Reading The Retail REIT Bond Tea Leaves

by: Rubicon Associates

Summary

I recently published a note on the bonds of two mall REITs.

I have expanded it to all retail REITs, looking at 5 and 10-year maturities.

My thoughts on what the credit tea leaves imply.

I recently wrote a note on the bonds of mall REITs CBL & Associates (CBL) and Washington Prime Group (WPG) where the premise was that the bonds of companies will often better reflect their fundamentals than the equities of the same companies. Readers seemed to like the premise and the insight that looking at the bonds can give to investors across the capital structure.

As a result, I have expanded this view to other retail-focused REITs and their bonds. In order to facilitate comparison, I screened for REIT bonds in 5 and 10-year maturities. Specifically, I screened the following:

  • Issue date: prior to 9/30/16
  • Issue size: greater than $100mm
  • Rating: BBB- or better
  • Currency: USD
  • 5-year Maturity: 1/1/21 - 1/1/24
  • 10-year Maturity: 1/1/24 - 1/1/27

The 5-yr screen produced 102 bonds, 29 of which were retail-focused. The 10-yr screen produced 92 bonds, 25 of which were retail-focused. In order to gauge the performance of the retail REIT bonds (and the universe), I measured the bonds' change in the spread to the Treasury curve from 11/15/16 until today as the period contained a significant portion of the downdraft in retail REITs. Spread was used rather than price, as it is the risk premium. Also included is the equity return (price change basis) for the same period.

Beginning with the 5-year sector:

The retail segment underperformed the broader universe as spreads widened (denoted with a negative sign) 13 basis points for the retail segment versus 6 basis points for the universe. I realize that this does not control for roll down to a different Treasury and that some bonds will show odd prints on any given day (the SPG '23s, NNN '23s), but the results are generally what one might expect - the risk premium on retail REIT bonds has increased.

I had expected them to increase more given the daily "death of retail" headlines and pressure within the equity market. This expectation (with the notable exception of the CBL '23s) generally was wrong.

Next, I plotted the spreads versus the years on a scatter plot diagram (with retail REIT spreads in orange). One would expect that if the sector was on its deathbed, the retail spreads would be higher than the universe.

That was (is) not the case. Retail trades within the pack (again, CBL the outlier).

Next, the same with the 10-year sector:

As was expected, the retail sector underperformed, widening out by 4bps while the universe was 9bps tighter. In equities, the retail segment got hammered compared to the universe (11 percentage points difference) and bonds underperformed by 13bps (on a spread basis). Again, not the "blood in the streets" you would expect.

Plotting the 10-yr universe and retail:

Again, retail is within the universe, not overly wide as one might expect.

Finally, the CDS market for a view of the broader universe:

Corporates are tighter during the period, but generally, in line with REITs although the retail sector has underperformed as one might expect.

Bottom Line: The concern within the equity market reflects a valuation move more than a fundamental move, as bonds are typically better proxies of fundamental health (yes, I know they are senior and have covenants) than equities. My interpretation of this is that equities reflect valuation and will, therefore, typically swing too far as momentum pushed them lower than their true value (just as it did on the way up). As a result, there are going to be value priced retail REITs (just as I believe WPG and CBL are) and investors who can look past the noise and the headlines will be able to buy cash flow for cheap.

Disclosure: I am/we are long CBL, WPG.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.