NEW YORK--(BUSINESS WIRE)--Fitch Ratings expects to assign an initial Issuer Default Rating (IDR) of 'BBB' to Washington Prime Group, Inc. and Washington Prime Group, L.P. (collectively, Washington Prime or the company). Fitch expects to initiate ratings as follows:
Washington Prime Group, Inc.
--Issuer Default Rating (IDR) 'BBB'.
Washington Prime Group, L.P.
--$900 million unsecured revolving credit facility 'BBB';
--$500 million unsecured term loan 'BBB'.
The expected Outlook is Stable. Should material changes occur which differ from Fitch's current expectations, the rating and Outlook could be revised.
On Dec. 13, 2013, Simon Property Group, Inc. (NYSE: SPG, Fitch IDR of 'A' with a Stable Outlook) announced a plan to spin off all of its strip center business and smaller enclosed malls into a separate publicly traded REIT named Washington Prime Group, Inc. Washington Prime is expected to initially own or have an interest in 55 strip centers and 44 malls.
KEY RATING DRIVERS
The expected 'BBB' IDR takes into account the company's strong expected credit metrics for the rating post spin-off over the next 12-to-24 months, including leverage and fixed-charge coverage, as the company migrates towards a strategy of funding its smaller malls and strip centers with a mix of long-term unsecured debt, secured debt and equity. As an independent, publicly traded REIT with a dedicated management team, Washington Prime should initially benefit from the franchise affiliation with SPG, which will provide the company with property management, leasing and development services but ultimately become self-managed. Credit strengths also include a high degree of portfolio granularity as evidenced by limited asset and tenant concentration, as well as good liquidity and a long-dated debt maturity profile.
The rating is balanced by the company's ownership of smaller malls (based on property-level NOI) that produced weaker through-the-cycle same-store NOI growth and occupancy performance when compared with those of select mall and strip center REIT peers. Malls are expected to generate 70% of Washington Prime's initial NOI with the remainder to be derived from strip centers. The majority of Washington Prime's properties are located outside of major market infill locations. Fitch has a cautious outlook on the competitiveness of such assets long-term. As such, a sustained deterioration in operating fundamentals or asset quality (e.g., sustained negative same-store NOI results or negative leasing spreads) could result in negative momentum on the ratings and/or Outlook.
Washington Prime's same-store NOI growth was positive in 2012 and 2013 and Fitch expects same-store NOI will continue to grow over the next 12 to 24 months. Further, the company's focus on organic growth along with development and redevelopment opportunities should improve asset quality and cash flow going forward.
Low Projected Leverage
Leverage will be 4.9x at spin and Fitch projects that leverage will remain around 5.0x over the next 12-to-24 months, driven by low-single digit same-store NOI growth from contractual rent increases (mainly 3% annual increases on base minimum rent), positive re-leasing spreads and incremental EBITDA from redevelopment, offset by moderately rising net debt. Leverage sustaining between 5.0x and 6.0x is appropriate for a 'BBB' rating. Fitch defines leverage as net debt to recurring operating EBITDA.
Initially, the company's capital structure will consist of equity capital along with mortgage debt assumed from SPG, a $500 million unsecured term loan and borrowings under the $900 million unsecured revolving credit facility. Fitch anticipates that Washington Prime will complete an inaugural unsecured bond offering within the next year and would view the establishment of broader capital access favorably.
In a stress case not anticipated by Fitch in which the company generates same-store NOI results comparable to the 2009-2010 period, leverage would approach the high 5x range, which would remain adequate for the 'BBB' rating. The company has a stated leverage range of between 5x and 6x and expects to issue follow-on common equity to fund acquisitions and development and/or maintain leverage in this range.
Strong Projected Fixed-Charge Coverage
Fitch projects that fixed-charge coverage will be 3.8x at spin and approach 3.0x over the next 12-to-24 months, which is strong for the 'BBB' rating. Washington Prime generated portfolio EBITDA growth in 2013, with occupancy up 90 basis points year-over-year to 92.8%, SSNOI growth of 2.8%, leasing spreads up $0.50 per square foot on new and renewal leases, and overall portfolio average rent PSF rising to $18.71 from $18.65. Fitch anticipates that organic and development-related growth will be more than offset by increased interest expense associated with additional debt incurrence.
In the Fitch stress case noted above, fixed-charge coverage would approach 2.5x, which would be adequate for a 'BBB' rating. Fitch defines fixed-charge coverage as recurring operating EBITDA less recurring capital expenditures and straight-line rent adjustments, divided by total interest incurred.
Agreements with SPG
Washington Prime has entered into several agreements with SPG to facilitate its transition towards becoming a self-managed entity. Under property management agreements, Washington Prime will pay annual property management fees to SPG equal to 2.5% of base minimum and percentage rents and will also pay leasing and development fees to effectively reimburse SPG. Washington Prime's management team has a renewed focus on improving the performance of the company's assets already managed by SPG, a recognized franchise and industry leader in terms of mall performance. Other agreements have been put into place to facilitate the spin-off, including a transition services agreement. It is unclear to what extent SPG will influence the performance of the Washington Prime portfolio upon expiration of these agreements.
