NEW YORK--(BUSINESS WIRE)--Fitch Ratings has upgraded the credit ratings for Boston Properties, Inc. (NYSE: BXP) and Boston Properties Limited Partnership as follows:
Boston Properties, Inc.
--Issuer Default Rating (IDR) to 'BBB+' from 'BBB';
--$200 million preferred stock to 'BBB-' from 'BB+'.
Boston Properties, L.P.
--IDR to 'BBB+' from 'BBB';
--$1 billion unsecured revolving credit facility to 'BBB+' from 'BBB';
--$5.9 billion senior unsecured notes to 'BBB+' from 'BBB'.
The Rating Outlook is Stable.
The upgrade reflects the strong qualitative elements in BXP's credit profile. Examples include the above average quality of BXP's largely unencumbered operating portfolio and its cycle-tested management team that has extensive real estate and capital markets experience. The upgrade also considers the consistency of the company's portfolio and balance sheet strategy, its demonstrated commitment to an unsecured borrowing strategy and proven access to multiple sources of debt and equity capital in varied capital markets environments.
The ratings reflect BXP's appropriate coverage for a 'BBB+' rated REIT. Moreover, BXP maintains an adequate liquidity position that is supported by its large unrestricted cash balance, meaningful retained free cash flow and near full availability under its $1 billion revolving credit facility. The company also has a large, high quality portfolio of unencumbered assets in markets with excellent transaction and financing liquidity characteristics - a credit positive in terms of contingent liquidity.
Execution and liquidity risk associated with the company's development platform and its concentrated geographical footprint and related exposure to finance, legal and government and defense industry tenants are credit concerns that balance BXP's ratings. BXP's size and asset and management quality help offset its above-average leverage relative to its similarly rated REITs.
SUPERIOR ASSET QUALITY
BXP owns a high-quality portfolio of predominantly class A office properties located in supply-constrained central business district (CBD) markets. The company's CBD properties are often leading properties in their submarkets that compete for the highest profile tenants, and have historically attracted significant investor and lender interest. The latter enhances BXP's contingent liquidity profile, including during challenging property and capital market environments.
QUALITATIVE ELEMENTS BALANCE ELEVATED LEVERAGE
Fitch expects BXP's leverage to be in the low 7.0x range through 2016, which is elevated for a 'BBB+' rated REIT. However, BXP's large size, superior portfolio asset quality and excellent track record of capital access and financial discipline balance this credit concern. BXP's net debt to recurring operating EBITDA for the trailing 12 months (TTM) ended March 31, 2014 was 6.8x, compared with 6.4x and 6.8x for the years ended Dec. 31, 2013 and 2012, respectively.
Fitch expects BXP's fixed charge coverage should sustain in the mid-2.0x range through 2016, aided by mid-single digit cash same store net operating income (NOI) growth and incremental NOI from new developments. Fixed-charge coverage was 2.4x for the TTM ended March 31, 2014, compared with 2.5x and 2.2x for the years ended Dec. 31, 2013 and 2012, respectively. Fitch defines fixed charge coverage as recurring operating EBITDA, including Fitch's estimate of recurring cash distributions from joint ventures, less straight line rents and maintenance capital expenditures and leasing costs, divided by interest incurred plus preferred dividends.
The seven-year weighted average term to maturity of BXP's leases provides stability to the company's cash flows. The company's in-service portfolio was 92.4% leased at March 31, 2014. BXP's lease profile is strong relative to its office REIT peers. The balanced maturities help ensure that the company is not overly exposed to leasing risk at any given time, notwithstanding tenant bankruptcies. Average annual lease expirations comprise approximately 8% of annualized base rent through 2023, with a maximum annual maturity of 14% in 2017. The company has historically been proactive in renewing tenants in advance of lease maturities to minimize downtime and leasing costs, which Fitch views as a risk adverse strategy that strengthens the credit by reducing cash flow volatility.
