so. The deal flow has been so heavy that we need to staff up a bit.

How did you get into CMBS?

Somewhat randomly, to be perfectly frank. I did graduate work out of Vanderbilt [University] with this idea that I wanted to teach, and after teaching for a couple of years I realized I didn’t. I took a job at Bank of America Securities and pitched myself as someone who knew how to program—which was not entirely true. This was back in the days when you were able to fake being able to program. I realized, fairly quickly, that wasn’t for me either, and then an opening on the CMBS desk popped up [in 2000]. They were looking for a database person to develop queries and write reports. I got started there, and I loved it.

What appealed to you about CMBS? 

My major is math, and CMBS is a nice combination of the qualitative and the quantitative. You can create a model that projects out default rates and prepayment rates that can be fairly accurate on the aggregate, however CMBS loans—each and every one of them—have unique characteristics that can make them fall off the model. It’s a mix of my analytical skills, and at the same time, there’s always a judgmental component to it.

As my career has developed, I’ve found there is an interesting dichotomy with commercial real estate being fixed assets in an ever-changing world. So, as our preferences for urban versus suburban living change, or online versus brick-and-mortar retail or even fashions change, the tenants in these locations also change while the structures themselves don’t. It’s fascinating to me how landlords and developers and tenants work together to figure out how commercial real estate works best.

 There seem to have been a lot of hotel special servicing transfers lately.

Hotels are always volatile because the rents reset every single night. If there is any change in the local economy, it is immediately reflected in the hotel market. We see it all the time—hotel developers look at the market, they all decide, “Oh, look, we’re undersupplied,” and start building. Then there’s oversupply. There’s this constant cycle of build, overbuild, stop, reassess and invariably something will happen that will trigger a hotel to be transferred. The default rates on hotels are higher, the loss severity on hotels are higher, and it’s a difficult asset class.

Is retail still experiencing the most pain as an asset class?

Yes, but we’re also seeing a decent amount of office stress. The office story flies under the radar, but I remember when I was buying bonds in early 2007 it was pitched as credit-positive if the main tenant had a lease that rolled near maturity of the loan—with the idea that in 10 years’ time you’d be able to up the tenant’s rent by X percent, making the loan an easy refi story. Which sounded great in 2007—when everything sounded great—but now that we’re in 2017, a lot of those tenants that were surefire “gonna stay” aren’t. We see a lot of office buildings where a tenant that took 50 percent and has decided to downsize or relocate or gone bankrupt and doesn’t need the same amount of space that it did 10 years ago. That’s decidedly a problem.

What was your experience through the crisis?

I bought bonds for a number of years through the credit crisis. That in and of itself was a fascinating experience, and I’m glad to have done it. When the market eased up, I realized I needed a little more of a challenge, and so I started at Nomura in 2010 to head up their CMBS and ABS research platform. I was at Nomura for six years until it closed down its CMBS and ABS trading desk.

Why did the move to Morningstar appeal?

I was looking for a place where I could continue to contribute to a research effort with my knowledge of CMBS but step away from a constant publishing regimen, which I found too restrictive. I joined Morningstar because working at a rating agency, from a researcher’s perspective, is a really great fit. You’ve got the resources you need to come up with great ideas, and you also have the flexibility to write whatever you want.

What was your biggest lesson from the crisis?

I think one of the things that I learned from it is that there are many more connections than you think. To say that a crisis is “contained” is foolish. There is no such thing as containment in this day and age. There are way too many links between nations and banks and financial institutions and the system is way too complex to be able to get a handle on what the fallout may or may not be. It bothers me when people start talking about containment because I don’t think that is something that can be properly defined.

But underwriting and loan origination standards have improved?

Definitely. The loans that were being securitized in CMBS [during the boom] were built on some very aggressive assumptions for continued growth, and at the time I don’t think any of us realized how aggressive those assumptions were. It didn’t take long after the wheels came off to see that they weren’t attainable. It’s interesting now, looking at some of the loans that are maturing—they never hit those projections. It’s been 10 years, and they’re still falling short.

I was as guilty as anyone else was at the time. I can remember looking at loans and saying “Okay, yes this is aggressive, but I think over the next two years the economy will be stable and they can hit these projections.” I applied that exact logic in 2007 and quite obviously I was wrong.

You weren’t alone.

