CBL's Recent Impairments

Summary

• CBL has suffered several asset impairments in recent years.
• I'm concerned by their timing.
• This may not be an encouraging sign for some of CBL's other assets.
• CBL may be in danger of breaching debt covenants.
• I suggest buying low-strike, long-dated puts. The senior notes may also be attractive if they get cheap enough.

A less-discussed detail

CBL & Associates Properties (NYSE:CBL) has long been a battleground stock. Bulls talk about the dividend, the need for retail locations in less-affluent and/or more rural locations, as well as the company's low price/book value. Bears talk about the company's high cost of capital and struggling rents.

Yet there are two risks for CBL that have not gotten sufficient examination: The true value of the assets, and what those values may indicate for its debt covenants. I have noticed, anecdotally, a few questionable impairments and losses and want to get some idea of how big a concern they may be.

A few notes of caution

Of course, I do not have access to CBL's internal data, which might tell me in which month some particular improvement was placed into service. Also, CBL only shares some data as a year-end snapshot and not at quarter-end. As such, I will be relying slightly on estimates (indicated with a "~"), particularly for any mid-year carrying values.

However, if my concerns prove valid, I expect my use of estimates will not prevent an unfortunate pattern from recurring.

With that, let's examine these recent impairments and losses.

1. Acadiana Mall

Let's start with Acadiana Mall in Lafayette, LA. On 12/31/16, it had a historical cost (2005 land, 2005 buildings, subsequent improvements) of $179.5 million and $70.2 million of accumulated depreciation for an unimpaired carrying value of about $109.3 million (2016 10-K, p148).

Around the end of Q1 2017, the unimpaired value was ~$110 million (presumably after some minor improvement or other capitalized cost) and CBL recorded no impairment for the asset (Q1 2017 10-Q, p19). However, they were unable to refinance the $122 million mortgage in April (one month later). In June, they wrote the asset down $43 million (~38%) to $67.3 million (Q2 2017 10-Q, p20).

Just think about that for a bit. Logically, at least one of five things must be true:

1. An asset worth at least the ~$108 million carrying value actually lost at least 38% of its value in the span of less than a month. CBL was classifying this as a mid-Tier 2 asset (2016 10-K, p28).
2. CBL isn't capable of detecting that a mid-quality asset has lost at least 38% of its value.
3. CBL thought it was only a "temporary" impairment... but I don't see how anyone can think a mall's "temporary" value isn't relevant when the mortgage is due in less than a month (Q1 2017 10-Q, p45) and efforts to refinance it haven't produced anything definite.
4. CBL exaggerated the subsequent impairment to negotiate with the lender. (I'll discuss this later.)
5. CBL knew the asset was overstated but did not write it down.

2. Cary Towne Center

Take the recent impairment on Cary Towne Center in Cary, NC. On 12/31/17, it had a historical cost of $129.9 million (2001 purchase price plus subsequent improvements) and accumulated depreciation of $44 million, with a carrying value of $85.9 million (2017 10-K, p156). By Q2 2018, the carrying value would be ~$84 million.

I'm not sure exactly what happened. It may have been related to the malls status as being repositioned, but the maturity of a $46.7 million mortgage was somehow accelerated (CBL release, 8/1/18). CBL wrote the asset down $52 million to ~$32 million. That's a 62% impairment!

3. Janesville Mall

In 1998, CBL purchased Janesville Mall in Janesville, WI. It paid $34.1 million initially, and later spent $22.5 million on improvements for a total historical cost of $56.6 million. Since 1998, CBL had taken $20.8 million of depreciation for a 12/31/17 carrying value of $35.8 million (2017 10-K, p156). By Q2 2018, this would have been ~$34.5 million.

Yet when CBL sold the unencumbered asset a month later, how much did it get? $18 million (48% less) (CBL release, 7/27/18). That's little more than half of its carrying value!

4. Hickory Point Mall

CBL purchased Hickory Point Mall in Forsyth, IL in 2005 for $42.4 million and after improvements had a total cost of $58.8 million (less $18.8 million for depreciation) (2016 10-K, p148). This gives a carrying value of $40 million on 12/31/16 (or ~$38.5 million by Q3).

Yet in Q3 2017, facing a 2018 debt maturity for a $27.4 million mortgage, they wrote the asset down by $24.5 million to $14 million (about 64%) (2017 10-K, p147).

Now, what risks does this reveal?

