Among all of the mall real estate investment trusts (REITs) that have been hurt by the retail apocalypse over the past few years, none has been worse off than CBL & Associates (NYSE:CBL). CBL primarily owns low-productivity and midtier malls, which have been decimated by department store closures and a string of bankruptcy filings by apparel retailers.

These negative trends have led to significant earnings erosion over the past three years. The rise in anchor vacancies has also forced CBL to increase its redevelopment spending. A big legal settlement has added to the pressure on the REIT's cash flow. This culminated in CBL suspending its dividend earlier this year.

Last week, CBL reported that its earnings pressure continued last quarter, with adjusted funds from operations (FFO) falling again. Still, the damage wasn't quite as bad as what analysts had been predicting.

A mediocre quarter

In the third quarter, CBL's same-center net operating income (NOI) fell 5.9% year over year. This was roughly in line with the 5.7% decline in same-center NOI that it had reported a quarter earlier.

A corridor in a shopping mall

CBL's NOI continues to decline, due in large part to tenant bankruptcies. Image source: Getty Images.

Retail bankruptcies have been the biggest driver of these NOI declines. Last quarter, CBL had more than 700,000 square feet of space impacted by tenant bankruptcies. The REIT has been faced with an unpalatable choice between accepting a spike in vacancy rates or agreeing to rent reductions.

It has been a tough balancing act. CBL's total occupancy rate fell to 90.5% last quarter from 92% a year earlier. The decline was even worse for the REIT's malls, which saw occupancy tumble to 88.7% from 90.7% a year earlier on a same-center basis. Meanwhile, the average rent for leases signed last quarter was 5.5% lower than the prior leases for the same space. The rent spread for new leases was surprisingly strong, with rental rates up 18.9% compared to the previous tenants. However, that was more than offset by an 11% decline in the average rent for renewal leases, as CBL tries to accommodate struggling tenants. (Renewals account for the vast majority of leasing activity.)

CBL's NOI decline caused adjusted FFO per share to fall 15% year over year last quarter, from $0.40 to $0.34. Still, that was an improvement compared to the second quarter, when adjusted FFO per share plummeted 26% on a similar decline in same-center NOI.

It could have been much worse

Indeed, CBL's Q3 adjusted FFO per share of $0.34 beat the average analyst estimate by $0.02. This helped keep CBL stock's recent rally alive. While the stock has lost nearly half of its value over the past year, it has doubled since bottoming out earlier in 2019.

CBL Chart

CBL & Associates Stock Performance, data by YCharts.

Even modest NOI declines can often have dramatic effects on a REIT's FFO. Strong cost control was the main reason why CBL was able to escape that outcome in the third quarter. Overhead costs and maintenance expense declined last quarter, both sequentially and on a year-over-year basis. The REIT has also reduced its debt significantly over the past year, mainly through a combination of asset sales and returning one underwater mall to the mortgage lender. This led to lower interest expense.

Together, these factors allowed CBL to mitigate the impact of lower NOI on its adjusted FFO last quarter. For the full year, management still expects adjusted FFO per share between $1.30 and $1.35, down 22% to 25% from last year's $1.73.

Too many reasons to stay away

There were some signs of stabilization in CBL's recent earnings report. Sales per square foot increased a little more than 1% in the 12-month period ending on Sept. 30. CBL is also making steady progress on redeveloping the many former Sears and Bon-Ton stores in its portfolio. Finally, the company has reduced its debt load by nearly $400 million over the past year.

Nevertheless, CBL still has a lot of debt -- nearly $4.3 billion. To support this heavy debt load, the REIT has mortgaged nearly all of its Tier 1 malls (those with sales per square foot of at least $375). The rest of its portfolio consists mainly of lower-tier malls that may need more investment than CBL can afford in order to remain relevant in the long run.

Furthermore, J.C. Penney has 47 stores in CBL's portfolio, or one in nearly every one of the REIT's malls. The struggling department store chain doesn't pay much rent, but if it were to close a significant number of stores, it could trigger co-tenancy clauses, leading to big rent reductions for many of CBL's other tenants. Depending on the severity of the fallout, this -- or any other scenario that would reduce NOI -- could put CBL at risk of violating its debt covenants, leaving it at the mercy of its lenders.

CBL stock is dirt cheap, trading for just 1.2 times projected 2019 adjusted FFO. But between the REIT's ongoing FFO declines, its weak balance sheet, and the risk of further tenant restructurings, there is too much risk to justify investing in CBL. It wouldn't take much of a setback to spark a new crisis.