November 9, 2017 / 7:27 PM / a year ago

Fitch Downgrades CBL to 'BB+'; Outlook Negative

(The following statement was released by the rating agency) NEW YORK, November 09 (Fitch) Fitch Ratings has downgraded the ratings of CBL & Associates Properties, Inc. (NYSE: CBL) and its operating partnership, CBL & Associates Limited Partnership, including the Long-Term Issuer Default Rating (IDR) to 'BB+' from 'BBB-'. The Rating Outlook is Negative. A full list of rating actions follows at the end of this release. Fitch's rating action is based on CBL facing portfolio-level operational stress, due primarily to a secular shift away from apparel towards non-retail uses. Fitch believes this shift will take several years to play out, putting pressure on the company's cash flows and access to capital. The Negative Outlook reflects the uncertainty as to whether the company's operating challenges will deepen and the nature and timing of the company's response to these challenges, such as how it will reduce leverage and access the debt capital markets. KEY RATING DRIVERS The downgrade of the IDR to 'BB+' reflects Fitch's view that the company's property-level fundamentals will continue to be pressured by retailer operating weakness, which will challenge the company to sustain investment-grade metrics and access to capital. The company's capital access is already weaker than most investment-grade REITs, and Fitch expects such weakness will persist for the foreseeable future. Further, the leverageability of the company's unencumbered pool via the mortgage market is uncertain, calling into question the contingent liquidity of the company's portfolio. Fitch previously noted that a lack of improvement in capital access and sustained deterioration in operating fundamentals could lead to negative rating action. The company also has relatively weak unencumbered asset coverage of unsecured debt, particularly given that Tier 2 assets comprise approximately 50% of the consolidated unencumbered pool. In addition, property-level performance has been declining, with worsening yoy occupancies, same store net operating income (SSNOI) and tenant sales per square foot, due primarily to inline tenant bankruptcies and a more challenging leasing environment. Fitch believes that portfolio operating metrics will be flat to down over the projection period. These factors are balanced by Fitch's expectation of leverage and fixed-charge coverage metrics that are good for the 'BB+' rating. Further, while 'B' malls are less financeable in the mortgage market than most traditional real estate assets, they are considerably more financeable than niche asset classes such as casinos, data centers and hospitals. Fitch also views positively the company's recent access to the unsecured bond market to further unencumber the portfolio, although reduced mortgage availability for less productive retail assets limits secured capital access, reducing contingent liquidity via the company's unencumbered pool. Market sentiment across most capital providers for 'B' malls has eroded given the challenges in ascertaining the long-term productivity and financeability of this asset class. In addition, the company's dividend reduction allows it to retain approximately an additional $50 million annually, enabling it to deploy those funds towards redevelopment costs. Property-Level Fundamentals Weaken: Fitch expects flat to negative same-center NOI growth during the projection period. The company's operating performance has been affected by negative retailer trends, in particular tenant bankruptcies and store closures. For the LTM ended Sept. 30, 2017, the company's stabilized mall same-center tenant sales per square foot was $373, down from $380 a year earlier, yoy stabilized mall occupancy declined approximately 80bps to 91.7% and same-center NOI declined 1.6% for the nine months ended Sept. 30, 2017. Of particular concern was the negative 16.1% renewal leasing spread for third quarter 2017 (3Q17), which likely presages future same-property NOI declines. Fitch expects continued softness in operating metrics as the company backfills vacant space, offset by negative leasing spreads for in-place tenants. Evolving Access to Capital: Fitch views CBL's access to most forms of debt and equity capital to be more consistent with below-investment-grade REITs, and it has weakened since Fitch initiated the ratings. Mortgage availability for 'B' malls is less plentiful and more discriminating than in prior years and has weakened over the last year, and we expect continued negative sentiment given soft property-level fundamentals. Similarly, Fitch views CBL's access to non-bank unsecured debt capital as weak compared to peers when measured by bond issuance spreads, attributable to its asset class and market sentiment around less-productive malls. CBL's ability and willingness to issue unsecured debt in September 2017 was a credit positive on the margin. However, the widening in spreads for CBL's issuances juxtaposed against tightening spreads for the broader REIT bond market may reflect deteriorating capital markets access. Liquidity is not a concern given manageable unsecured debt maturities over the next few years and increased retained cash flow given the recent dividend reduction that should enable the company to retain $50 million annually of cash flow; however, access to attractively priced debt and equity capital is a key rating consideration for REITs in light of their dividend distribution requirements. CBL's common equity is trading at over a 60% discount to consensus net asset value, the largest discount in Fitch's rated universe (the REIT index is at a 3% discount). Fitch attributes the discount to the wide bid-ask spread for 'B' malls generally, as the market struggles to ascertain the long-term viability and value of less productive malls. By extension, thinner investor demand and reduced mortgage availability for 'B' malls limits the extent to which CBL can raise equity through asset sales. Adequate Leverage And Coverage: Fitch expects that leverage will sustain in the mid-to-high 6.0x range, driven by (re)development NOI coming on line and asset give-backs to lenders, along with modestly negative single-digit SSNOI growth over the projection period. CBL's LTM leverage was in the high-6.0x vicinity at Sept. 30, 2017, up slightly from Dec. 31, 2016 