The portfolio is comprised of 99 properties (including one strip center property held for development) dispersed across 23 states. Top states in 2013 by gross leasable area were Florida at 19%, Texas at 14%, Illinois at 10%, Ohio at 8% and Indiana at 6%. Washington Prime's top tenants as of Dec. 31, 2013 were L Brands, Inc. (IDR of 'BB+' with a Stable Outlook) at 2.6% of minimum rent, Foot Locker, Inc. at 2.5%, Ascena Retail Group, Inc. at 1.8%, Sterling Jewelers, Inc. at 1.8% and Zale Corporation at 1.5%, minimizing tenant concentration.
Exposure to Sears Holdings Corporation (IDR of 'CCC' with a Negative Outlook) and J.C. Penney Co., Inc. (IDR of 'CCC') is marginal at 0.7% and 1.3% of minimum rent, respectively. However, the effects of a closure may be greater than the minimum rent paid by the tenant due to decreased foot traffic at the mall generally. Fitch continues to have a cautious view on malls with exposure to J.C. Penney and Sears in secondary markets; however, only two recently announced J.C. Penney closures impacted the Washington Prime portfolio.
The company has a solid liquidity coverage ratio of 2.8x for the period Jan. 1, 2014 to Dec. 31, 2015. Fitch defines liquidity coverage as liquidity sources divided by liquidity uses. Liquidity sources include unrestricted cash, availability under unsecured revolving credit facilities and projected retained cash flows from operating activities. Liquidity uses include debt maturities, projected recurring capital expenditures and development expenditures. Liquidity coverage would improve to 3.8x if the company refinances 90% of secured debt maturities through 2015.
The company intends to access both the secured and unsecured debt markets regularly, and debt yields on upcoming secured maturities are in the low-to-mid-teens, reflecting strong refinancing capacity. Near-to-medium-term debt maturities are minimal as approximately 5.7% of debt matures in 2015 followed by 14.1% in 2016 and 5.0% in 2017.
Liquidity is enhanced by Washington Prime's low expected adjusted funds from operations (AFFO) payout ratio. Fitch expects the company's AFFO payout ratio will trend in the low-to-mid 60% range, which should allow for internally-generated liquidity of over $100 million annually.
The company also has strong contingent liquidity from its unencumbered pool and will derive more than half of its EBITDA from the unencumbered pool. The unencumbered pool includes numerous assets including those that the company considers 'redevelopment targets' such as Virginia Center Commons in Richmond, VA, 'only game in town' assets such as Southern Park Mall in Youngstown, OH and major market in-fill malls such as Orange Park Mall in Jacksonville, FL. Unencumbered assets (unencumbered EBITDA divided by a stressed 8.5% capitalization rate) cover net unsecured debt by 4.8x at spin and Fitch projects that this ratio will trend between 3.0x and 4.0x, which is appropriate for the 'BBB' rating.
Initial Lender Commitments Support Capital Access / Liquidity
The company has established two facilities with Bank of America and J.P. Morgan as joint lead arrangers including a $900 million unsecured revolver and $500 million unsecured term loan. Lender commitments have been robust across 22 institutions totaling $2.5 billion of commitments. The company already has accessed the secured debt market and an inaugural unsecured bond offering over the near-to-medium term will further expand access to capital.
Weaker Relative Asset Quality
Washington Prime's same-store NOI growth averaged negative 0.2% for 2010-2013, 270 basis points below all mall REIT peers (which reflects WPG's portfolio relative to all mall classes) and 90 basis points below select mall REITs with more similar portfolios. The company's average occupancy during the cycle was 91.6%, 160 basis points below select mall REITs. Notably however, in 2013, Washington Prime's 2.8% SSNOI growth exceeded the 0.9% growth achieved by the company's closest peer, CBL Associates, Inc. (Fitch IDR of 'BBB-' with a Stable Outlook). Overall, Fitch believes there are risks associated with the longer-term viability of certain smaller mall assets.
Development Opportunities Should Improve Cash Flow
The company's development pipeline includes $90.9 million of development projects and $162.8 million of re-development projects, totaling $253.7 million. Net of construction-in-progress as of Dec. 31, 2013, cost-to-complete development represents 4.5% of undepreciated assets. Fitch views the pipeline favorably from a credit standpoint as Washington Prime has adequate liquidity to fund these developments and all but one project has committed tenants. These projects should improve operating cash flows assuming Washington Prime achieves its target returns that range from 8% to 11%.
The Stable Outlook reflects Fitch's expectation of leverage sustaining between 5.0x and 6.0x, fixed-charge coverage sustaining between 2.5x and 3.5x, along with solid liquidity coverage, offset by relatively weaker asset quality.
The following factors may have a positive impact on Washington Prime's ratings and/or Outlook:
--Fitch's expectation of leverage sustaining below 5.0x (leverage at spin is expected to be 4.9x and Fitch expects leverage to sustain around 5.0x over the next 12-to-24 months);
--Fitch's expectation of fixed charge coverage sustaining above 3.5x (this ratio is 3.8x at spin but Fitch expects this ratio to migrate towards 3.0x over the next 12-to-24 months).
The following factors may have a negative impact on Washington Prime's ratings and/or Outlook:
--Sustained deterioration in operating fundamentals or asset quality (e.g., sustained negative same-store NOI results or negative leasing spreads);
--Fitch's expectation of leverage sustaining above 6.0x;
--Fitch's expectation of fixed charge coverage sustaining below 2.5x;
--Fitch's expectation of unencumbered assets, using a stressed 8.5% capitalization rate, coverage of net unsecured debt sustaining below 3.0x.
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 - Effective 12 August 2011 to 8 August 2012