Fitch Ratings has downgraded the ratings of Washington Prime Group, Inc. and its operating partnership, Washington Prime Group, L.P., including the Long-Term Issuer Default Rating, to ‘CCC+’ from ‘B’. Fitch has also downgraded WPG’s senior unsecured rating to ‘B-’/’RR3′ from ‘BB-’/’RR2′. The Rating Outlook is Negative.
The deterioration of the operating performance of WPG’s mall assets and its capital access has severely limited the company’s ability to navigate coronavirus-related retailer tenant stress. Fitch expects property-level fundamentals will remain pressured by store closures and bankruptcies of weaker performing retailers, intensified by the current social distancing and wide spread retailer closures, which will challenge the company’s ability to sustain portfolio and financial metrics. The acceleration of store closures and bankruptcy activity of department stores (e.g. Macy’s, JC Penney) will trigger the activation of co-tenancy clauses throughout WPG’s portfolio in 2H20 and FY21.
The company’s already challenged cash flow profile has been hampered further by the significant non-payment of rent throughout its portfolio. WPG collected 30% of April rent (25% mall; 50% open air), and Fitch expects collections to remain at similar levels or lower through at least 2Q20 due to the challenge of attracting customers to enclosed retail assets, even for locales that have reopened non-essential businesses. Investment needs prior to the pandemic were already at a level that required triaging of redevelopment capital. The increase in the rate of expected store closures in combination with declining capital availability will exacerbate the loss of competitive positioning for even WPG’s strongest assets.
WPG has drawn substantially all of its remaining revolver capacity and will require waivers from its bank lenders to avoid breaching a leverage covenant in either 2Q20 or 3Q20. Fitch believes that there is a high likelihood for WPG’s bank lenders to require collateralization of its credit facility to obtain covenant waivers. WPG’s remaining unencumbered pool, including many of its better performing open air assets, and the demonstration of access to new mortgage capital in early 2019 were key factors supporting the ‘B’ IDR. The anticipated dilution of the remaining unencumbered pool and Fitch’s expectations of greater scrutiny and rising performance hurdles for any retail-based lending will minimize the remaining capital access afforded the company prior to the pandemic
Fitch’s updated ‘RR3′ recovery ratings on all senior unsecured obligations assume the company enters a bankruptcy event with the obligations pari passu. Within the unsecured obligation rating actions, Fitch has placed the company’s revolving credit facility and bank term loans on Rating Watch Positive due to the potential for positive recovery implications should the company’s bank lenders receive collateral in exchange for providing the necessary covenant waivers.
Under this scenario, the expected recovery for holders of WPG’s 2024 unsecured bond would be negatively impacted, thus Fitch has placed the obligations on Rating Watch Negative to reflect this downside risk. Further, if WPG’s unsecured bond recoveries were expected to fall in the range of 0%-10%, consistent with its preferred stock, Fitch would notch the preferreds down three from the IDR as opposed to the current two notches to reflect the seniority of the unsecured debt. For this reason, Fitch has also placed the ratings of the preferred stock on Rating Watch Negative.
KEY RATING DRIVERS
Eroding Cash Flows: Fitch expects WPG’s operating performance to deteriorate further in the near term, marked by mid- to high-single-digit SSNOI declines in the consolidated core portfolio (Tier I and Open Air) per annum through FY21. WPG’s operating performance has been diminished by negative retailer trends, in particular department store anchor closures and bankruptcies within its mall portfolio that have induced incremental occupancy and rental income losses through co-tenancy clauses.
Weak Relative Capital Access: WPG’s access to capital has been limited to its unsecured credit facility and select mortgage activity. The company has drawn substantially all of its remaining revolver capacity and lenders are expected to exhibit limited interest in extending capital to retail-based real estate without a significant grocery component.
WPG has had no tangible access to the REIT unsecured bond market or public equity markets. The company does have some runway prior to the maturity of its credit facility in December 2022, but Fitch anticipates obtaining covenant waivers could require some form of collateralization which would materially dilute the company’s remaining unencumbered asset portfolio.
Low UA/UD: Fitch believes WPG retains material value in its unencumbered portfolio through its Tier I and Open Air assets. Unencumbered asset coverage of unsecured debt (UA/UD) was 0.9x when applying a stressed 14.0% capitalization rate to 1Q20 annualized unencumbered NOI, excluding Tier II assets. The presumed finance of the company’s best remaining unencumbered assets is one of the few avenues available to access additional liquidity to fund its capital needs.
Credit Metrics Weak, Declining: Fitch expects that leverage will rise to the low-9x range as the company will have difficulty maintaining its revenue base once department store anchors and weaker performing retailers begin vacating space as soon as 2H20. Investment needs continue to rise within the portfolio but declining cash flow generation will further limit the already thinly spread available capital.
