Morningstar: J.C. Penney store closures could impair $30B in commercial mortgage-backed loans

Dive Brief:

The roughly 140 store closures announced by J.C. Penney last month could impair some $30 billion in commercial mortgage-backed securities, with 39 closings in particular — in malls already suffering from below-average tenant sales — poised to impair some $7.29 billion in commercial mortgage-backed loans, according to a report from credit rating firm Morningstar emailed to Retail Dive.
The 39 J.C. Penney store closures identified by Morningstar include one location each in Arizona, Arkansas, Connecticut, Florida, Georgia, Kansas, Maine, Mississippi, New Hampshire, New Jersey, Oklahoma, South Carolina, Tennessee, Texas, Virginia and Washington; two each in Illinois, Indiana, Maryland, Minnesota, New York, North Carolina and Ohio; three in California; and six in Pennsylvania.
Meanwhile, J.C. Penney is expanding bathroom remodeling services across 100 of its remaining locations, touting home HVAC systems, window blinds, whole home water solutions, awnings and smart home technology, according to a report from CNBC. Bathrooms represent "a $300 billion market that we believe we have the opportunity to pick up some significant market share," the discount department store's CEO Marvin Ellison told CNBC's "Power Lunch."

Dive Insight:

J.C. Penney has said that its massive store closure plan will generate annual cost savings of some $200 million, mainly by saving on occupancy, payroll, home office support, corporate administration and other store-related expenses. To soften the impact of the closures on its store workers, Penney is instituting a voluntary early retirement program for some 6,000 eligible employees.

It's a bold step, but necessary, according to GlobalData Retail managing director Neil Saunders. “The blunt truth is that from a financial standpoint, some of these stores are just not working and future investment in them cannot be justified,” Saunders said in a note emailed to Retail Dive. “In our view, this fairly aggressive action is sensible. At a stroke it will improve JCP’s same-store sales numbers as these outlets are the ones dragging down the company’s performance. It will also allow the group to direct capital and resources to the stores which have the best prospects of delivering profitable growth. Admittedly, there will be a short term impact on the bottom line from lease termination and staff severance costs, which we expect to hit during the first half of the upcoming fiscal year.”

But Penney's exit from so many struggling malls nationwide will serve to exacerbate an already tenuous position for those properties, Morningstar analysts said in their report.

“We continue to observe a bifurcation in the market where lower-quality, Class B assets, particularly those in secondary and tertiary markets, continue to lose tenants and cash flow, while higher-quality, Class A malls receive ongoing investments from their owners in an effort to broaden their appeal to consumers,” according to the report. “Class B properties may not be able to produce a sufficient return on capital to justify continued investment from their owners. Those properties may have more trouble filling anchor spaces, which may stay vacant for an extended period of time. This can lead to further deterioration of sales performance and increased vacancy.”

J.C. Penney last month announced that in addition to closing between 130 to 140 underperforming stores, it will shut down two distribution facilities and offer buyouts to 6,000 workers over the next few months, even after delivering a net profit for the first time since 2010. The closures represent an effort to trim costs, leverage lucrative real estate value from a Buena Park, CA supply chain facility and better position the discount department store “to effectively compete against the growing threat of online retailers,” Ellison said in a statement.

J.C. Penney will issue a list of stores targeted for closure in mid-March, once the affected employees are notified, with most locations expected to shutter in the second quarter of 2017. The stores in the crosshairs represent some 13% to 14 % of the company's 1,014-store portfolio, less than 5% of total annual sales, less than 2% of earnings before interest, tax, depreciation and amortization and 0% of net income.