I’ve been a long-running bear critic of the CBL & Associates (CBL) saga going on two years now. That bearishness has primarily been driven by an extremely tight capital structure that has left little room for operational improvement. Has that now changed that the company has refinanced its nearest term maturities?
While everyone has been quick to break out the celebratory champagne on the news of the credit facility recast, taking management’s party line that the facility gives them flexibility to execute on their strategy, it seems no one bothered to wait until the Form 10-K was filed to actually read through the loan documentation to get into the nitty gritty details. If you’re buying distressed firms, it pays to wait: CBL common equity is down another 20% since the refinance was announced and remains down after the 10-K filing. There has been no respite for bulls.
Make no mistake – the refinance was a positive move for overall company health. Just getting it done was an effort which I think was pretty clear on how long it took to reach an agreement. After all, management was saying that they would have a term sheet inside of three months during the Q2 conference call; it took twice that length to get the facility closed and investors were left partially in the dark on progress for several quarters. While the facility brings with it a relaxation on covenants, it also includes several negative provisions (both new and old) that impact the firm’s ability to navigate its current environment. I want to go through these step by step and how this impacts investment decision-making at all levels of the capital stack (unsecured bonds, preferreds (CBL.PD) (CBL.PE), the common).
High Level Overview
Late in January, CBL & Associates entered into a new $1,185mm Senior Secured Credit Facility, including a fully funded $500mm Term Loan and a Revolving Line of Credit with borrowing capacity of $685mm. This replaced all of the prior Term Loans and Revolver which had much higher credit availability which was, quite frankly, unnecessary given its current path.
Importantly, the facility matures in July 2023 - right before the first swath of unsecured bonds. This essentially moves the goalposts out for the bear camp several years; the next challenge will be rolling over unsecured debt at reasonable rates.
Looking back at my prior bearish coverage, the elimination of the capitalization rate method of valuation – instead a shift to gross book value – removes a key covenant issue. However, it brings about a new problem. In the past, asset value was based on net operating income ("NOI") and a benchmark capitalization rate. Now, it is based on gross book value. This means impairment charges now matter and impact valuations. Moody's, echoing my sentiments, shared similar thoughts in (yet another) downgrade about two weeks ago:
The rating downgrade reflects CBL's closing of a new senior secured credit facility to replace its unsecured credit facility, resulting in a significant reduction of its unencumbered pool of assets. The rating downgrade also considered CBL's reduced covenant compliance cushion and its expectation that 2019 operating performance will be lower as compared to 2018.
Hypothetically, say CBL & Associates owns a cash flow negative mall. In the past, they were not penalized on removing the property from balance sheet; NOI did not materially change and neither did property valuation under covenants. Under new calculations, they are penalized for the write-down. This creates some perverse incentives for them to retain weak properties with high initial cost, avoiding taking an impairment charge.
Overall, I think there are some key takeaways here:
- Unsecured to Secured. Moving from unsecured to secured debt, quite obviously, negatively impacts the unsecured bond valuations. This is exacerbated by the property pool borrowing base being nearly entirely made up of Tier 1/Tier 2 properties - the best CBL & Associates has to offer. Publicly-traded debt reacted unfavorably to this news and yields to maturity are now north of 10.5%. This makes the eventual refinance of these bonds more difficult assuming the Credit Facility is extended on similar terms in July 2023. Assuming these bonds had to be rolled at today’s implied yields, demanded interest costs would rise $68mm annually. Also, given the secured debt to total asset value covenant, CBL & Associates cannot issue materially more secured debt from here via asking for more borrowing capacity.
- Higher Rates. Despite the move towards senior debt, all-in interest costs will rise about 100bps; call it $9mm/year.
- Amortization. The Term Loan will amortize at $35mm/year. While this is providing value by reducing leverage and improving net asset value (“NAV”) it is also cash that cannot be invested in the business for redevelopment. Given this is a linchpin of the CBL & Associates story (high levels of free cash flow support asset repositioning that will stop same store net operating income (“SSNOI”) declines) it is unfortunate to see.
What is clear is that while CBL & Associates has bought itself time to fix its business, overall market perception remains negative. Why? If past fear has been driven by default concerns, why was the refinance reception so negative?
This is, partially, being driven by other factors. Number one, and getting off track from the credit agreement for a moment, CBL & Associates has, once again, given absolutely bleak guidance. Contrast these two statements:
So, we should see some improvement in 2019 given sales, the better sales environment that we have this year and the strength of the economy [reference to leasing spreads].
- CEO Stephen Lebovitz, Q2 2018 Conference Call
We are providing an initial FFO as adjusted per share guidance of full year 2019 in the range of $1.41 to EUR 1.46 per share, which assumes a same-center NOI decline in the range of 6.25% to 7.75% [for 2019].