and 2015. When treating 50% of CBL's preferred stock as debt, leverage would be approximately 0.5x higher. Fitch expects fixed-charge coverage to remain relatively unchanged from around the low-2.0x area for the TTM ended Sept. 30, 2017; this level is appropriate for the rating. Low Unencumbered Asset Coverage of Unsecured Debt: Sept. 30, 2017 unencumbered asset coverage of unsecured debt was 1.7x when applying a stressed 9.0% capitalization rate to consolidated unencumbered NOI. This ratio is appropriate for the 'BB+' rating, and is driven in part by approximately 50% of the company's consolidated unencumbered NOI being derived from Tier 2 malls whose tenants generate only $326 of sales per square foot. Secured debt financing for less productive malls has become less plentiful, calling into question the depth of contingent liquidity provided by the company's unencumbered pool. Coverage would be only 0.6x when giving credit only to Tier 1 consolidated unencumbered assets, whose tenants generated $402 of sales per square foot. RECOVERY RATINGS In accordance with Fitch's Recovery Rating (RR) methodology, Fitch provides RRs for issuers with IDRs in the 'BB' category. The 'RR4' for CBL's senior unsecured debt supports a rating of 'BB+', the same as CBL's IDR, and reflects average recovery prospects in a distressed scenario. The 'RR6' for CBL's preferred stock supports a rating of 'BB-', two notches below CBL's IDR, and reflects weak recovery prospects in a distressed scenario. DERIVATION SUMMARY Relative to the broader mall REIT sector, CBL's levels of occupancy, SSNOI growth, leasing spreads and tenant quality are slightly weaker than B-mall peer Washington Prime (WPG; BBB-/Negative) and weaker than Simon Property Group (SPG; A/Stable). In addition, Fitch expects CBL's leverage to sustain at slightly higher levels than WPG. Relative to the broader retail REIT peer set, the company has weaker access to capital, given its significant equity trading discount to NAV and wide spreads at which its bonds trade. Further, secured lender sentiment for the 'B' mall asset class has declined to a level that Fitch believes is below that of many other retail commercial real estate asset classes. Fitch links and synchronizes the IDRs of the parent REIT and subsidiary operating partnership, since the entities operate as a single, connected enterprise with strong legal, financial, and operational ties. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: --Annual SSNOI growth of between -2.5%-0% for 2017-2019; --Annual development/redevelopment spend of $175 million-$250 million for 2017-2019. The weighted average initial yield on cost for projects coming online is approximately 8%; --Total non-core asset sales of approximately $575 million; --Deed-in-lieu of foreclosure transactions of approximately $200 million; --Annual recurring capital expenditures of $120 million; --Total bond issuance of $900 million for 2017-2019. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action --Improved capital markets sentiment regarding 'B' malls, specifically enhanced insurance company mortgage lending to the sector, bond issuance pricing closer to investment-grade peers, or a lower NAV discount for the company's common stock which may result in the company raising equity; --Sustained improvement in operating performance as measure by SSNOI; --Fitch's expectation of leverage sustaining below 5.5x; --Fitch's expectation of unencumbered assets coverage of unsecured debt exceeding 2.0x --Fitch's expectation of fixed-charge coverage sustaining above 2.0x. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action --Sustained deterioration in operating fundamentals or asset quality (e.g. sustained negative SSNOI results or negative leasing spreads); --Fitch's expectation of leverage sustaining above 6.5x; --Fitch's expectation of fixed-charge coverage sustaining below 1.5x; --Reduced financial flexibility stemming from significant utilization of lines of credit; --Failure to maintain unencumbered asset coverage of unsecured debt (based on a stressed 9% cap rate) above 1.75x. LIQUIDITY CBL's base case liquidity coverage ratio of 1.4x through the end of 2019 is good for the rating and is driven primarily by limited near-term debt maturities and good availability under its unsecured line of credit. Fitch defines liquidity coverage as sources of liquidity divided by uses of liquidity. Sources of liquidity include unrestricted cash, availability under unsecured revolving credit facilities, and retained cash flow from operating activities after dividends. Uses of liquidity include pro rata debt maturities, expected recurring capital expenditures and remaining (re)development costs. As of Sept. 30, 2017, the company had $31.4 million of cash and equivalents and $1.1 billion revolver availability (consisting of three separate facilities) with aggregate outstanding borrowings of $80 million. The revolvers mature in 2019/2020 with a company option to extend those maturing in 2019 to October 2020. FULL LIST OF RATING ACTIONS Fitch has downgraded the following ratings: CBL & Associates Properties, Inc. --Long-Term IDR to 'BB+' from 'BBB-' --Preferred stock to 'BB-/RR6' from 'BB'. CBL & Associates Limited Partnership --Long-Term IDR to 'BB+' from 'BBB-' --Senior unsecured lines of credit to 'BB+/RR4' from 'BBB-'; --Senior unsecured term loans to 'BB+' /RR4 from 'BBB-'; --Senior unsecured notes to 'BB+' /RR4 from 'BBB-'. The Rating Outlook is Negative. Contact: Primary Analyst Steven Marks Managing Director +1-212-908-9161 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Christopher G. Pappas Director +1-646-582-4784 Committee Chairperson Bill Densmore Senior Director +1-312 368-3125 Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor: --Historical and projected recurring operating EBITDA is adjusted to add back non-cash stock-based compensation and include operating income from discontinued operations and Fitch's estimate of recurring cash distributions from joint venture operations; --Fitch has adjusted the historical and projected net debt by assuming the issuer requires $25 million of cash for working capital purposes, which is otherwise unavailable to repay debt; --Fitch has included 50% of the company's cumulative perpetual preferred stock as debt in certain ratios. 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