“Little or nothing.” Toys “R” Us and its commercial mortgage backed securities.

Here’s what a central-bank induced credit bubble – when investors are chasing yield while willfully ignoring risks – looks like when in full bloom, and what happens when even the worst-case scenario at the outset turns out to have been more hype than realistic.

This is how it started:

In October 2016, about 11 months before it filed for bankruptcy and 17 months before it decided to liquidate its operations in the US, Toys “R” Us sold $512 million in commercial mortgage-backed securities, backed by 123 Toys “R” Us and Babies “R” Us stores across 29 states with a combined 5.1 million sq. ft. rentable area.

At the time of the deal, the over-indebted brick-and-mortar retailer, which had been stripped of cash and loaded up with debt by its PE firm owners following the leveraged buyout in 2005, was already in financial trouble, deeply engulfed in the brick-and-mortar meltdown.

Nevertheless, it was able to persuade S&P Ratings to rate the $512 million in “commercial mortgage pass-through certificates,” as they’re called (TRU Trust 2016-TOYS). The borrowing entity was Toys “R” Us Property Company II LLC. The servicer was Wells Fargo. The deal was cut into six slices, with the lowest-rated slices taking the first loss:

A: $244.8 million, or 48%: AAA

B: $52.1 million, or 10%: AA-

C: $39.1 million, or 8%: A-

D; $47.9 million: BBB-

E: $65.1 million: BB- (junk)

F: $62.9 million: B- (junk)

In other words: 48% of the deal was rated AAA, 66% was rated A- or higher, and about 75% was rated investment grade (BBB- or higher).

But no problem. At the time, S&P assigned a value of about $618 million to the collateral. So there was nothing that could go wrong.

S&P said at the time that the ratings were based on its “view of the collateral’s historic and projected performance, the sponsor’s [PE firms KKR, Vornado Realty Trust, and Bain Capital that own the place] and managers’ experience, the trustee-provided liquidity, the loan’s terms, and the transaction’s structure.”

It added that even in their worst-case scenario – the “dark value” scenario – things would be just fine: “We determined that the loan has a 98.3% beginning and a 91.4% ending loan-to-value (LTV) ratio based on our estimate of the portfolio value under a “dark value” scenario, where the master lease tenant is no longer able to meet its obligations, vacates, and the properties must be re-tenanted.”

And this is how it turned out:

Now the worst-case scenario has gotten a lot worse. Deutsche Bank analysts Ed Reardon and Simon Mui wrote in a note Wednesday, cited by Bloomberg, that as many as 26 of the 123 properties backing this deal may have little or no value if they’re vacated by Toys “R” Us and would have to be re-leased – which is likely given the liquidation of Toys “R” Us.

They figured that a new appraisal of the properties will likely show the value, estimated at $618 million at the time of the deal, may have dropped 34% to $407 million. Bloomberg, citing the analysts:

Adding difficulty to valuations are the varying types of store locations – including outside malls, strip centers and standalone locations – and a retail industry “in such a state of flux.”

Other retailers that would want to move into the stores will be hard to find for many of the locations, as their own operations have gotten tangled up in the brick-and-mortar meltdown and a slew of them have filed for bankruptcy, and many more will soon do so, and they will shrink their footprint, and some of them will get liquidated. And these stores will become vacant too — if they haven’t already.

The analysts wrote that an appraised value of less than $495 million could lead to the $63-million F-tranche losing control of servicing decisions or taking losses. At an appraised value of $407 million, the losses will expand. And the brick-and-mortar meltdown has just gotten started.

While there are retailers that want new locations, and while there are some mall REITs that are looking at opportunities, they will only be interested in the best-situated properties. The analysts hoped that local real estate investors might be the best option for lower-value lots. And they won’t be willing to pay a lot for these properties.

These buyers “face massive execution risk,” the analysts wrote, including lower-than-expected rents, more retailer defaults, a long leasing process, and potential tenants that “have significant negotiating power.”

Some loans in the deal have other large vacancies nearby, or other weak tenants that may close stores. In some cases, potential replacement tenants like Michaels Cos. and Dick’s Sporting Goods Inc. already have stores near or in the same shopping strip where a Toys “R” Us is closing, meaning they’re unlikely to step in and lease.

As the old and now forgotten banker adage goes: Bad deals are made in good times. And perhaps conversely: It takes bad times to be able to make good deals.

Brick & Mortar Meltdown and the mall REITs: The weakest plunged 80% and the strongest plunged “only” 30%. Read… What Are We Going to Do with these Plunging Mall REITs?

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