WPG’s leverage is likely to be buffered at the margin by the company’s ability to shed non-performing assets and the committed mortgages at maturity with minimal direct EBITDA impact. WPG’s leverage was 7.8x for the TTM ended March 31, 2020, up from 7.3x for the year ended Dec. 31, 2019.
When treating 50% of WPG’s preferred stock and 100% of redeemable noncontrolling interests as debt, leverage would be 8.1x.
Fitch expects fixed charge coverage to decline to the mid-1x range and sustain at that level through the forecast period. WPG’s TTM fixed charge coverage was 1.9x, down from 2.0x for the year ended Dec. 31, 2019.
Recovery Ratings: Fitch’s recovery analysis assumes WPG would be considered a going-concern in bankruptcy and the company would be reorganized rather than liquidated. Fitch applies individual stressed capitalization rates, based on the addition of 250bps to January 2020 estimated market cap rates for the Tier I and Tier II mall assets and 100bps to the open-air assets, to the 1Q20 NOI generated by each tier of asset to determine a weighted average stressed capitalization rate of 15.5%. The stressed cap rates applied to each asset tier are as follows: Tier I malls, 16.5%, Tier II and noncore malls, 26.9%, Open Air centers, 9.5%.
1Q20 annualized consolidated NOI of $373 million is discounted by 12.7%, based on anticipated SSNOI declines of 3.8% in fiscal 2020 and 9.3% in fiscal 2021, and added to forecasted 6% redevelopment yields on $85 million of expected redevelopment spending through 2021. The weighted average stressed cap rate of 15.5% is applied to the post-reorganization NOI of $330 million to determine a recoverable value for the real estate portfolio. This value is combined with a discounted valuation of non-real estate assets, including the book equity of unconsolidated joint ventures, to determine a net recoverable value available to holders of WPG’s obligations of $2.2 billion, after applying a 10% to administrative costs and priority claims. There is no assumption of concession allocation to unsecured claims due to expected recoveries of the unsecured bonds in the 50%-70% range.
Fitch assumes that WPG’s $650 million revolving credit facility is fully drawn in a bankruptcy scenario, and includes that amount in the claim’s waterfall. Fitch also assumes that all $1.1 billion in outstanding first-lien mortgages are fully repaid via the recoverable value in a going concern scenario.
The distribution of value yields a recovery ranked in the ‘RR3′ category for the senior unsecured revolver, terms loans, and 2024 unsecured bond based on Fitch’s expectation of recovery for the obligations in the 50%-70% range, and the ‘RR6′ category for the preferred stock based on recovery in the 0%-10% range. Under Fitch’s Recovery Criteria, these recoveries result in notching one level above the IDR for the unsecured obligations to ‘B-’ and notching two levels below the IDR to ‘CCC-’ for the preferred stock.
Should the company be required to collateralize its credit facility with some, or all, of its remaining unencumbered asset pool, Fitch would envision a materially weaker recovery for the 2024 unsecured bonds.
The recoveries of WPG’s unsecured obligations are approximately $470 million lower than Fitch’s January 2020 recovery analysis reflecting the eroding performance of the operating portfolio in 1Q20, expectations of weaker performance in FY20 and FY21 due to accelerating department store closures/bankruptcies and associated cotenancy clause effects, a weakened cash flow profile expected to limit WPG’s ability to invest in redevelopment, as well as more conservative cap rate assumptions in valuing the company’s mall assets.
WPG’s relative levels of occupancy, SSNOI growth, leasing spreads and tenant sales productivity in its consolidated mall portfolio are marginally better than CBL & Associates and considerably weaker than Simon Property Group (SPG; A/Stable). WPG’s open air retail assets have generally performed well based on reported occupancy levels and SSNOI growth, but the disclosed performance figures include WPG’s unconsolidated joint venture assets and open-air tenant-level performance data is limited. Fitch estimates that the Open Air portfolio generates approximately one-third of consolidated NOI.
WPG’s leverage in the high-7x to high-8x range is comparable to CBL’s but significantly higher than SPG which historically sustained leverage in the low-5x range prior to accounting for the Taubman acquisition. Further, WPG’s contingent liquidity, as measured by UA/UD, is estimated at 0.9x compared to CBL’s of 0.5x and SPG’s in the mid- to high-2x. WPG exhibited better capital access than CBL prior to the pandemic, but Fitch believes that capital access will be restricted to a level that will make the redevelopment and re-tenanting of its asset base increasingly challenging. SPG has exhibited market-leading capital access through-the-cycle to both the bond and equity markets.
