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The sales trends impacting municipal bonds

Tom Chan
Tom Chan
Senior Credit Analyst, Refinitiv

Municipal bonds issued for shopping mall developments look very different in today’s changed retail landscape. How has the rise of online shopping impacted investor assumptions on sales tax collections?

  1. U.S. department store sales declined 5.2 percent last year, creating ramifications for Tax Increment Financing bonds secured with sales tax collections.
  2. At the Pinnacle Project outlet center in Tennessee, sales tax collections are 28 percent below the original base case projections when the bonds were issued in 2016.
  3. Past assumptions of growth in sales and sales tax collections will need to be reassessed by investors due to the impact of this new retail landscape for municipal bonds.

Driving 70 percent of the nation’s economy, consumer spending in the United States is alive and well. Retail sales hit a new record of US$5.6 trillion in 2019, an increase of 3.4 percent during the year.

Despite this overall strength, traditional brick-and-mortar retail stores continue to see a dramatic decline. In contrast, online retail sales surged by 14.8 percent last year. It also remains to be seen if the recent global outbreak of the coronavirus will put further pressures on brick-and-mortar sales.

For municipal investors, the shift to online shopping will have credit ramifications for a niche corner of the market — Tax Increment Financing (TIF) bonds secured by sales tax collections.

U.S. retail sales for department stores vs. online. 02-03-2020-The-sales-trends-impacting-municipal-bonds
Sources: US Census Bureau; Refinitiv

Low-cost municipal debt

Municipal finance has long played a vital role in providing capital to fund retail and commercial development projects throughout the nation.

Tax-exempt and taxable municipal bonds have financed local outlet centers, shopping malls, and sports arenas to name a few. For many municipalities, these projects have spurred job and income growth as they attract local and regional shoppers.

Many of these retail districts are funded with low-cost municipal debt, the proceeds of which are used to build-out the sewer systems, roads, and buildings of the development itself.

Typically, the tax base of the entire city or town is not directly responsible for paying back bondholders. Rather, sales tax TIF bonds are issued.

Sales taxes collected in the shopping development in excess of a certain base amount are used to repay the debt (a typical repayment structure for this type of financing).

Retail developments, particularly those made up of large anchor tenants, have historically provided a stable source of sales tax collections as security for bondholders.

However, as shopping continues to shift online, municipal debt issued for retail developments may need to be reassessed.

Challenges for retail developments

These changes in the retail landscape are directly being played out in the Pinnacle Project, an outlet center in Bristol, Tennessee. The Pinnacle is labeled as the “largest shopping center between Roanoke, Virginia and Knoxville, Tennessee”.

The shopping outlet was financed with non-rated sales tax TIF bonds issued in 2016 amounting to $120 million. The bonds are repaid with sales tax collections from the retail development.

First opened in 2014, the Pinnacle is envisioned to be a mixed-use shopping and recreation center with one million square feet of retail, dining, and hotel space.

The outlet consists of five anchor stores including large-box retailers Bass Pro Shops and Dick’s Sporting Goods. At the end of 2019, there were 71 stores open in the shopping center, covering 748,863 square feet or 74 percent of total leasable space.

According to recent public disclosure, the project is still in the ramp-up phase, with the developer scheduled to bring in new tenants, and additional sales tax collections in 2020. However, historical annual sales tax collections have trailed original projections.

A new retail landscape for municipal bonds

In 2019, sales tax collections totaled $6.3 million, 28 percent below the original base case projections as presented when the bonds were issued.

This resulted in debt service coverage to fall below 1.0x. The borrower also anticipates a draw on the debt service reserve fund in the amount of $304,000 in order to make the June 1, 2020 interest payment.

Credit spreads for bonds issued for the Pinnacle Project have widened over the last few years. The last institutional size trade was on 1/22/20 for 5.125s of 2042 at 4.64 percent yield, or a spread of +311 basis points to the AAA benchmark. This compares to a spread of +252 basis points back in Aug 2018.

It is yet to be seen if increased online sales pose a lasting threat to the existing sales tax increment financing model.

For muni bond investors, past assumptions of exponential growth in sales and sales tax collections may need to be reassessed given the secular changes occurring in the retail landscape.

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