Hudson's Bay taps Canadian CMBS to refinance flagship stores

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Hudson’s Bay Co. is tapping Canada’s commercial mortgage bond to refinance the sale and lease-back of a pair of flagship department stores in downtown Montreal and Ottawa.

A joint venture between Hudson’s Bay and Rio-Can Real Estate Investment Trust obtained a pair of mortgages totaling CA$250 million ($187.91 million) on the department stores from Royal Bank of Canada. Proceeds were used to partially refinance a four-year old loan with an outstanding balance of CA$352 million, according to DBRS. (Of the outstanding balance of the original loan, CA$170 million and CA$80 million were allocated to the Montreal and Ottawa properties, respectively. The remaining CA$102 million existing debt will continue to be secured by the remaining three properties.)

The new mortgage, which pays a fixed rate of interest is being used as collateral for an offering of mortgage bonds called Real Estate Asset Liquidity Trust, Series 2019-HBC. Both DBRS and Moody's Investors Service expect to assign triple-A ratings to the senior tranche of notes to be issued in the transaction.

While DBRS considers the net cash flow from the two properties to be more volatile than is typical for properties with multiple tenants, DBRS notes that Hudson’s Bay is Canada’s largest department store chain and has a dominant market share. “These two The Bay flagship stores have been operating in both locations for more than 50 years; its parent company and tenant … will likely continue to fulfill its debt service obligation along with its partner, RioCan, even in a downturn to maintain its presence in these two desirable downtown locations,” the presale report states.

Additionally, the Montreal property is the second-best performer within The Bay department store chain in Canada with reported in-store annual sales of over $135 million and a gross profit margin of 42.6% as at Nov. 3, 2018, which is higher than Hudson’s Bay’s company-wide margin of 39.9% for the same period.

Although the Ottawa property is an underperforming asset, it benefits from cross-collateralization with the Montreal property. On a consolidated basis, the properties demonstrated a 41.2% gross profit margin, which is still higher than the company-wide ratio, and generated sufficient EBITDA to pay rents and cover realty taxes and property insurances.

"As Hudon's Bay continues to improve business efficiency by reducing operating expenses and improving inventory management and cost structure, its cash flow is expected to improve, which in turn should improve the affordability of rental payments," the presale report states. "Furthermore, the properties are well located in primary urban markets fronting prominent commercial streets where retail spaces are in high demand; therefore, in the event of The Bay downsizing or closing down, the properties should be easily subleased."

Hudson’s Bay has signed 20-year absolute net leases that include five six-year renewal options. The company also retains an 87.5% ownership interest in the properties through a joint venture with RioCan.

The DBRS value, on a consolidated basis, represents a 41.3% discount to the appraised value and a 35.5% discount to the 2015 allocated purchase price. Additionally, the loan per square foot of CA$259 for the Montreal property and CA$239 for the Ottawa property are considered reasonable for these primary urban markets.

The borrowers are prohibited from obtaining any subordinate liens, mortgages and other encumbrances with respect to the related mortgaged property, including in connection with any subordinate secured financing, without the consent of the master servicer or the special servicer.

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