NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a 'BBB-' rating to the $200 million term loan due 2019 entered into by Healthcare Realty Trust Incorporated (NYSE: HR). The loan bears interest at LIBOR plus 145 basis points. Loan proceeds will be used to repay borrowings on the unsecured revolving credit facility.
Fitch currently rates HR as follows:
--Issuer Default Rating (IDR) 'BBB-';
--Unsecured line of credit 'BBB-';
--Senior unsecured notes 'BBB-'.
KEY RATINGS DRIVERS
The ratings reflect the expectation for improving leverage and fixed charge coverage metrics, offset in large part by weak contingent liquidity and an adjusted funds from operations (AFFO) payout ratio near 100%.
The ratings also reflect the company's geographically diversified portfolio, positive medical office fundamentals, strong liquidity and manageable debt maturity schedule.
The Stable Outlook is based on Fitch's expectation that credit metrics will continue to improve; however, positive momentum is restrained by weak unencumbered asset coverage of unsecured debt. Thus, the overall credit profile will remain consistent with a 'BBB-' rating.
STRENGTHENING CREDIT METRICS
Leverage was 6.9x and 6.6x for the year and quarter ended Dec. 31, 2013 as compared to 7.0x and 8.4x at year-end 2012 and 2011, respectively. Fitch forecasts leverage will improve towards 6.5x through 2015, which may be consistent with a higher rating all else being equal. Fitch defines leverage as net debt to recurring operating EBITDA.
Fixed-charge coverage was 2.2x for the year ended Dec. 31, 2013, compared with 1.9x and 1.6x during full years 2012 and 2011 and is forecast to improve towards 2.4x through 2015. The amount and pace by which leverage and fixed-charge coverage improves will be dictated in large part by the lease-up of properties in stabilization. Fitch defines fixed-charge coverage as recurring operating EBITDA less Fitch's estimate of routine capital expenditures less straight-line rent adjustments, divided by total interest incurred.
STRONG LIQUIDITY AND MANAGEABLE MATURITY SCHEDULE
Healthcare Realty's liquidity coverage ratio is strong for the rating pro forma for the term loan at 5.9x for the period Jan. 1, 2014 to Dec. 31, 2015 and a key credit strength. The ratio is driven primarily by HR's manageable and long-dated debt maturity schedule which does not have a recourse debt obligation maturing until 2017. Fitch calculates liquidity coverage as sources of liquidity (unrestricted cash, availability under its unsecured revolving credit facility, projected retained cash flows from operating activities after dividend payments) divided by uses of liquidity (debt maturities, projected routine capital expenditures and development and construction mortgage funding commitments).
The company's portfolio of predominantly on-campus, medical office buildings (MOBs) is geographically diversified save for its exposure to Texas (which comprised 29.6% of square footage at Dec. 31, 2013). Following Texas were Tennessee (10%), Virginia (7.3%), Indiana (5.7%), North Carolina (5.6%) and Colorado (5.2%), with no other state exceeding 5% of the total portfolio. The portfolio is also well diversified by tenant with the top 10 tenants making up less than 31% of leased square footage. Healthcare Realty's portfolio positions the company to benefit from increasing demand for health care services, given Fitch's expectation of continued growth in the health care industry due to demographic trends.
WEAK CONTINGENT LIQUIDITY
Offsetting these credit strengths is weak contingent liquidity. Unencumbered asset coverage of net unsecured debt was 1.4x at Dec. 31, 2013. Fitch has previously stated that maintenance of unencumbered asset coverage below 1.5x may result in negative momentum in the ratings and/or Outlook. However, Fitch notes that incremental EBITDA from the stabilization-in-progress (SIP) portfolio should improve the ratio towards 1.6x, all else being equal. Fitch calculates asset coverage as unencumbered trailing 12 month (TTM) EBITDA, divided by a stressed 9% capitalization rate, divided by unsecured debt.
ELEVATED LEASE EXPIRATIONS
Over the past few years, several expiring master leases were converted to operating leases with underlying tenants, driving a near-term reduction to occupancy as the company became responsible for leasing up the vacancy in those properties. Further, HR also faces significant lease expirations in 2014 when 21% of revenues expire. Elevated lease expirations reduce the certainty and durability of the cash flows that support the rating. However, the development portfolio continued to make progress leasing, ending 2013 at 80% leased (63% occupied), up from 46% and 28%, respectively at the first quarter of 2012 (1Q'12).
AFFO PAYOUT RATIO ABOVE 100% IMPEDES CASH RETENTION
The aforementioned leasing challenges (i.e. development lease-up and master lease expirations) have resulted in an AFFO payout ratio consistently above 100%, which is a credit concern. Although HR modestly covers its dividend on a funds from operations (FFO) basis (Fitch adjusted) with a payout ratio of approximately 94% in 2013 and 92% in 2012, the dividend is not covered when based on Fitch's estimate of AFFO. Fitch calculates AFFO as funds available for distribution less certain adjustments and Fitch's estimate of recurring capital expenditures (tenant improvements, leasing commissions and maintenance capital expenditures). The payout ratio based on AFFO was approximately 107% in 2013 and 113% in 2012.
The earnings drag from the slow lease-up of properties in stabilization contributes to this high payout ratio and limits Healthcare Realty's ability to generate internal liquidity. In turn, HR needs to draw on its credit facility or source other forms of liquidity to fund a portion of the common dividend. An AFFO payout ratio in excess of 100% is inconsistent with an investment-grade rating and could have negative rating implications.
CREDIT METRIC VOLATILITY
The company has periodically funded acquisitions and development initially with debt, prior to deleveraging over time principally through equity issuances and/or the lease-up of development properties. As such, leverage may periodically remain high and coverage may remain low. This has increased risk, as the capital markets may be expensive or difficult to access when needed or fundamentals may be challenging when development properties need to be leased-up.
The Stable Outlook is driven by Fitch's expectation that HR's forecasted improvements in leverage and fixed-charge coverage in excess of Fitch's rating sensitivities are offset by weak contingent liquidity and maintenance of an AFFO payout ratio above 100% (two rating sensitivities that could result in negative momentum).
The following factors may have a positive impact on HR's ratings and/or Outlook:
--Fitch's expectation of leverage sustaining below 7.0x (leverage was 6.9x as of Dec. 31, 2013);
--Fitch's expectation of fixed-charge coverage sustaining above 2.0x (coverage was 2.2x for the TTM ended Dec. 31, 2013);
--Fitch's expectation of unencumbered asset coverage of unsecured debt sustaining above 2.0x (coverage was 1.4x as of Dec. 31, 2013).
The following factors may have a negative impact on HR's ratings and/or Outlook:
--Unencumbered asset coverage of unsecured debt sustaining below 1.5x;
--An AFFO payout ratio sustaining above 100%;
--Fitch's expectation of leverage sustaining above 8.0x;
--Fitch's expectation of fixed-charge coverage sustaining below 1.5x.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Rating U.S. Equity REITs and REOCs: Sector Credit Factors,' Feb. 26, 2014;
--'Recovery Ratings and Notching Criteria for Equity REITs,' Nov. 19, 2013;
--'Corporate Rating Methodology,' Aug. 5, 2013.
Applicable Criteria and Related Research:
Criteria for Rating U.S. Equity REITs and REOCs
Recovery Ratings and Notching Criteria for Equity REITs
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage