Kmarts announcement last week that it is planning to buy Sears Roebuck & Co. - in a transaction valued at $11 billion - might result in increased collateral concentration as well as potential store closings. Both companies have a considerable presence in CMBS deals.

In a recent report, Merrill Lynch said that the downside of the merger is it would likely result in store closings. "Kmart has demonstrated a strategic pattern of streamlining its real estate," analysts wrote, noting that the retailer closed almost 600 of its stores as part of its January 2002 bankruptcy. Earlier this year, the retail chain also sold 50 stores to Sears, as well as 18 of its locations to Home Depot.

Both companies expressed their intention to conduct a full store asset review as part of their goal to monetize non-strategic real estate assets. Merrill believes that some stores might be closed quickly while others might take a while to assess, adding that it would not be surprising if existing Sears mall locations were closed as well.

Merrill thinks these potential store closings could be challenging for CMBS. For instance, the CMBS market is still feeling the ripple effect from some significant losses on Kmart-related loans after the retail company went into bankruptcy. However, the difference this time around is that this is a merger and not a bankruptcy, Merrill said. Analysts said that while leases can be rejected as part of a bankruptcy plan, the same could not be done under terms of a merger.

Collateral concentration might also be a problem. Citing Trepp, LLC data, Merrill said that CMBS exposure to the combined entity would amount to almost $5 billion, or roughly 1% of the total balance of all the transactions that are tracked by Trepp. Sears has the biggest tenant exposure in the CMBS universe. On the other hand, Kmart is the eighth largest, according to Trepp. Merrill said that the combined exposure of these two retailers amounts to twice as much as the next highest retail tenant exposure, JC Penny.

Merrill said the merger capitalizes on both Kmart's real estate portfolio and Sears' products and merchandising, noting that the combination involves economies of scale and real estate. Analysts said at the combined entity, Sears Holding Corp., would be the third biggest U.S. retailer behind Wal-Mart and Home Depot.

Researchers noted that executives plan to generate over $500 million in cost and revenue synergies and efficiencies. "If successful, we think the company may be able to compete with the likes of Wal-Mart," Merrill analysts wrote. "If it fails it is going to be a very big headache for CMBS investors."

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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