A downgrade to near-junk status for bonds backed by payments-in-lieu of taxes issued for a Syracuse, New York, shopping mall project underscores the long-term risks of investing in traditional retail projects.
Moody’s Investors Service lowered its rating for the Syracuse Industrial Development Agency’s Carousel Center Project $297 million of outstanding PILOT revenue bonds two notches to Baa3 from Baa1 in April citing ongoing financial struggles with the Destiny USA shopping mall.
The tax-exempt bonds sold in 2007 to finance an 874,200 square-foot-expansion of New York State’s largest mall were also placed on review for a further downgrade from Moody’s lowest investment-grade rating.
“The downgrade reflects our view that material near-term improvement in the project’s financial performance and coverage ratios is unlikely, absent a reduction in total debt, which is not anticipated,” Moody’s analyst Joseph Medina wrote in an April 23 report. “The issuer is exposed to the overall trends in the brick and mortar retail sector where consumer demand can vary over time and through economic cycles, and which currently faces difficult competition from alternate mediums such as online retail.”
The mall is owned by Carousel Center Company, which is managed and operated by Pyramid Management Group. It first opened in 1990 as Carousel Center on a former landfill site that required extensive environmental cleanup.
The two-notch downgrade came after commercial mortgage-backed security loans totaling $430 million tied to the project were transferred to a special servicer, Wells Fargo Bank. Medina said this move indicates “potential difficulties with extending or refinancing the CMBS loans that are slated to mature on June 6, 2019.”
The PILOT bonds are senior to a subordinate $300 million CMBS loan with JPMorgan Chase Bank except in “an unlikely” scenario of casualty, condemnation, or eminent domain, according to Moody’s. Debt service on the bonds is scheduled to ascend to a peak of $36 million in 2034 before stepping down to $34 million in 2035 at final maturity.
Under a PILOT agreement forged with developer Robert Congel, Pyramid pays fixed annual PILOT payments to fund debt service obligations. The City of Syracuse and Onondaga County waived their right to receive the PILOT payments.
Moody’s had already revised its outlook for the Destiny USA bonds to negative from stable in November citing occupancy levels that remained below expectations since the expansion project opened in 2011 coupled with the annually growing debt service schedule. The mall has experienced declines in occupancy since peaking at 97% in 2014 with expiring leases comprising 15.6% of annualized rent in 2019, according to Moody’s.
Medina said the review period will focus heavily on not just Pyramid’s ability to obtain a “reasonable” extension on its due mortgage loans.
The rating will likely be downgraded below investment grade unless Pyramid can demonstrate an adequate business plan that will foster long-term financial improvements, according to Moody’s.
Pyramid said in a statement that the Moody’s downgrade was “expected” since it initiated the transfer of the property’s mortgage debt into special servicing. The company also said it is in negotiations with Wells Fargo seeking to reach an agreement on modifying the mortgage loans “that meets the needs of all parties.”
Rob Arscott, an assistant professor of finance at Syracuse University’s Martin J. Whitman School of Management, said a Destiny USA foreclosure is unlikely and he expects Pyramid to seek and be granted an extension on the $430 million in mortgage payments due next month. Arscott said that lenders typically extend loan terms of when there is risk of a default since they don’t want to be put in the position of running a mall or finding another operator.
“Pyramid owns the mall and knows how to operate it so it’s not like they don’t have any leverage at all,” said Arscott. “At the end of the day the lender doesn’t want to foreclose if they don’t have an alternative in mind.”
Challenges with Syracuse’s Destiny USA project have come into focus as the bond-funded American Dream megamall in East Rutherford, New Jersey, gets set to open later this year following lengthy delays. The long-stalled development project was funded with a $1.1 billion tax-exempt revenue bond transaction in June 2017 backed by a PILOT agreement between Triple Five Group and the borough of East Rutherford. The unrated deal was comprised of $800 million in limited obligation revenue bonds and $287 million of grant revenue bonds supported by anticipated sales tax revenue.
“There are always risks with a retail project so it is very important to look at not only the project risks but the debt structure as well,” said Lisa Washburn, managing director at Municipal Market Analytics.
Washburn noted that the Destiny USA and American Dream projects are both risky for bondholders because the retail landscape is moving away from brick-and-mortar stores toward increased online shopping. She said the American Dream development just six miles from midtown Manhattan differs since it is being marketed as a tourist destination with large-scale entertainment options similar to what other malls have attempted as a way draw more visitors.
“Trying to make a mall an entertainment destination with significant retail is a risk because if they don’t draw foot traffic, what happens to the overall project when you have increasing vacancies?” Washburn said. “I have a difficult time imagining that these entertainment options are going to be enough to draw more buying shoppers to these stores.”
Arscott said that while Destiny USA is more of a regional mall for Central New York, it has in the last couple years tried to lure customers through entertainment attractions such as a WonderWorks amusement park, go kart track and Imax Theater. He said this strategy poses risks since it can lead to lower-margin tenants that create further cash flow challenges.
“Are you a mall or an amusement park? And only time will tell if this strategy make sense,” Arscott said. “I have seen no evidence that this creates further food traffic to stores.”