You might not realize it, but there’s a kind of ongoing debate about the best way to play the brick and mortar retail apocalypse.
This is one of those running narratives that you should be aware of and stay up on irrespective of whether you plan to trade it. In that regard, it’s kind of like the increasingly amusing back-and-forth about the relative merits of trying to short auto ABS amid growing concerns about subprime car loans.
On Friday afternoon we brought you “‘Brick And Martyr: When Retail Workers Become Bartenders,” a post which you should read and which undoubtedly would have gotten more attention had it not been for the fact that the second it was published, this crossed the wires: “Trump to unveil ‘massive’ tax cuts.”
In the “brick and martyr” post we showed you the following chart:
So that’s from BofAML internal data and clearly it doesn’t presage anything good for department stores, which are on the front-lines of the brick and mortar death spiral. We also noted the following rather amusing color from the bank:
Given the disruption in the retail sector, we think we are headed for a structural change in the retail industry and it’s likely to disrupt the retail workforce. In this context it’s worth considering where displaced retail worker may end up. In particular, majority of retail workers that find jobs in the leisure and hospitality sector find jobs in the food services and drinking places industry.This isn’t all too surprising given that skills that are useful in the retail sector overlap with skills needed in other service industries.
As we also pointed out, that might not be all bad for consumer spending because after all, bartenders make a shit load more money than retail workers.
Getting back to the trade, the go-to has been the now famous CMBX 6 BBB- short but as Citi suggested earlier this month, that might be all played out. For their part, the bank recommended buying protection on individual retailers.
Well Goldman has a different idea: Shorting CMBX 7 BBB-. Because while the underlying deals look better than series 6 on a number of important points, they actually look worse than the series 6 deals on others.
So for those interested, here’s the trade…
CMBX market is pricing large differences between CMBX 6 and CMBX 7: Negative news flow in the retail sector – including store closings and weak corporate earnings – has led to substantial widening of CMBX index spreads, but the effect has not been uniform across series and tranches. Exhibit 1 below, for example, shows that CMBX 6 BBB- traded tight vs. CMBX 7 BBB- five months ago but is now trading 115 bp wide. The historically tighter spreads of CMBX 6 vs. CMBX 7 were driven by the fact that CMBX 6 is priced one year shorter on the credit curve, and was thought to have benefited from an extra year of strong price and rent appreciation during 2013. The recent widening of CMBX 6, conversely, is driven largely by the greater retail exposure in series 6. To assess differences in credit risk across the CMBX series, Exhibit 2 below summarizes the average attributes of the deals underlying each series. For example, column B shows that 38% of CMBX 6 underlier deals are backed by retail properties, vs. 33% of CMBX 7. CMBX 6 deals also have incrementally less credit enhancement up to BBB- (column C) and incrementally lower debt service coverage (column G). However, conversely, CMBX 7 has a larger share of interest-only loans (column E), and one more year of remaining maturity until the deals mature, giving more time for an adverse mall scenario to play out. Exhibits 3 and 4 show the distribution of net income growth rates for the retail loans backing CMBX 6 and 7. In both cases, the majority of loans have seen positive growth in NOI since securitization, but both distributions also have a left tail of loans with significant income deterioration. In all, we see the difference in price moves in series 6 vs. 7 to be exaggerated relative to the fundamental default risks, which seem more comparable across the indices.
Finally, here’s the latest from Goldman which references the color excerpted above and also kind of harkens back to Citi’s trade idea:
CMBX 6 mezz remains wide vs. retail corporate credit: Over the past month, CMBX mezz spreads have tightened slightly while retail sector corporate credit spreads have widened. Exhibit 1, below, however, shows that the CMBX spreads still remain substantially wide vs. the spreads on corporate credit retail names. Currently, JCPenney and Macy’s have average spreads of 395 bp and 285 bp, respectively, while the names less associated with shopping malls, such as Walmart and Home Depot, are priced at spreads of 120 bp and 110 bp, respectively. Across all the retail names (IG and HY), the average corporate credit spread is 145 bp. Even when we exclude names that are not typically associated with the “death-of-the-mall” theme, retail sector corporate spreads are significantly tighter than CMBX mezz spreads. Exhibit 2 shows a breakdown of the retail sector corporate bonds, by rating: 84% of the bonds are IG, and virtually none are rated CCC or below. Naturally, most of the troubled store names fall at the lower end of the ratings spectrum, but these also tend to be the names with the least debt outstanding, which helps explain why the aggregate retail sector corporate spreads shown in Exhibit 1 have not widened as much as CMBX spreads. Our credit and equity strategists are cautious on the department store sector, expecting a continued decline in sales going forward. Within CMBX, we view series 7 BBB- as a better short opportunity than series 6, given series 7’s higher price point, longer remaining maturity, and a roughly similarly challenged set of retail underliers.