Debt service payments on some of the 96 municipal bond deals sold on behalf of Kmart Corp. have been halted entirely under its bankruptcy restructuring due to the company's rejection of certain department store leases that secured bond interest and principal payments.
Though Kmart announced its intention to sell the leases to 284 underperforming stores in March, DJM Asset Management Inc., the real estate brokerage firm hired to handle the lease liquidations, was not able to find buyers for 214 properties.
In the vast majority of those cases, where either "the bids were not high enough to make the deal worthwhile to Kmart or where no bids were received," the leases have already been rejected, said Christine DeMott, an associate with the law firm Skadden, Arps Slate Meagher & Flom, which representing Kmart.
The lease payments for some of those stores were pledged to pay back investors who own the tax-exempt bonds sold on Kmart's behalf by municipal issuers to finance the construction of those stores. Debt service payments in those cases will now be dependent upon how much rent landlords will be able to get from a new tenant, according to one source close to the proceedings.
For now, however, the lease terminations have halted all debt service payments to some investors.
On Sept. 13, FT Interactive Data Inc. posted a material-event default notice for a $1.71 million industrial development revenue bond sold on behalf of Kmart by the Douglas, Ariz., Industrial Development Authority in 1993. The bonds are guaranteed by Kmart and secured by an assignment of rents and leases on the local Kmart store that the proceeds of the bond sale went to build, along with a first deed of trust lien on the facility.
The store was closed this spring, along with many others, and now stands vacant at 50 West 16th Street, in Douglas, which has a population of 14,312. "We put the property up for auction, but didn't have any interested bidders, so we rejected it and it was deemed to have no value to the estate," DeMott said.
Chances of finding a successful tenant for the Douglas store are slim because the weak economy has led to the closing of several maquiladoras -- manufacturing plants for U.S. corporations just over the border in Mexico. About half of Douglas's retail business comes from Mexico, said city attorney Anita Sanchez. A Phelps-Dodge copper smelter in Douglas has also closed. At the same time, Wal-Mart is expanding its store in the area into a superstore, she said.
"No further Kmart lease payments will be received," SunTrust Bank, the trustee for the bond deal, told investors in a letter dated July 19. While the trustee could not comment on specifics, Andy Graiser, a spokesman for the Melville, N.Y.-based DJM Asset Management, said the facility will likely revert to the trustees for the bondholders.
The Douglas IDA, which was set up as a separate board to authorize debt for projects that would create jobs, has only issued debt for this one Kmart store. For the city of Douglas, its closure has been quite a blow, according to Sanchez. "It had about 60 employees," she said.
Martin Ryan, the attorney for the authority, said that the IDA will not be affected by the default, however, since it served only as a conduit issuer.
Overall, there are 96 outstanding municipal bond deals sold on Kmart's behalf by conduit issuers to finance store construction across the country, for an original par amount of $230.2 million, according to Thomson Financial Securities Data.
Jeffrey A. Ayers, a vice president at Bank One Trust Co. -- which serves as trustee on many other Kmart municipal bond deals -- said that the Douglas deal is not the only one to have its debt service payments halted due to store lease terminations.
And Kmart's January bankruptcy filing in -and -of itself constituted an immediate event of default under the indenture terms of the some of the other Kmart municipal bond deals.
While lease payments are not generally halted under bankruptcy protection -- as long as the lease has not been terminated -- any unpaid interest or principal payments accrued prior to the retailer's bankruptcy filing are being held in abeyance for the time being, according to one source.
"I used to say I've never seen one of these fail, but those days are over," Douglas IDA attorney Ryan said.
