NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the Issuer Default Rating (IDR) of iStar Financial Inc. (NYSE: STAR) at 'B'. Fitch has also upgraded the senior unsecured and convertible senior notes ratings to 'BB-/RR2'. A full list of rating actions follows at the end of this release.
On June 10, 2014, iStar announced that it agreed to sell $1.32 billion of senior unsecured notes, the proceeds of which, together with cash on hand, are intended to repay in full all amounts outstanding under, and terminate, its 2013 secured credit facility due 2017.
KEY RATING DRIVERS
The 'B' IDR is driven by improvements in the company's leverage, continued demonstrated access to the capital markets and new sources of growth capital and material reductions in non-performing loans (NPLs). Further improvements in the company's land and operating property portfolios should increase the company's earnings power and cash flows. Stronger performance should be driven by the mild improvement in commercial real estate fundamentals, value stabilization, and financing markets, which increases the likelihood of iStar's borrowers to repay their debt.
While concepts of Fitch's Recovery Rating methodology are considered for all companies, explicit Recovery Ratings are assigned only to those companies with an IDR of 'B+' or below. At the lower IDR levels, there is greater probability of default so the impact of potential recovery prospects on issue-specific ratings becomes more meaningful and is more explicitly reflected in the ratings dispersion relative to the IDR.
The senior unsecured notes and senior convertible notes ratings of 'BB-/RR2' or a two-notch positive differential from iStar's 'B' IDR, are based on Fitch's estimate of superior recovery in the 71%-90% range based on iStar's current capital structure. In Fitch's view, the full repayment of the 2013 secured credit facility enabled the company to add higher quality assets with higher recoverable values than the pre-existing unencumbered pool, to iStar's pro forma unencumbered pool. This improves Fitch's estimates of recoveries for the company's unsecured obligations to the benefit of unsecured bondholders, resulting in stronger recoveries relative to the previous 'B/RR4' ratings.
The preferred stock rating of 'CCC/RR6' or a three-notch negative differential from iStar's 'B' IDR, is based on Fitch's estimate of poor recovery based on iStar's current capital structure. Fitch's Recovery Rating criteria provide flexibility for a two- or three-notch negative differential between the IDR and instrument rating. A three-notch negative differential is based on the nature of iStar's perpetual preferred stock - a deeply subordinated security that has weak terms and remedies available both before and after a general corporate default (e.g. no stated maturity, an inability for holders to put the security back to the company, and iStar has the ability to defer dividends indefinitely without triggering a corporate default).
The 2012 senior secured tranche A-2 secured credit facility rating of 'BB/RR1', or a three-notch positive differential from iStar's 'B' IDR, is based on Fitch's estimate of outstanding recovery in the 91%-100% range. These obligations represent first-lien security claims on collateral pools comprising primarily performing loans, credit tenant lease assets and operating properties.
CAPITAL ACCESS IMPROVES LIQUIDITY AND GROWTH OPPORTUNITIES
iStar has accessed the public capital markets five times since the beginning of 2013, raising $2.3 billion. Uses of proceeds have been to repay indebtedness, refinance upcoming unsecured debt maturities and for general corporate purposes. Importantly, the company raised $200 million of convertible perpetual preferred stock in 2013, the first non-debt capital STAR raised via the public markets since 2007. The ability to raise growth capital for future investment is indicative of the market's improved confidence in the company's management and ability to invest in assets with good risk-adjusted returns.
IMPROVING LOAN PORTFOLIO METRICS
The company has reduced its gross NPL balance by 47% since the beginning of 2013 through a combination of loan sales and loans returning to performing status. The quality of STAR's loan portfolio has improved, with gross NPLs representing approximately 31% of the company's gross loan portfolio balance as of March 31, 2014, down from 42% as of Dec. 31, 2012. The company's ability to monetize its NPLs has generated additional cash flow to repay debt. Further, NPLs net of asset-specific reserves comprise approximately $200 million or only 4% of gross undepreciated assets as of March 31, 2014, indicative of limited exposure going forward.
LAND PORTFOLIO CURRENTLY AN EARNINGS DRAG, BUT GROWTH DRIVER
The land segment makes up approximately 19% of the carrying value of the company's portfolio as of March 31, 2014, and generates minimal revenue and a significant segment loss. The segment is currently a cash flow drain as the company invests capital toward improving the land for development and/or sale. Fitch expects that this segment will begin generating cash flow over the next several years, but the company will likely need to invest significant capital during this time period to realize the embedded value in its land holdings.