Debt covenants

CBL has one set of debt covenants for its unsecured lines of credit and unsecured term loans, and another set for its senior unsecured notes:

Unsecured Lines of Credit and Unsecured Term Loans		12/31/17
Ratio	Required	Actual
Debt to total asset value	< 60%	50%
Unsecured indebtedness to unencumbered asset value	< 60%	48%
Unencumbered NOI to unsecured interest expense	> 1.75x	3.3x
EBITDA to fixed charges (debt service)	> 1.5x	2.4x

Click to enlarge

(Source: 2017 10-K, p132)

Senior Unsecured Notes		12/31/17
Ratio	Required	Actual
Total debt to total assets	< 60%	52%
Secured debt to total assets	<45%	23%
Total unencumbered assets to unsecured debt	>150%	208%
Consolidated income available for debt service to annual debt service charge	> 1.5x	3.1x

Click to enlarge

(Source: 2017 10-K, p132)

The danger

My main concern is about the particular covenant I have bolded: Total debt to total assets for the senior unsecured notes.

The above losses and impairments have not been small: ~38%, ~62%, ~48%, and ~64%. These have also only been recorded at the time CBL abandoned a property, or sold it... times when CBL could no longer claim the asset was still very valuable. CBL does not seem to be a company that is very proactive about recognizing when an asset has fallen in value.

This realization leads me to two other implications:

1. There may be other assets CBL cannot or does not value properly, particularly when rents are falling at its properties (CBL release, 8/1/18). It failed to notice on a timely basis that these assets were overstated. There may be many other assets where impairments, even small ones, are necessary.
2. If that is the case, CBL may be much closer to breaching its debt covenants than it claims to be.

Implications

These impairments are not small. CBL seems to have confidence in the values it uses... until it actually needs to refinance or sell some of them!

I know the company has been generally able to refinance its relatively stronger assets, but the company also has about $4.8 billion of debt as of June 30 (CBL release, 8/1/18), both secured and unsecured.

I know Cary Towne Center and Hickory Point were already classified as "repositioning" assets at the end of 2016 (2016 10-K, p32). But if CBL was aware then of the assets' problems, why would they maintain the high book values? Did they really expect a little redevelopment would prevent a 62% or 64% impairment?

An innocent explanation?

I've heard some investors claim that CBL only records impairments as a negotiating tool with lenders. If so, it wouldn't appear to be working for them. I suspect the truth is not so shareholder-friendly. It also wouldn't explain the carrying value of the unencumbered Janesville asset.

A more likely explanation

It seems like the CBL balance sheet reflects hope and optimism more than the current reality for some of the assets. It reflects the days in the 1990s and 2000s when they were buying and building mediocre assets for very high prices. Despite a decade or two of inflation and depreciation, some of these assets are selling for less than carrying value.

Importantly, I think the current reality of CBL's assets may not just be temporary. They may identify the more problematic assets early on, but they don't seem in a rush to actually write them down to reflect reality. I know companies are generally reluctant to record impairments, but with lower-quality assets, I think it's critical.

If creditors take over

In the event the company violates the debt covenants on the senior unsecured notes, CBL would not have the cash to quickly pay them off and would struggle to find a fresh source of cash. Creditors could quickly take many of the company's unsecured assets.

CBL already has enough trouble selling assets. If CBL (or a committee of its creditors) had to sell assets in a rush, both common and preferred shareholders might be wiped out.

How to trade this?

I don't suggest shorting CBL. If CBL does not default on its debt covenants, there is a chance it could recover. I don't think a strong recovery is likely, but when it's already beaten down and yields 15.3%, there may be little return left with a lot of risk in the (unlikely) event the company recovers shares rally.

My case is based on my concern that the financial statements do not properly reflect the property values or debt ratios. As most of CBL's properties have maintained their paper values for many quarters, I can't say for certain if or when CBL will actually recognize the impairments.

Instead, I think there are a few reasonable options:

1. Buy long-dated puts for a very low option premium (just 5 or 10 cents per share) and strike price ($1 or $2). One downside in this, however, is that I only see (on Fidelity) options going out to March 2019. This thesis may take longer than that to play out.
2. Stay on the sidelines for now.
   1. If things get worse, buy some senior secured notes if they get much cheaper... perhaps around 50 cents on the dollar.
   2. If things get better, move on to something else.

Disclaimer: Do your own due diligence. Nothing I say here is formal professional advice.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

I was long CBL puts earlier this year, but closed my position months ago (for a modest gain). I may buy the unsecured senior notes if they get cheap enough.