Fitch’s Key Assumptions Within its Rating Case for the Issuer
– Annual SSNOI growth in the negative 4%-10% range for FY20-FY21 (Tier I and Open Air assets) with weakness accelerating in FY21 as activation of cotenancy clauses ramps up significantly with the closures of department stores in the 2H20 into FY21 (e.g. Macy’s, JC Penney);
– Tier II and noncore assets generate approximately $40 million in NOI on annualized basis. Fitch assumes that the NOI generation is halved in FY20 due to tenant failure and inability to pay. Deed-in-lieu foreclosures (asset givebacks) then account for approximately $15 million in lost NOI in FY21-FY22. The remaining $5 million in NOI is run off in FY23 as these assets close permanently;
– Fitch assumes one-quarter of full year 2020 rent is deferred for 70% of WPG tenant roster, approximating $105 million in unpaid rent. This amount is included as straight-line rent;
– Fitch assumes that 25% of the deferred rents are ultimately repaid in FY21 with the remainder written off as uncollectible due to tenant failure and/or inability to repay upon reopening.
– Annual recurring UJV distributions of $25 million, 25% reduction from normalized FY19 levels;
– Deed-in-lieu transactions of $120 million in FY21 and $100 million in FY22 (consistent with NOI run off discussed above for Tier II and noncore assets);
– Annual recurring capex of approximately $40 million in FY20 and $50 per annum in FY21-FY23. Reduced from $60 million per annum expectations prior to pandemic given cash flow constraints;
– Annual (re)development spend of $60 million for FY20 and $25 million per annum in FY21-FY23. The weighted average initial yield on cost for projects is estimated at 6%. Prior to pandemic Fitch had anticipated approximately $100 million in annual redevelopment spend at initial yields of 7%-8%;
– Total asset sales (outparcels) of approximately $35 million in FY20, $20 million in FY21, $15 million in FY22, and $10 million in FY23;
– Mortgage refinancing requires partial principal reduction in many cases as lending is more heavily scrutinized;
– No further dividend payments in FY20 beyond $28 million payment in 1Q20. Fitch includes same level of dividend payments in FY21-FY23 but notes that this level could be higher/lower depending on taxable income levels and implications on REIT distribution requirements.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
– Improved financial flexibility stemming from an increase in capital markets access, including the unsecured debt market and the public equity market;
– Sustained improvement in operating fundamentals or asset quality (e.g. sustained positive SSNOI results and/or corporate earnings growth);
– Fitch’s expectation of UA/UD exceeding 1.0x;
– Fitch’s expectation of net debt to recurring operating EBITDA sustaining below 7.5x;
– Fitch’s expectation of REIT fixed charge coverage sustaining above 1.25x.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
– Reduced financial flexibility and/or a deteriorating liquidity profile stemming from the collateralization of the company’s unsecured credit facility, difficulty refinancing debts, or a debt restructuring/exchange;
– Sustained deterioration in operating fundamentals or asset quality (e.g. sustained negative SSNOI results and/or corporate earnings growth);
– Fitch’s expectation of UA/UD sustaining below 1.0x;
– Fitch’s expectation of REIT fixed charge coverage sustaining below 1.0x.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance.
LIQUIDITY AND DEBT STRUCTURE
WPG’s base case liquidity coverage of 0.6x through the end of 2021 is weak but adequate for the rating. Fitch assumes the company continues to pay an annual dividend of just $0.125/share, or $28 million per annum, through the forecast period as asset impairments and credit losses limit WPG’s taxable income.
WPG drew $120 million from its revolving credit facility in April 2020, leaving $3 million of remaining capacity on its existing $650 million revolver. WPG has no unsecured debt maturities before its revolver and $350 million term loan mature in December 2022, assuming revolver extension options are exercised. The company’s other $340 million bank term loan matures a few weeks later in January 2023.
The company is in active discussions with its bank lenders for covenant waivers as reduced cash collections are expected to result in a covenant breach in either 2Q20 or 3Q20. Fitch believes that WPG’s bank lenders could leverage these negotiations to collateralize the unsecured facility in a similar fashion to peer CBL & Associates. The revolver and term loans are currently pari passu with the outstanding $720.9 million unsecured bond due 2024. This provides an incentive for the bank lenders to work with WPG to provide covenant waivers to avoid entering a bankruptcy process on equal standing with the bondholders.
WPG has deferred some of its planned FY20 capex to FY21 to support its near-term liquidity profile, but the level of investment required in WPG’s assets remains critically elevated and delayed capital improvements and redevelopment of vacant anchor boxes is expected to further impair the competitive positioning of the company’s assets.
The company’s liquidity coverage improves to 1.1x assuming it is able to refinance 60% of its secured mortgage maturities through 2021. Fitch assumed a lower refinancing rate of mortgage debt (60% vs. 80%) than its traditional analysis based on the expectation of increased lender scrutiny of refinancing transactions.
Fitch defines liquidity coverage as sources of liquidity divided by uses of liquidity. Sources include unrestricted cash, availability under unsecured revolving credit facilities and retained cash flow from operating activities after dividends. Uses include pro rata debt maturities, expected recurring capex and forecasted (re)development costs.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
The highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies).