Marc Rosenthal, chief investment officer of MP Securitized Credit Partners, is betting the CMBX6 rally is growing long in the tooth and sees two foreclosed malls in CMBX6 deals — and other troubled properties like them — as breaking points for the trade that’s gripped the index’s BBB- and BB tranches this year.
Both the 211,404 sq ft Salem, Oregon, mall that previously backed the USD 33.3m Salem Center loan in JPMCC 2012-LC9 and the 377,722 sq ft Fashion Outlets of Las Vegas in Primm, Nevada, that backed a USD 73m loan in COMM 2012-CRE4 have been seized by the trusts and the next moves could be painful ones, said Rosenthal.
Rosenthal, who in 2008 co-founded MP’s predecessor FrontPoint Strategic Credit Fund to capitalize on distressed residential credit at the depths of the financial crisis, said the malls could be sold out of the trusts at losses at any time, potentially providing a trigger that could destabilize the CMBX6's upward momentum. The Salem property was most recently appraised at USD 20m, down from USD 44m at securitization, and the Fashion Outlets was last appraised at USD 28.8m, compared to USD 125m at securitization, according to Trepp.
The Fashion Outlets appraisal, in particular, was "inflated and inconceivable," he said.
“Eventual liquidation sales of these properties below their recent appraisals could be a trigger" for the index, Rosenthal said. "Additional mall loan defaults in CMBX6 could be other triggers,” he added, noting that many of the 39 malls in the index are not in strong hands.
“It has to go down significantly,” he said, of the index.
Rosenthal declined to specify the level that properly reflects the coming doom. Some shorts have asserted that the CMBX6 BB tranche should be priced in the 30 to 40 dollar range or slightly higher, well below the 80 price range seen this month, according to a first source familiar.
Relief rally vs. short triggers
The CMBX6 has become a flashpoint in the long vs. short investment debate over just how bad the trend away from brick and mortar retail will get. MP, which also has cash positions in CMBS and RMBS, is standing firm with its CMBX6 short trade despite a year in which "risk-on" sentiment has been tough on retail bears.
The CMBX6 BBs are now at a roughly 80 dollar price, up from the 72 area at year-end 2018. But levels are still below the 87 dollar price of January 2017, before Alder Hill Management fanned the shorting fever with a report in early that year, an analyst said. The CMBX6 BBB- tranche is priced at nearly 90, up from a low in the 83 area in November 2017 but below pricing in the 94.5 area in January 2017.
“What you’ve had in the last five months is a growing general perception that the world isn’t going to end and people are perceiving risk to be more interesting,” an analyst said.
While some investors and analysts have become inured to the constant drip-drip of store closures and bankruptcies, Rosenthal said the pain can get worse. Changes wrought by online shopping are dramatic ones that will continue to cut deeper distress into the retail market, he said.
“Is this a cyclical phenomenon where retail is going to recover or is it an accelerating downward spiral in regional class B and C malls?” Rosenthal asked. “We view the declining performance at the bulk of CMBX6 malls as a fundamental issue rather than a cyclical issue that will potentially improve over time.”
"Recent anchor closings, tenant bankruptcies and store closings, which are expected to hit record levels in 2019, are not yet fully reflected in reported financials but point toward a further acceleration in deterioration in the years to come,” he said.
Troubling fundamentals and severe losses seen on horizon.
Rosenthal challenged bullish views with data. For instance, he said 28 of the 39 malls in the CMBX6 index saw their net operating income decline by 9% on average in 2018 and 14% since origination through 2018 and that the same number of properties are underwater. Because it doesn’t make sense for an owner to pay back an underwater loan, owners will default and hand properties to creditors, he said.
In addition, the CMBX6 series’ retail exposure has increased to about 43% from 35% at origination, he said. But that's not the proper metric, according to at least one big firm on the other side of the trade. AllianceBernstein measures retail exposure by comparing the current balance of retail loans in a conduit to the deal’s original value rather than the current balance, a second source familiar said.
Rosenthal’s comments come just weeks after Brian Phillips, director of commercial real estate credit research at USD 568bn money manager AllianceBernstein, supported CMBX6 long positions and denigrated reports justifying the other side of the trade as “irresponsible,” as reported. Phillips had said that retail exposure dropped to 28% from the 35% at origination, as reported.
”Saying [the malls are] all going to hell in a handbasket just doesn’t make sense,” Phillips said, as reported. He said AB was taking the contrarian view and was so far this year winning the argument. “Would any rational investor walk away from a mall asset that’s still covering its debt service and producing millions of dollars a year in internal cash flow, assets that have the potential to be a tenant consolidator in their region?”
By contrast, Rosenthal said the "big risk-on rally" in credit markets is blinding investors who might normally be aghast at disturbing trends in retail. Investors should alarmed that cap rates for mall properties have risen to about 16% from about 7% in 2012, he said. Also, the current loan-to-value ratio for mall loans in the CMBX, on average, would be 146%, again suggesting significant losses at liquidation, he said.
“That’s the framework for what the severity of the loss could be,” he said.
For now, the shorts and longs are largely digging their heels in. The analyst said even a severe loss from the liquidation of a mall like the Fashion Outlets will not be enough to change the current status quo. CMBX spreads even last week’s spate of negative news around JCPenney missing their earnings and Dressbarn’s decision to close its business had little impact on the spreads, which instead continued to tick in slightly.
Spreads in the CMBX6 BBB- and BB tranches moved in to S+ 663bps and S+ 1,297bps as of Wednesday (22 May), respectively, from S+ 668bps and S+ 1,304bps Monday (20 May), according to JPMorgan data.
“Because shorts and longs are generally convinced about the sides they’re on, you generally don’t see [the CMBX6 index] move much…They’re pretty dug in,” the analyst said. Perhaps shock to macro outlooks, akin to the December sentiments that rocked global financial markets , would shake out longs, he said.
“It would have to be a big surprise,” he said.