No. But now, things are underwritten pretty much to how they’ve been performing historically. We see some upside but there’s nowhere near the level of pro forma aggressive underwriting that we saw back then.

Would you say that we’re in a healthy real estate market right now?

I think so. There are indications with certain property types that the cycle has started to turn in the wrong direction. The underwriting we’re seeing is still strong, but there is certainly this sense that even projecting that cash flows are going to stay flat might be a little more aggressive than it should be. It’s always a problem when you’re near the top of the cycle: You can feel it shift, but there are some indications that if it does shift it may be a shallow downturn. It’s hard to say.

Has issuance volume been what you expected?

I’ve been pleasantly surprised by how strong it is. I had concerns about the second half of this year, particularly about transaction volume, because there is considerably less that has to get refinanced. But there is every indication that we’re doing fine.

What’s driving the pipeline of deals?

The economy is still strong. There is still money to put to work, there’s foreign capital coming into the country, and there are still deals to be done. A lot of the deals we see are these large single asset-single borrower deals. That money is less prone to taking a breather than the guy who’s looking to buy a $50 million shopping center.

Why is the CMBS market the right place for these huge single assets?

If a loan gets large enough, the CMBS market is a more efficient way to move risk. That’s the long and short of it: CMBS is designed to transfer risk and for large assets in particular it makes sense to chop up that risk and transfer it as appropriate.

What trends are you seeing?

The retail percentage has dropped off a cliff. Of course, if one thing drops off, everything else has to increase, so now we’re seeing a good amount of office properties come into deals. We are also seeing an increase in interest-only loans, especially recently as interest rates tick up. An interest-only loan is an affordability product, and so my guess is that lenders are offering more interest-only loans because as interest rates tick up they can still keep the payment flat.

Source: commercial

CMBS Delinquencies Fall to 3 Percent in August

Granted, a slew of bad vintage loans continues to dog the performance of pre-crisis CMBS transactions.

But in a sign of robust industry health, the overall delinquency rate for securitized commercial mortgages fell in August to 3.02 percent, its lowest level since January, according to a report by Morningstar Credit Ratings.

Headlining the improvements were industrial loans, whose delinquencies dropped over 10 percent from the August, 2016 level. The lapsed payment rates for residential, lodging, and retail properties progressed as well, with office space the only sector that showed slight deterioration.

Underscoring the strength of the broader market, a sizable chunk of delinquencies were concentrated in just a few regions. With more than $2 billion overdue, the Washington, D.C. metro area alone accounted for nearly 10 percent of the industry’s delinquent mortgages in August, despite making up only a fraction of a percent of outstanding CMBS as a whole.

Chicago borrowers have struggled as well, holding 57 delinquent loans totaling nearly $800 million in late payments.

“Downtown Chicago has seen increasing occupancies, while the suburbs have felt the pain,” Steve Jellinek, the author of the Morningstar report, told CO. He described turbulence in the D.C. and Chicago markets as the result of simple cyclical churn. “As companies change their demands and their business plans, they’re going to pull up stakes and move to new locations,” he said.

Indeed, a bird’s-eye view of the industry yielded a rosy view at summer’s end.

Only 3.4 percent of outstanding CMBS had been sent for special servicing in August—a rate which has steadily declined from its high of 12 percent in January, 2011. The volume of newly delinquent mortgages dropped for the second straight month to $1.42 billion. And in perhaps the best omen for CMBS investors’ bottom lines, the volume of liquidated loans fell by 60 percent from the July level—marking the first time this year it sank below the billion-dollar mark.

screen shot 2017 10 04 at 17 04 30 CMBS Delinquencies Fall to 3 Percent in August
Chart: Morningstar Credit Ratings

Despite that welcome news, the sector remains haunted by the specter of failing loans that date to the freewheeling epoch before the financial crisis. In August, more than three dozen active loans that were originated in 2007 were transferred to special servicing—more than the number sent to special servicing from all years since then combined.

Even so, Jellinek believes that investors have already priced in any losses still to come from vintage loans, and that the August delinquency data is a positive indicator for CMBS nationwide.

“Interest rates are low, and underwriting is a lot more conservative,” the Morningstar analyst said, noting that any lingering losses, while pernicious, have at least been predictable. Jellinek will be keeping his eye on Texas to track whether Houston-based oil and gas companies toy with downsizing, but for now, he has to squint to see any signs of trouble.

