Fitch Ratings has removed from Rating Watch Negative and downgraded the following Syracuse Industrial Development Agency, New York (SIDA) bonds to 'BB' from 'BBB'.
Approximately $198.8 million PILOT revenue refunding bonds, series 2016A (Carousel Center Project);
Approximately $10.6 million PILOT revenue refunding bonds, taxable series 2016B (Carousel Center Project);
Approximately $82.6 million PILOT revenue bonds, series 2007B (Carousel Center Project).
The Rating Outlook is Negative.
SECURITY
The bonds are secured by Payments in Lieu of Taxes (PILOTs) on the original or 'legacy' Carousel Center mall payable to SIDA by the Carousel Center Company LP (the Carousel Owner) pursuant to a PILOT agreement, and interest earnings on the debt service reserves. The debt service reserve funds total 125% of average annual debt service or about $31 million.
ANALYTICAL CONCLUSION
The downgrade reflects concerns that value of the Carousel Center is on a declining trend, increasing risk to the property owner's incentive and ability to continue to make the PILOT payments. Fitch has learned that the borrower will be unable to meet required debt yield targets and make the next scheduled payment on the CMBS loans for the Carousel Center and the expansion project, together known as Destiny USA. The loans have been turned over to the special servicer (Wells Fargo & Co; IDR A+/Outlook Negative). The servicer was required as part of the securitization of the underlying commercial mortgage loans.
The Negative Outlook reflects the potential impact of the continued closure of Destiny USA as part of state and national efforts to mitigate the coronavirus outbreak on the mall's value and its performance after it reopens. The willingness and ability of tenants to continue to maintain and renew their leases upon reopening is uncertain. The role of the mall's commercial mortgage loan servicer in advancing the payments remains an important rating consideration. Weaker performance on a sustained basis could result in a declining trend in the mall's value relative to the balance of the PILOT debt outstanding, which could have an adverse effect on the servicer's incentive to advance PILOT payments. This could result in an additional rating downgrade. The rating continues to incorporate the strong lien position of PILOT payments in the mall's debt structure, making payments highly likely as long as the property has at least modest value above the PILOT debt amount.
KEY RATING DRIVERS
POTENTIAL LEVERAGE RATIO WEAKENING: Uncertainty about the loan-to-value (LTV) ratio of the mall property is heightened given the mall's indefinite closure and recent indications that the owner has not been making its performance targets under the CMBS loan agreement. The 'BB' rating assumes sufficient value still exists to provide incentive for the mortgage servicer to advance PILOT payments.
SERVICER PROVIDES LIQUIDITY: The mortgage servicer, required as part of the securitization of the underlying commercial loan on the Carousel Center, is responsible for providing needed liquidity to cover any shortfalls in PILOT payments until mall operations recover or the PILOT lien is foreclosed.
WEAKENED BORROWER POSITION: Recent reports indicate that the CMBS loans have been turned over to the special servicer and that the borrower has requested a CMBS loan debt service deferment. A bankruptcy of the borrower would increase the possibility of a CMBS loan default and could delay monthly PILOT payments and trigger a foreclosure of the PILOT mortgage by the trustee.
PILOT LIEN STATUS: PILOT payments are on parity with all governmental fees and charges, all of which are senior to other payment obligations. Repayment of the CMBS loans is subordinate to the PILOTs.
SOLID PRIOR TENANCY, OPERATIONS AND MARKET POSITION: Destiny USA, which includes the legacy Carousel Center, has limited competition in the Syracuse, New York region. Mall occupancy rates and sales had improved slightly prior to the closure and sales per square foot (SF) were strong compared to national norms. The mall continues to expand and diversify its offerings.
SINGLE-SITE RISK: The PILOTS are subject to concentration risk, as PILOT payments are secured by the obligations of the Carousel Center, a single income-producing property.
NO ISSUER DEFAULT RATING (IDR): SIDA has no material exposure to operating risk. As such, Fitch has not assigned an IDR, and there is no related cap on the PILOT bond rating.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Evidence that occupancy and sales performance will approach levels prior to the mall's closure, leading to consistent or improved estimated value of the Carousel Center once it has reopened.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Evidence that the estimated value of the Carousel Center has declined to a level that approaches PILOT bond principal outstanding;
Indications that multiple tenants will be unable or unwilling to continue to occupy their space and pay rent upon the mall's reopening;
A weakening in the servicer's capacity to advance payments, or loan refinancing without a servicer role similar to the current CMBS loan;
A decline in interest earnings available for a portion of debt service due to a downgrade or other trigger affecting Royal Bank of Canada (AA/Outlook Stable), the provider of the guaranteed investment contract (GIC) in which a portion of debt service reserve funds are invested.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Public Finance issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
CURRENT DEVELOPMENTS
Destiny USA is closed until further notice. The Governor of New York ordered all malls in the state to be closed beginning March 19, 2020 due to the outbreak of the coronavirus. There is no indication of when they may be reopened.