BXP maintains an adequate liquidity position. For the period April 1, 2014 to Dec. 31, 2015, the company's base case liquidity coverage ratio is forecasted to be 1.2x. BXP's liquidity coverage would improve to 1.3x assuming the company refinances maturing mortgages at 80% of current balances. Fitch defines liquidity coverage as sources of liquidity (unrestricted cash, availability under the company's unsecured credit facility, and expected retained cash flows from operating activities after dividends) divided by uses of liquidity (pro rata debt maturities, expected recurring capital expenditures, and development costs).
Unfunded development commitments of approximately $1.1 billion (Fitch estimate) from April 1, 2014 through Dec. 31, 2015 are the largest anticipated use of capital. BXP's total unfunded development commitments were $1.4 billion at March 31, 2014. BXP likely has some flexibility to defer spending if market conditions weaken unexpectedly and materially. The company demonstrated its willingness to stop development (when possible) in response to changing market conditions when it capped its 250 W. 55th Street development at grade level during the last downturn. BXP's liquidity coverage ratio would improve to 2.5x absent committed development expenditures.
BXP paid out approximately 67% of its adjusted funds from operations (AFFO) as dividends to common shareholders during 1Q'14. The company has historically kept its payout ratio below 75% - a credit positive. BXP's dividend policy is to pay out 100% of taxable net income. As such, BXP retains approximately $100 million of cash flow per annum that can be used to meet its liquidity obligations including funding new investments and development and satisfying debt maturities.
EXCELLENT CONTINGENT LIQUIDITY
BXP has a large, high quality pool of unencumbered assets with above average financeability and salability characteristics. As of March 31, 2014, BXP owned 146 unencumbered assets that generate annualized cash NOI of approximately $919 million, or 67.2% of its consolidated NOI. The company's unencumbered pool includes a number of trophy assets such as 399 Park Avenue and Times Square Tower in New York, Embarcadero Center One, Two, and Three in San Francisco, the Prudential Center complex in Boston (including three office towers, one of the most productive retail centers in the U.S., and a supermarket), and the Capital Gallery complex in Washington, D.C., among others.
Fitch expects the quality of BXP's unencumbered portfolio to improve further over the rating horizon through the addition of Embarcadero Center 4 in San Francisco and the John Hancock Building in Boston, which Fitch expects are likely candidates to be unencumbered when their mortgages mature in 2016 and 2017, respectively. Also, the delivery and stabilization of BXP's high quality development portfolio will further bolster the company's unencumbered portfolio quality, primarily through the addition of 250 W. 55th Street in Manhattan and 680 Folsom and 535 Mission St. in San Francisco.
The company's unencumbered assets cover its net unsecured debt by 2.9x based on a direct capitalization approach of unencumbered NOI using a stressed 7.5% capitalization rate. Fitch views this level of coverage as adequate for the rating. BXP has maintained UA/UD coverage in the high 2.0x range during the past five years.
ELEVATED 2017 DEBT MATURITIES
BXP's debt maturity schedule is reasonably well staggered, with the exception of 2017 when 29% of its pro rata debt matures. The company has historically been able to go to market with sizable notes offerings to refinance its debt maturities. BXP management endeavors to keep annual bond issuance within a range of $1.0 billion to $1.5 billion to maintain a well laddered maturity schedule.
The unusually high level of maturing debt in 2017 is principally related to mortgages inherited through opportunistic property acquisitions during the last downcycle including the GM Building and the John Hancock Tower. BXP management is exploring ways to address its 2017 maturities ahead of time. The company has the option to pre-pay at par just under half of its 2017 maturities during the second half of 2016.
BXP proactively renegotiated and expanded its unsecured revolving line of credit in July 2013 - ahead of the prior line's June 2014 expiration - partly to ensure adequate liquidity to handle its large maturities in 2017. BXP increased the capacity on the new line to $1 billion from $750 million and negotiated an expanded $500 million accordion feature as a potential source of additional contingent liquidity, up from $250 million previously. The new line expires in July 2018 - beyond its 2017 maturity wall.
Fitch calculates BXP's leverage by deconsolidating its consolidated joint ventures. Virtually all of the company's pro rata JV debt is nonrecourse to BXP. Although BXP has contributed equity to right-size mortgages at times, it has also been willing to offer deeds in lieu of foreclosure on assets where it feels the value of the assets is permanently impaired below the value of the mortgage. The Feb. 20, 2013 foreclosure sale and subsequent transfer of ownership of Montvale Center in suburban Maryland is a recent example.
TENANT INDUSTRY CONCENTRATION RISK
The company has a high proportion of financial, legal and government related tenants in its portfolio. Tenants in these segments comprised approximately 28%, 25% and 5% of gross rent, respectively, for a combined total of 58% as of March 31, 2014. Lower trading volumes and increased regulation are key issues that are challenging financial services companies resulting in delayed leasing decisions, at best, and, in many instances, led to reductions in space demand. Legal tenants continue to optimize their space needs and are often shrinking their office footprints when leases expire. Finally, the U.S. Government (BXP's largest tenant at 6.4% of leased square feet) and related government contractors are demanding less space due in large part to the impact of sequestration, particularly in the Washington D.C. metro area.
Development is a key component of BXP's strategy and the company has historically allowed its pipeline of projects under construction to become a large percentage of its portfolio on both a relative and absolute basis. For example, the pipeline grew to 20.3% of total undepreciated book assets in 2Q'08, with the unfunded portion representing 11% of total assets. The total estimated investment of BXP's development pipeline was $3.2 billion at March 31, 2014, which represented 14.2% of total assets with the unfunded portion comprising a materially smaller 6.3% of total assets. Fitch would view cautiously a pipeline that grows close to 20% of total assets or approaching 10% of remaining funding, absent significant pre-leasing.
BELOW AVERAGE SAME-STORE GROWTH
Fitch expects BXP's cash same-store NOI growth to accelerate to the mid-single digits during 2014 compared with 2.6% during 2013. BXP's same-store NOI growth averaged 1.4% between 2007 and 2013, trailing a selected group of office REIT peers by approximately 30 basis points. Fitch attributes the underperformance to outsized exposure to financial services and government related tenants due to the company's portfolio overweights in New York City and Washington, D.C. The company's internal growth has also been held back by elevated levels of leasing concessions that are generally abating and should support stronger cash same store NOI growth in the near-to-medium term.
PREFERRED STOCK NOTCHING
The two-notch differential between BXP's IDR and its preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB+'. Based on Fitch's research on 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis,' 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.
STABLE RATING OUTLOOK
The Stable Outlook reflects Fitch's expectations that fixed-charge coverage and leverage will sustain at the current levels over the next 12-24 months.
Fitch expects BXP to continue to pursue a portfolio and balance sheet strategy that is consistent with a 'BBB+' rating. Although upward rating momentum is unlikely, the following factors could collectively or individually result in an upgrade to BXP's ratings and/or Outlook:
--Fitch's expectation of leverage sustaining below 6.0x for several quarters. (leverage was 6.8x for the TTM ended March 31, 2014);
--Fitch's expectation of fixed-charge coverage sustaining above 3.0x for several consecutive quarters (coverage was 2.4x for the TTM ended March 31, 2014);
Conversely, the following factors may result in negative momentum in the ratings and/or Outlook:
--Fitch's expectation of net debt to recurring operating EBITDA sustaining above 7.5x;
--Fitch's expectation of fixed-charge coverage sustaining below 2.0x.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage' (May 28, 2014);
--'Rating U.S. Equity REITs and REOCs: Sector Credit Factors' (Feb. 26, 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).
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)
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis
Recovery Ratings and Notching Criteria for Equity REITs