Credit rating firm Fitch Ratings predicts the retail default rate to climb to roughly 9% in 2017 from its current 1% level. By comparison, it forecasts a 3% overall default rate this year, which is slightly above the 2.3% nonrecessionary mark, but in line with 2014 and 2015, according to a report released Monday emailed to Retail Dive.
There is more than $4 billion of retail high yield bond outstandings with a high risk of default on Fitch’s "Bonds of Concern" list, led by Claire’s Stores (which has $1.799 billion in debt outstanding and an interest payment due March 15) and Sears Holdings Corp. (which has $1.134 billion of debt outstanding and an interest payment due April 15).
Other retailers on the list include: Nine West Holdings, with $704.2 million in debt outstanding; 99 Cents Only Stores, with $250 million; rue 21, with $250 million; and Gymboree, with $171 million. All have interest payments due in 2017.
Most of the retailers flagged by Fitch in Monday’s report — all but Sears — are owned by private equity firms, which often load up struggling retailers with debt in the name of turnaround efforts, but that don’t always have the patience that retail turnarounds require. For example, The Limited and Wet Seal recently filed for bankruptcy, shuttering all retail operations, and Bain-owned Gymboree recently said its CEO is stepping down amid a possible $1 billion debt restructuring.
“Now private equity is there with billions in debt — and goodbye,” Howard Davidowitz, chairman of New York City-based retail consulting and investment banking firm Davidowitz & Associates, told Retail Dive regarding Wet Seal and others. “The first thing they do is borrow billions, and retailers can’t function that way because the business is too volatile and it’s too unpredictable. These poor apparel chains end up one way or another in the hands of private equity — and in the end, there’s no company, no stores, no employees, and the private equity made money. Congratulations. That’s how it works.”
The problem for retailers is that the money they get from such investors is relatively expensive, like a payday loan with onerous terms, according to Jasmin Yang, an associate attorney at law firm Snell & Wilmer who has helped several clients in various aspects of bankruptcy and restructuring.
“For [private equity], it’s about monetizing, and they don’t really care about the continued operation of the business — they don’t have much attachment to it," Yang told Retail Dive. "Wet Seal, The Limited — these are all stores that I shopped at as a teenager at the mall, but they were definitely overstored. They don’t have other options. If they could have gotten a loan under less onerous terms, they would have.”
Financial firms, on the other hand, often do fine, as long as they get out in time. The Limited’s owner, private equity firm Sun Capital, told its investors that despite the closures, it had nearly doubled its Limited Stores investment, according to an email to shareholders obtained by Reuters. Due to prior distributions and dividends, Sun Capital made back its original $50 million 1.8 times over and will write down the remaining equity value of Limited Stores to zero.
“Private equity wants to be in and out in five to seven years,” Suneet Chandvani, head of middle market research at corporate debt intelligence firm Debtwire, told Retail Dive. “The goal is after five years, sell it or IPO it. Closing the stores, slashing jobs, the fact that Sun Capital is marking the capital to zero — that just says it all. Retail is just a declining business, especially the brick-and-mortar business where fixed costs are high and margins are thin. It’s not they haven’t done what they were supposed to do as far as managing costs, cutting costs, cutting down on their brick and mortar footprint — it’s the nature of the business.”