The recent outbreak of coronavirus and related government containment measures worldwide creates an uncertain global environment for U.S. state and local governments and related entities in the near-term. As severe limitation on economic activity only began very recently, most state governments' fiscal and economic data do not reflect any credit impairment. Material changes in revenues and expenditures are occurring across the country and are likely to worsen in the coming weeks and months as economic activity suffers and public health spending increases. Fitch's ratings are forward-looking, and Fitch will monitor developments in state and local governments as a result of the virus outbreak as it relates to severity and duration and incorporate revised expectations for future performance and assessment of key risks.
ECONOMIC RESOURCE BASE
With approximately 26 million in annual customer visits, Destiny USA is the dominant shopping center in the Syracuse area and draws shoppers from Canada. The mall is made up of the Carousel Center and an expansion project completed in 2012. It is anchored by nationally recognized stores including Macy's, J.C. Penney and Lord & Taylor. In total, the mall includes over 100 retail tenants, restaurants, entertainment options (including a Regal Movie Theater and a go-kart track), as well as various outlet and discount stores. An Embassy Suites opened in 2017.
DEDICATED TAX CREDIT PROFILE
ADEQUATE BONDHOLDER PROTECTIONS
The obligation of the Carousel Owner (Pyramid Company of Onondaga) to pay the PILOTs is on par only with governmental charges and fees, all of which are senior to any other payment obligations. The requirement of the Carousel owner to make PILOTs is evidenced by a PILOT note, payable to SIDA. The bonds are further secured by PILOT mortgages granted by SIDA and the Carousel Owner, encumbering their interests in the existing mall to the PILOT trustee. The PILOT mortgages do not extend to the expansion property. They impose a lien analogous to liens imposed by taxing authorities, and provide for similar remedies including foreclosure of property, providing a strong incentive to pay.
Mall tenants are contractually obligated to pay the Carousel Owner, as additional rent, their pro rata portions of PILOTs, and payment of the PILOTs by the Carousel Owner is absolute and unconditional, notwithstanding the inability of the Carousel owner to recover this payment from its tenants. Tenant leases generally have five- to 10-year expirations.
A non-impairment covenant by the city of Syracuse and New York State prohibits the city and state from altering the rights of the issuer to collect PILOTs.
SUM SUFFICIENT COVERAGE STRUCTURE
Annual debt service is structured on an ascending basis. Debt service on the bonds totals $21.3 million in 2020, increasing to about $36 million in 2035. In order to service this debt, PILOT payments are scheduled to grow by 4% annually through the final maturity of the bonds in 2036. The annual escalation of PILOTs heightens the structure's reliance on the mall's operations, but Fitch believes it to be manageable as long as the mall retains value due to the additional liquidity support per the mortgage servicer agreement. Parity bonds can only be issued as refunding bonds and may not increase debt service.
The bonds have cash-funded debt service reserve funds equal to 125% of average annual debt service of the PILOT bonds or $31 million in aggregate. Funds on deposit in the taxable series 2007B and 2016B bonds' debt service reserve fund are invested in a GIC with an expiration date of Jan. 1, 2036 (bond maturity). Earnings are guaranteed at 3.59% from the Royal Bank of Canada and are used to pay a small portion of debt service. A failure of the GIC to earn the required return could lead to a downgrade of the PILOT bonds as the debt service reserve fund would be insufficient to cover PILOTs over an extended period of time.
PRESENCE OF MORTGAGE SERVICER AS A SOURCE OF LIQUIDITY
Fitch views the presence of a mortgage servicer (Wells Fargo) pursuant to the securitization of the underlying mortgage loans on the mall project as a key credit factor. Under the pooling and servicing agreement, the mortgage servicer is required to advance funds when necessary to preserve the security of the mortgage loans. Given the subordinate nature of the underlying mortgage loan to the PILOT bonds, this includes funds to make PILOT payments. The obligation to advance applies as long as the servicer (or special servicer) is in place and determines that the advances will be repaid. Servicer advances provide temporary cash flow support should pledged funds prove insufficient to cover all PILOTS until such time that either mall performance recovers or the property is foreclosed and sold to another entity.