IMPROVING BOOK LEVERAGE; HIGH CASH FLOW LEVERAGE
The company's leverage on a net debt/undepreciated book equity basis has improved to 2.2x as of March 31, 2014 from 2.8x as of Dec. 31, 2012. The improvement in book leverage has been driven by significant debt reduction via proceeds from loan sales and monetizations of other real estate assets and investments. On a net debt/latest 12 months (LTM) EBITDA basis leverage was approximately 15x as of March 31, 2014, up from approximately 13x as of Dec. 31, 2012. This high leverage is due to the weak earnings power of the overall portfolio.
Fixed charge coverage was only 0.8x for the 12 months ended March 31, 2014, compared with 0.8x and 0.7x for the years ended Dec. 31, 2012 and 2011, respectively. The weak coverage is driven in part by the land segment, which has generated substantial losses over the last several years. Fitch expects this ratio to strengthen moderately as the company reduces debt from proceeds of loan resolutions and asset sales and begins to recognize additional earnings from lease-up of assets within its operating property segment, further sales of residential properties, and land monetizations.
MODESTLY CONSTRAINED GROWTH
The company is moderately constrained by non-compliance with an unsecured bond fixed charge incurrence covenant, which limits the company's ability to incur any additional debt to grow its investment portfolio. STAR's growth will occur via investment of unrestricted cash on hand, asset sales proceeds and from external capital raising, such as preferred stock and, potentially, common equity. The company's recently announced joint venture with a sovereign wealth fund to acquire and develop up to $1.25 billion of net lease assets is indicative of the company's ability to obtain growth capital outside of traditional capital markets channels. In addition, the company closed on approximately $950 million of new investments between June 2013 and March 2014, which should drive future revenue growth.
The Positive Outlook is based on Fitch's expectation that the company will be able to access the capital markets to refinance indebtedness and obtain growth capital to expand its portfolio. Further, the company does not have meaningful debt maturities until 2016 when 22% of debt matures, creating a stronger liquidity profile and providing the company adequate runway to redeploy asset sales proceeds and loan repayments towards future investments. In addition, recovery in commercial real estate fundamentals and valuations should enable the company to further monetize assets within its operating property segment and its unencumbered asset pool more broadly.
The following may have a positive impact on iStar's ratings and/or Outlook:
--Demonstrated ability to generate earnings and monetize assets within the company's land segment;
--Generating adequate earnings to be able to incur additional debt under the company's debt incurrence fixed charge covenant;
--Further monetization of the company's unencumbered real estate investment portfolio via asset sales to repay unsecured debt;
--Continued demonstrated access to the common equity or unsecured bond market.
The following may have a negative impact on the ratings and/or Outlook:
--Deterioration in the quality of iStar's loan portfolio, including an increase in non-performing loans and additional provisions for loan losses;
--An inability for the company to generate earnings and monetize land segment assets;
--Encumbrance of the company's higher-quality assets.
Fitch has taken the following rating actions for iStar Financial Inc.:
--IDR affirmed at 'B';
--2012 senior secured tranche A-2 due March 2017 affirmed at 'BB/RR1';
--Senior unsecured notes upgraded to 'BB-/RR2' from 'B/RR4';
--Convertible senior notes upgraded to 'BB-/RR2' from 'B/RR4';
--Preferred stock affirmed at 'CCC/RR6'.
Fitch has withdrawn the ratings on the 2013 secured credit facility due 2017 as this obligation has been paid in full.
The Rating Outlook is Positive.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 28, 2014).
--'Rating U.S. Equity REITs and REOCs: Sector Credit Factors' (Feb. 26, 2014);
--'Criteria for Rating U.S. Mortgage REITs and Similar Finance Companies' (Feb. 25, 2014);
--'Global Financial Institutions Rating Criteria' (Jan. 31, 2014);
--'Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis' (Dec. 23, 2013);
--'Recovery Ratings and Notching Criteria for Equity REITs' (Nov. 19, 2013);
--'Recovery Ratings for Financial Institutions' (Sept. 24, 2013);
--'Finance and Leasing Companies Criteria' (Dec. 11, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
Rating U.S. Equity REITs and REOCs (Sector Credit Factors)
Global Financial Institutions Rating Criteria
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis
Recovery Ratings and Notching Criteria for Equity REITs
Recovery Ratings for Financial Institutions
Finance and Leasing Companies Criteria