Fitch: Severe US retail shock could fan out to REITs, CMBS

A hypothetical rapid rise in Amazon's U.S. apparel market share could have significant credit implications for existing retailers, real estate investment trusts (REITs) and commercial mortgage-backed securities (CMBS) transactions, says Fitch Ratings in a shock scenario report published Thursday.

The following statement was released by the rating agency.

Sharp declines in retailer revenue and margins and accelerated store closings would likely drive significant cash flow erosion and weaken credit profiles for apparel-focused retailers, -mall REITs and retail-heavy CMBS deals in such a scenario. The Fitch shock scenario assumes an accelerated three-year apparel market share shift to Amazon.com as a price-competitive and convenient alternative to traditional in-store purchases.

The hypothetical rapid growth in Amazon's apparel market share to 25% by 2020 could cut apparel retailer margins by around 300 basis points, pushing several retailers toward financial distress.

Assuming Amazon's share gains are concentrated in lower price points, low to mid-tier apparel retailers, including JC Penney, Kohl's and Dillard's, would face intense competitive pressure in such a scenario.

Importantly, the shock scenario considered in the report differs greatly from Fitch Ratings' current base and stress case expectations and is not intended to call into question the assumptions underpinning Fitch's existing credit ratings or outlooks. The stress test does not explicitly factor in management responses to a more challenging operating and financing environment. Many of these responses, including cost reduction initiatives, asset sales and secured debt issuance, could mitigate the impact of such a severe competitive shock, particularly for companies that have ample liquidity to respond to accelerated competitive threats.

This shock would likely fan out broadly across retail real estate, with large credit profile effects on mall REITs and retail-heavy CMBS transactions. Large-scale store closures, going well beyond previously announced cuts, would likely follow. REITs owning regional malls with high exposure to troubled anchor stores and a less diverse tenant base would face heavy cash flow pressure.

Fitch estimates that as many as 400 of approximately 1,200 US malls could close or be repurposed as a result of retailer liquidations and square footage reductions. In addition to weaker cash flow, many mall owners would face reduced access to capital due to negative lender and investor sentiment.

Attempts to re-tenant or repurpose underperforming malls with high vacancy rates would likely take considerable time and capital. Efforts by REITs to reposition mall properties in this scenario would be difficult given constraints on capital spending and liquidity in a tight financing environment. Widespread defaults on loans backed by malls would have a significant impact on credit quality for Fitch-rated CMBS transactions.

Given the accelerated timeframe of this retail shock scenario, special servicers would be forced to sell lower tier malls at significantly distressed values rather than undertaking normal stabilizing efforts. We estimate that significant negative ratings migration would occur for 92 of 145 Fitch-rated CMBS classes in 19 deals. These 19 deals have exposure to retail loans exceeding 50% of the current pool.

In contrast, much more limited rating migration would occur for a similarly-sized cohort of 19 deals with lower levels of retail concentration (less than 25% of current pool assets).

The parameters of the hypothetical apparel retail market shock and sector-specific conclusions for retailers, REITs and CMBS are included in the report "Shock Scenario: U.S. Retail," dated Sept. 13, available at Fitch Ratings.