- CFO Farzana Mitchell, Q4 2018 Conference Call
Bulls have long awaited 2019 as the year the market turns. Prominent past/current proponents of CBL on Seeking Alpha encapsulate that in their sentiment such as Rida Morwa (CBL: We Bought More And We Were Right) stating that "...just imagine how the market could react when CBL gets back on track to positive growth potentially in 2019 or 2020" or Jussi Askola (Make CBL Great Again) feeling that the company had opportunity "...due to difficulties which we expect to lessen going in 2019/2020". I'm not highlighting these comments to make a point about who was right or who was wrong. That is not the point. Both of these contributors had valid reasons to be bullish at the time. However, I think it is important to see what overall expectations have been for 2019 from the longs.
They have had reasons to feel that way. CBL & Associates has always pitched to the market that 2019 would be a year where SSNOI declines stabilized and a base was formed. That can has now been kicked down the road yet again and the firm is back to mid single digit declines. The market has been worried about this for some time and the market, at least for now, continues to call it right.
Back into the new credit agreement and getting more nuanced, what became apparent to me is the lack of flexibility this agreement provides – even compared to the older facility. I do not think that some investors appreciate just how much of a pain these kinds of bank lines can be. The reason that the market – and the ratings agencies themselves – value unsecured debt with no covenant structure so highly is that management can be nimble and flexible when they have total control. In other words, there is more to the story than a strict interest rate and maturity date view. What are some of those restrictions (from the credit facility documents)?
Without the prior written consent of the Requisite Lenders, such consent not to be unreasonably withheld, the Parent and the Borrower shall not, and shall not permit any other Loan Party or any other Subsidiary to, (A) enter into any transaction of merger or consolidation; (B) liquidate, windup or dissolve itself (or suffer any liquidation or dissolution); (C) convey, sell, lease, sublease, transfer or otherwise dispose of, in one transaction or a series of transactions and whether effected pursuant to a Division or otherwise, all or any substantial part of its business or assets.
This is a major one. Before any asset sale or purchase, management has to reach out to the secured creditors to secure approval – even outside the property base that secures the facility. This is not a phone call agreement – creditors can hold up asset agreements for months before allowing or denying a transaction. Particularly for real estate managers that are buying and selling a lot of properties – think the shopping center REIT market or what is the case here – secured debt is avoided for this reason even though it frequently carries lower interest rates.
After all, the story with CBL & Associates is all about flexibility. It's a bet on management being able to turn around a distressed operation. In order to do that, it needs to act nimbly and swiftly. However, restrictions remain abound:
The Borrower shall not, and shall not permit any other Loan Party or other Subsidiary to, prepay any principal of, or accrued interest on, any Subordinated Debt or otherwise make any voluntary or optional payment with respect to any principal of, or accrued interest on, any Subordinated Debt prior to the originally scheduled maturity date thereof or otherwise redeem or acquire for value any Subordinated Debt. Further, the Borrower shall not, and shall not permit any other Loan Party or other Subsidiary to, amend or modify, or permit the amendment or modification of, any agreement or instrument evidencing any Subordinated Debt
Not surprising to see no subordinate debt payments allowed. Also importantly, the company cannot mortgage up its properties as any activity that increases the amount of scheduled principal or interest is off the table. This is a shame because dollars have to go back to paying back the secured facility - at interest rates of around 5% - versus retiring unsecured debt that is trading well below par.
That's a shame. At 10.5% yield to maturity today, those returns rival the internal rates of return ("IRR") that CBL & Associates has stated it would get from property development. And unlike redevelopment, it's risk free.
The Parent shall at all times maintain its status as, and election to be treated as, a REIT under the Internal Revenue Code.
Likewise, speculation on the company converting to a C-Corp in order to retain more cash flow for redevelopment has also been discussed ad nausem on Seeking Alpha and elsewhere - especially after the drop in corporate tax rates in 2018. This restriction has been embedded in the Credit Agreements for some time and it has not been removed. I had hoped to at least see this dropped so that the option was out on the table.
As a recap, creditors have increased their stranglehold on corporate control, limiting operational flexibility. Whether that contributes to the lack of SSNOI/FFO growth (or even stabilization would be nice) is debatable. What is certain is that CBL & Associates will see FFO shrink - again - after redevelopment benefits cannot offset the portfolio run-off. If I had seen stronger guidance out of management, I likely would have changed my tune a bit but a 7% decline in same store numbers after such a bad 2018 is just disheartening to any bull.
I still view the common stock as uninvestable. Unsecured bonds, while hit by the new lending facility, remain the best way to play the company in my opinion. The preferreds carry risk as well but at this point investors should at least collect those fat checks until 2023.
NOTE: Tired of stepping on high yield landmines in your portfolio? Investors have seen quite a lot of dividend cuts over the past year. Members of the Industrial Insights community receive access to actionable and concise research to keep your portfolio generating income in safe, higher yielding issues. This isn't your average investing resource. Receive deep dive insight into companies that include facility tours, management interviews, and in-person conference coverage.
Sign up for a NO OBLIGATION FREE TRIAL today.
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.