CHALLENGES EVIDENT PRIOR TO CLOSURE
The $300 million mortgage loan on the legacy Carousel Center property along with a $130 million mortgage on the expansion project have been securitized as commercial mortgage pass-through certificates. Both loans are interest only and were originally due in June 2019. Rather than being refinanced as expected, the loans were transferred to a special servicer in March 2019 amid questions about Pyramid's ability to repay or refinance the loans.
A Loan Extension and Modification Agreement was signed on May 31, 2019, providing a conditional three-year extension. The second two years of the extension require the property to meet a debt yield test that requires improvement in net operating income or repayment of a portion of the loans. Mall occupancy and sales figures did improve for calendar year 2019, but the first debt yield test requires net operating income (NOI) of the combined property to be at least 7.5% of the loan balance by April 2020, about two weeks after the mall's closure, in order to extend the loan to June 2021. Fitch has become aware that that borrower has requested a deferment and other relief due to the impact of the coronavirus pandemic. The second debt yield test, required for the third year of the loan extension, requires a higher NOI of 8.5% by April 2021. The servicer arrangement remains in place through the loan extension period.
The senior obligation of the PILOTs, on par with property taxes, ensures that support funding and any proceeds from foreclosure will be allocated first to the PILOTs before the excess is utilized for underlying mortgage claims.
MALL VALUE UNCERTAIN; PROPERTY FUNDAMENTALS REMAIN SATISFACTORY
The most recent appraisal of the Carousel Center was in July 2016, when the mall was valued at $500 million. This was down from the appraised value of $550 million in 2006 but up from the $490 million appraised value in 2014. Given the ongoing mall closure and Pyramid's attempts to defer or reduce loan payments, Fitch has concerns about declines in the mall's current and future value and the implication for leverage.
In a normal operating environment, mall revenues continue to be supported by its dominant market position and the broad geographic area from which customers are derived. As of December 2019, occupancy for the Carousel Center was 91%, up from 89% in 2018. Sales/SF of mall shops (tenants with less than 10,000 square feet of leased space) were strong at $652 and up notably from $605 as of Dec. 31, 2018. Aggregate occupancy at Destiny USA is weaker, due in part to a large presence of outlet stores experiencing high vacancies in the expansion section (which is not part of bond security).
PROJECT SUMMARY
Opened in 1990 in Syracuse, New York, the original Carousel Center mall is a 1.5 million SF super-regional shopping center with easy access from Interstate 81, a major north-south highway that runs from Tennessee to the Canada/New York border.
The expansion project completed in 2012 added approximately 850,000 square feet of gross leasable area (GLA) and is fully integrated with the original mall. The expanded mall was rebranded to Destiny USA and totals 2.4 million square feet, making it the sixth largest mall in the country.
The Carousel owner is a wholly owned subsidiary of the Pyramid Company of Onondaga, which is part of the Pyramid Companies. Based in Syracuse, New York, Pyramid Companies was established in 1969 and has developed malls across the northeast portion of the U.S.
CONCENTRATION AND MARKET RISKS
As a single-site property with one owner the mall is subject to concentration risk. This risk is partly mitigated by the large and diverse number of tenants whose leases include the payment of a proportionate share of the PILOT burden. However, mall performance is also vulnerable to changes in the competitive landscape and overall trends in retailing. These risks are heightened by the long-term tenor of the bonds, which extend to 2036.
CRITERIA VARIATION
The analysis supporting the 'BB' PILOT revenue bonds rating includes a variation from Fitch's U.S. Tax-Supported Rating Criteria. A variation was made to the dedicated tax bond analysis by incorporating an analysis of the transaction's overall leverage, or loan-to-value (LTV) cushion, calculated by dividing the total amount of debt by the value of the property. This evaluation is supported by Fitch's U.S. Tax-Supported Rating Criteria, which includes modifications to the analysis of the dedicated revenue stream coverage cushions to address factors specific to a transaction. The revenue volatility that would be produced through the FAST States & Locals - Fitch Analytical Stress Test Model does not anticipate this dedicated revenue source, which is derived from the value of the property.
In addition to the sources of information identified in Fitch's applicable criteria specified below, this action was informed by information from Lumesis.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG CONSIDERATIONS
N/A
RATING ACTIONS
ENTITY/DEBT RATING PRIOR
Syracuse Industrial Development Agency (NY) [Carousel Center PILOT]
Syracuse Industrial Development Agency (NY) /Property Assessment - PILOT/1 LT
LT BB Downgrade BBB
VIEW ADDITIONAL RATING DETAILS
Additional information is available on www.fitchratings.com
WELLS FARGO & COMPANY 
