NEW YORK--()--Fitch Ratings has affirmed the credit ratings of Liberty Property Trust (NYSE: LRY) and its operating partnership, Liberty Property Limited Partnership (collectively Liberty, or the company) as follows:
Liberty Property Trust
--Issuer Default Rating (IDR) at 'BBB+'.
Liberty Property Limited Partnership
--IDR at 'BBB+';
--Unsecured revolving credit facility at 'BBB+';
--Medium-term notes at 'BBB+';
--Senior unsecured notes at 'BBB+';
--Preferred operating units at 'BBB-'.
The Rating Outlook is revised to Negative from Stable.
The ratings evidence Liberty's moderate leverage, consistent coverage of fixed charges, and solid unencumbered asset coverage.
The Outlook revision to Negative principally reflects Fitch's expectation for Liberty's dividends as a percent of adjusted funds from operations (AFFO) to exceed 110% in 2013 and 2014. Elevated leasing costs - due to a greater mix of new office leases - will likely drive the anticipated dividend coverage shortfall. Liberty's AFFO payout ratio was 100.5% for the nine months ended Sept. 30, 2012 and 96.6% and 108.4% for the years ended Dec. 31, 2011 and 2010, respectively. A high AFFO payout ratio places pressure on the company's ability to generate internal liquidity. An AFFO payout ratio in excess of 100% for 2013 could have negative rating implications.
In addition, the expansion of Liberty's non-stabilized asset pool (primarily through development and, to a lesser extent, under-leased acquisitions) has weakened the company's leverage and fixed-charge coverage ratios to levels that, if sustained, are more appropriate for a 'BBB' IDR. Fitch expects Liberty's leverage to reach 6.2x at year-end 2014. Fitch's forecast contemplates $200 million of at-the-market (ATM) equity issuance in 2013, but does not assume any additional de-leveraging transactions.
As of Sept. 30, 2012, leverage was 5.4x, compared with 4.9x, 4.7x and 4.6x as of Dec. 31, 2011, 2010 and 2009, respectively. Fitch defines leverage as net debt to recurring operating EBITDA, including Fitch's estimate of recurring joint venture (JV) distributions.
Coverage metrics are adequate for the rating category. Fitch projects that the company's fixed-charge coverage ratio will be in the low- to mid-2.0x's for both 2013 and 2014. This will be driven by a modest increase in same-store net operating income (NOI) over the next two years and lower fixed charges due to the redemption of higher-cost preferred stock, but offset by increased recurring capital expenditures.
For the TTM ended Sept. 30, 2012, fixed-charge coverage was 2.4x, compared with 2.4x, 2.2x and 2.2x for the years ended Dec. 31, 2011, 2010 and 2009, respectively. Fixed-charge coverage is calculated as recurring operating EBITDA, including Fitch's estimate of recurring JV distributions less recurring capital expenditures and straight-line rents, divided by total interest incurred and preferred operating unit distributions.
The company has demonstrated prudent balance sheet management by maintaining a ratio of unencumbered operating real estate, valued at a stressed 9% capitalization rate, to net unsecured debt of 2.1x as of Sept. 30, 2012. This ratio is appropriate for the 'BBB+' rating category for a portfolio of office, industrial and flex assets.
Supporting the ratings are Liberty's smooth and manageable lease expiration schedule and tenant granularity. The company has on average approximately 12.6% of its net rent expiring annually between 2013 and 2017, with no year representing more than 14.8% of net rent. In addition, no tenant represents more than 4.1% of annual base rent, and the top 10 tenants comprise only 17.2% of base rent.
When including Liberty's share of JV debt, the company has no more than 21.1% of its debt maturing in any year between 2013 and 2016. This manageable debt maturity profile leads to adequate liquidity, as the company's liquidity coverage ratio, pro forma for the December 2012 senior notes offering, is 1.5x for the period from Oct. 1, 2012 to Dec. 31, 2014. Fitch calculates liquidity coverage as the company's sources of liquidity (cash, availability under the company's unsecured revolving credit facility and expected retained cash flows from operating activities after dividends and distributions) divided by uses of liquidity (pro rata debt maturities, expected recurring capital expenditures and expected development expenditures).
The company should be able to refinance upcoming unsecured indebtedness given its demonstrated ability to access various forms of capital over the past two years. In addition, the company's ratios under its unsecured credit facility and senior unsecured note financial covenants do not hinder its financial flexibility.
The ratings also point to the strength of Liberty's management team, including senior officers and property and leasing managers. The company has successfully disposed of lower-growth assets such as secondary-market suburban office and flex properties and has acquired or is in the process of developing industrial distribution assets, which have exhibited stronger demand characteristics.
Offsetting these rating strengths are expectations of continued soft fundamentals, as measured by same-store NOI. Fitch expects Liberty's same-store NOI to grow by 1.1% in 2013 and 0.7% in 2014, on a GAAP basis, as modest occupancy gains are partially offset by negative office leasing spreads. The company experienced flat same-store cash NOI growth for the nine months ended Sept. 30, 2012 relative to the same period in 2011.
Additionally, although Liberty has a presence in several markets, the company derives approximately 47% of annual net rent from the Pennsylvania/New Jersey region. One mitigant to this geographic concentration is that wholly owned rent across the company's consolidated portfolio is relatively evenly split between office (52%) and industrial (48%) property types. In addition, Liberty's long-term presence in and local knowledge of markets that comprise a large portion of the company's portfolio offset some of the geographic concentration concern.
Liberty has managed its development activities such that the total estimated cost to complete for its wholly owned development pipeline represented only 1.5% of total undepreciated assets as of Sept. 30, 2012. This compares to 3.2% at Dec. 31, 2011 and 0% at Dec. 31, 2010.
While not currently a rating concern, Fitch would view negatively a material increase in speculative development, particularly if it were focused on the office sector and/or geographic regions outside of management's area of expertise.
The two-notch differential between Liberty's IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB+'. Based on Fitch research on 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis', dated Dec. 13, 2012, these preferred securities are deeply subordinated and have loss absorption elements that would likely result in poor recoveries in the event of a corporate default.
The following factors may have a negative impact on Liberty's ratings:
--Fitch's expectation of an AFFO dividend payout ratio exceeding 100% for 2013;
--Fitch's expectation of leverage sustaining above 6.0x for several consecutive quarters (leverage was 5.4x as of Sept. 30, 2012);
--Fitch's expectation of fixed-charge coverage sustaining below 2.0x for several consecutive quarters (coverage was 2.4x for the TTM ended Sept. 30, 2012);
--Fitch's expectation of a sustained liquidity shortfall.
The following factors may result in a revision of Liberty's Rating Outlook to Stable from Negative and an affirmation of Liberty's 'BBB+' IDR:
--Fitch's expectation of an AFFO dividend payout ratio sustaining below 100%;
--Fitch's expectation of leverage sustaining below 6.0x for several quarters;
--Fitch's expectation of fixed-charge coverage sustaining above 2.3x for several quarters.
Additional information is available at 'www.fitchratings.com'.The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' (Dec. 13, 2012);
--'Recovery Rating and Notching Criteria for REITs' (Nov. 12, 2012);
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Criteria for Rating U.S. Equity REITs and REOCs' (Feb. 27, 2012);
--'Parent and Subsidiary Rating Linkage' (Aug. 8, 2012).
Applicable Criteria and Related Research:
Criteria for Rating U.S. Equity REITs and REOCs
Corporate Rating Methodology
Recovery Ratings and Notching Criteria for Equity REITs
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis
Parent and Subsidiary Rating Linkage