How the Brick & Mortar Meltdown works for Commercial Mortgage-Backed Securities after America’s largest mall landlord defaults on a mortgage and walks away from the mall.

The dust has settled and the numbers have emerged: A $200-million commercial real estate mortgage on an indoor mall of over 1 million square feet in a suburb of Kansas City, MO, generated a $149.7 million loss for commercial mortgage-backed securities investors, for a loss ratio of 74.9%, when the mall was sold in a foreclosure sale. On Thursday, Trepp, which provides analysis on CMBS, reported that it was “the largest loss ever incurred by a retail CMBS loan.”

The mall had been owned by Simon Properties Group (SPG), the largest mall landlord in America. It was not a shuttered zombie mall, but a live super-regional mall, the Independence Center, built in 1974, with 88 stores anchored by Sears, Macy’s, Dillard’s, and Dick’s Sporting Goods. The debacle shows how far the brick-and-mortar meltdown has eaten into the values of mall properties.

According to a special servicer commentary quoted by Trepp in August 2017, SPG defaulted on the mortgage in May 2017 when it came due because it was “unable to repay the loan at maturity due to the size of the loan compared to the net operating income that the property generates and the tenants inability to increase sales due to the economic challenges.”

Instead of paying off the mortgage, which was backed by 39% of the mall, SPG walked away from the entire mall in 2017 and washed its hands off it, knowing that the entire mall wasn’t worth anywhere near the $200 million required to pay off the mortgage. It then removed the name of the mall from its website. And it was up to CMBS investors to eat the loss.

Senior Managing Director of Trepp, Manus Clancy, told KSHB in February 2018 that Independence Mall had been valued at $250 million in 2007, when the mortgage was packaged into the CMBS. By May of 2017, the value had dropped to $136 million.

Compare that to the $63.3 million that the mall fetched at the foreclosure sale in February 2019, when it was acquired by International Growth Properties (IPG).

IPG will have to do some creative thinking about what to do with the mall. But whatever it will do with it, and however it may repurpose it, its cost base is a lot lower.

The mortgage had been packaged into CMBS (WBCMT 2007-C33) in August 2007 by Wachovia, just about moments before it all collapsed, including Wachovia. By the time the write-off occurred, the mortgage represented 52.4% of the CMBS’s remaining collateral, according to Trepp.

Last month, after the sale of Independence Center, Moody’s further downgraded three of the seven tranches of these CMBS, including the highest-rated tranche to Caa1.

As rationale for the downgrade, Moody’s cited “higher anticipated losses from the specially serviced loans… driven by the deterioration in performance of the Independence Mall Loan and the high expected loss severity from the reported sale of the asset.”

Moody’s said that the downgrade “reflects a base expected loss of 67.5% of the current pooled balance, compared to 56.2% at Moody’s last review. Moody’s base expected loss plus realized losses is now 14.0% of the original pooled balance, compared to 12.9% at the last review.”

In its monthly CMBS delinquency report, Trepp reported that the retail-sector delinquency rate rose 13 basis points in March to 4.9%. Over the past 12 months, this delinquency rate has been running between 4.7% and 6%. The report notes:

For retail-sector CMBS issued after the Financial Crisis (“CMBS 2.0”), the delinquency rate rose 16 basis points to 0.92%.

the Financial Crisis (“CMBS 2.0”), the delinquency rate rose 16 basis points to 0.92%. But for retail sector CMBS issued before the Financial Crisis (“CMBS 1.0”), such as our infamous WBCMT 2007-C33, the delinquency rate soared 249 basis points in March to 63.0%. This is where the descriptor “toxic” comes from.

In its Kansas City Retail Report for 2018, Lane4 Property Group said that the “setback” for Independence Center “is part of a larger trend” that had already “claimed such former major Kansas City shopping destinations as Metcalf South Mall, Metro North Mall, Mission Mall, Antioch Center, Bannister Mall, Indian Springs Mall and the Great Mall of the Great Plains.” And Independence Center is one of only “two remaining true indoor malls” in the Kansas City metro area.

Simon Properties Group CEO David Simon had a special word about how the brick-and-mortar meltdown is impacting his firm: “I prefer not to scare you at this point, okay,” he said during the earnings call. “But it’s something that we’ve been able to withstand.” Read… What the CEO of America’s Largest Mall REIT, Simon Property Group, Just Said about the Brick & Mortar Meltdown and How it’s Trying to Manage It

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