Source: commercial

Toys ‘R’ Us Files for Bankruptcy, No Stores Slated to Close (at Least for Now)

Ahead of its Sept. 26 second-quarter earnings call, toy giant Toys “R” Us has voluntarily filed for bankruptcy protection in the Eastern District of Virginia as a means of unburdening itself from massive debt on its balance sheet, $400 million of which comes due next year.

“Together with our investors, our objective is to work with our debtholders and other creditors to restructure the $5 billion of long-term debt on our balance sheet,” Chairman and Chief Executive Officer Dave Brandon said in a statement.

Toys “R” Us, which was purchased by Kohlberg Kravis Roberts, Bain Capital and Vornado Realty Trust for around $6 billion in 2005, said in a letter to its customers that it is “working to strengthen our financial position. The company, some of our U.S. subsidiaries and our Canadian subsidiary proactively and voluntarily filed for Chapter 11 in the U.S. and began parallel reorganization proceedings in Canada. … Through these important actions, we expect to restructure our long-term debt and instead use these resources to reinvest in our business, so that we can continue to improve your experience in our stores and online and separate ourselves from our competitors in today’s rapidly changing retail landscape.”

As of April 29, the company had $6.57 billion in assets and $7.89 billion in liabilities, according to yesterday’s bankruptcy petition, obtained via Nationwide Research Company. Net sales decreased by $113 million, or 4.9 percent, to $2.2 billion for the 13 weeks ended April 29, compared with $2.3 billion for the same period last year, the company’s U.S. Securities and Exchange Commission 10-Q filing indicates.

Steve Jellinek, a vice president at Morningstar Credit Ratings, told Commercial Observer the bankruptcy didn’t come as a great surprise.

“I was expecting it for a couple of reasons,” Jellinek said, “Firstly, Toys ‘R’ Us had a heavy debt load because of its leveraged buyout. Secondly, the state of the retail market; there are just too many retailers—it was only a matter of time.”

He went on to say following the retail industry’s consolidation of bookstores and sporting goods stores, consolidation among toy retailers was bound to follow. “The competition in toys is pretty much the same as the competition in books,” Jellinek said. “You’re dealing with a commodity and the lower-priced retailer is going to win.” Two of those lower-priced retailers bringing the heat are online giant Amazon and Walmart.

As CO reported on Sept. 11, a bankruptcy could place $3.6 billion in commercial mortgage-backed securities loans at risk. The $507.6 million loan securitized in the Goldman SachsBank of America-sponsored TRU 2016-TOYS deal, backed by a portfolio of 123 Toys “R” Us and Babies “R” Us stores, is the CMBS loan with the largest exposure. “The big question everyone is asking is what’s going to happen with the TRU deal, but nobody knows at this point. The positives is strong diversity of geographic locations, conservative underwritten loan to value and a conservative dark value on the whole portfolio—around 82 percent,” Jellinek added.

All of Toys “R” Us’ roughly 1,600 Toys “R” Us and Babies “R” Us stores and e-commerce sites will remain open for business, the company said, due to a commitment of over $3 billion in debtor-possession financing from existing lenders led by J.P. Morgan.

Morningstar expects there to be some store closings eventually, Jellinek said. The stores that will escape the shutterings will be “good locations with high demand, strong populations and most likely high sales per square foot, and you’ll see that in the more densely populated areas,” he said.

Meanwhile, Toys “R” Us is maintaining hope about this year’s holiday season. The company said it has started its “seasonal hiring push,” and as CO previously reported, it recently opened a pop-up shop in Times Square.

One broker spoke of the benefits of the bankruptcy filing.

“I think Toys’ bankruptcy filing is probably a good thing, strategically, for the company,” retail broker Richard Hodos of CBRE said over email. “If they are able to secure the debtor-in-possession financing package, it should give them breathing room and a whole new level of cushion so they can make the strategic investments in the business and operational platform necessary (for the business) in the long run.”

Jellinek concurred that the bankruptcy filling isn’t all doom and gloom. “It could be a good thing if they have some of the debt extinguished so it’s more manageable, and can focus on profitable stores. The question is how are they going to compete going forward, even if they do close stores. Even in Class A locations, will the revenue be strong enough to survive? That’s the question.” 

Source: commercial