Fitch Rates EPR Properties' $300MM Sr. Unsecured Notes 'BBB-'; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned a 'BBB-' credit rating to the $300 million 4.50% senior unsecured notes due 2025 issued by EPR Properties (NYSE:EPR). The notes were priced at 99.638% of par, or at 4.545%, a 235 basis point (bps) spread to the benchmark treasury. EPR expects to use the net proceeds from the offering to repay the outstanding balance of its unsecured revolving credit facility and the remaining amount for general business purposes, which may include funding its ongoing pipeline of acquisition and build-to-suit projects.

Fitch currently rates EPR as follows:

--Issuer Default Rating (IDR) 'BBB-';

--Unsecured revolving line of credit 'BBB-';

--Senior unsecured term loan facility 'BBB-';

--Senior unsecured notes 'BBB-';

--Preferred stock 'BB'.

KEY RATING DRIVERS

The 'BBB-' IDR is driven by the consistent cash flows generated by the company's triple-net leased megaplex movie theatres and other investments across the entertainment, education and recreation segments, resulting in strong credit metrics. EPR benefits from generally strong levels of rent coverage across its portfolio and structural protections including cross-collateralization among properties operated by certain tenants.

While cinema attendee demand has remained consistent over a long time period, some other investment types lack as long a track record. Credit concerns include significant, though abating, tenant concentration in the charter school segment and concerns about the company's investment in niche asset classes that are less proven and may be less liquid or financeable during periods of potential financial stress.

Low Leverage for 'BBB-'

Leverage was strong at 5x for year-end 2014, identical to year-end 2013 and 2012. Fitch projects leverage will increase and sustain at 5.3x through 2016, driven by an expansion in build-to-suit investments, which require large capital outlays in advance of the assets producing cash flow. This ratio is appropriate for the 'BBB-' rating given EPR's niche property focus. Leverage is defined as debt, less readily available cash, divided by recurring operating EBITDA.

Strong Fixed-Charge Coverage

EPR's fixed-charge coverage (FCC) is solid for a 'BBB-' IDR. FCC was 2.7x for year-end 2014, up slightly from 2.6x in 2013 and 2.5x in 2012. Fitch projects that EPR's FCC ratio will continue to improve and surpass 3x by 2016, which would be strong for the 'BBB-' rating. The expected improvement is driven by an increasing level of high-yielding acquisitions, partially offset by increased interest expense from unsecured bond issuances. Fitch expects that new investments will generally target equal weightings across the entertainment, education and recreation segments. Fitch defines FCC as recurring operating EBITDA less recurring capital expenditures and straight-line rent adjustments, divided by cash interest incurred and preferred stock dividends.

Manageable Lease Expiration Profile

EPR has only three megaplex theatre leases expiring in 2015, accounting for 3% of total revenue, and theatre lease expirations through 2017 represent only 8% of total revenues. Megaplex theatres currently represent 55% of total revenues at year-end 2014. Within the company's charter school segment, which represents 13% of total revenue, there are no significant lease expirations until 2031. Historically, most tenants have chosen to exercise their renewal options, which has mitigated re-leasing risk and provided predictability to portfolio-level cash flows. Over the past several years some theatre tenants have given back space, but more recently this trend has subsided as tenants have reconfigured space to downsize seat counts and include more amenities such as dining options and more spacious seating. Releasing spreads can vary greatly depending on the operating performance of the asset.

Below-Average Liquidity

Fitch calculates that EPR's liquidity coverage ratio is 1.2x for the period Jan. 1, 2015 to Dec. 31, 2016. While EPR benefited by expanding its revolving credit facility (RCF) earlier in 2014, liquidity coverage is weighed down by $246 million of expected build-to-suit development expenditures over the forecast period. Additionally, mortgage debt maturing over the next two years is decreasing liquidity, assuming that this debt will not be refinanced. Liquidity coverage would improve to 1.8x assuming secured debt is refinanced at 80%, although this scenario is unlikely as EPR has stated its intention to have a fully unencumbered portfolio. Fitch defines liquidity coverage as sources of liquidity (unrestricted cash, availability under the unsecured RCF, expected retained cash flows from operating activities after dividend payments) divided by uses of liquidity (debt maturities, development expenditures and recurring capital expenditures).

EPR paid out 86% of its AFFO in the form of dividends in 2014, down from previous years. Fitch expects the company's payout ratio will be in the 80% to low-90% range and internally generated liquidity will be used in part to fund new investments.

Appropriate Unencumbered Asset Coverage of Unsecured Debt

EPR has adequate contingent liquidity from its unencumbered asset pool. Unencumbered asset coverage of net unsecured debt is 2.1x when applying a stressed 12% capitalization rate to unencumbered net operating income (NOI). This ratio is appropriate for a 'BBB-' IDR. The company continues to unencumber its megaplex theatre assets, improving the quality of the unencumbered pool as it transitions to an entirely unsecured funding model.

Staggered Debt Maturities

Debt maturities are manageable through 2016, with no year's maturities representing more than 6.7% of total debt, and only mortgage debt is maturing. Beginning in 2017, the maturities represent unsecured debt offerings which are larger in size coupled with a growing mortgage pool being taken on through acquisitions. As EPR continues to grow, Fitch expects the company will continue to ladder its debt maturity profile appropriately, which will reduce refinancing risk in any given year. EPR plans on continuing to pay off mortgage debt and further migrate to an unsecured funding model. However, in certain instances adding mortgage debt may be necessary as obligations can be linked with acquired properties. For example, EPR assumed $90.3 million of mortgage debt in April 2014 in order to complete an 11-theatre, $117.7 million portfolio acquisition.

High Tenant Concentration is Receding

EPR's largest tenant, American Multi-Cinema, Inc. (AMC) (IDR of 'B+'; Stable Outlook), accounted for 21% of total revenues in the fourth quarter of 2014 followed by Regal Cinemas, Inc. (Regal; 9%), Cinemark USA, Inc. (8%), Imagine Schools, Inc. (6%), and Peak Resorts, Inc. (5%). The exposure to AMC has consistently decreased since the company's inception principally via acquisitions. The company's top 10 tenants accounted for 68% of total revenue in the most recent quarter, emblematic of the limited number of national operators across the entertainment and recreation segments.

In April 2014, the company sold four Imagine charter schools in Florida to a Florida-centered buyer, generating net proceeds of $46.1 million. This sale not only reduced EPR's exposure to Imagine, but also helped demonstrate some degree of liquidity in the public charter school space.

While most of EPR's theatre leases and all of EPR's charter school leases for a given operator are cross-defaulted, a tenant bankruptcy could allow for the rejection of certain non-economic leases. Given that most of EPR's top tenants are either unrated or have below-investment-grade ratings, the potential for corporate default, bankruptcy and lease rejection could reduce EPR's rental revenues. Mitigating this risk is that on a portfolio- and property-level basis, EBITDAR adequately covers rent payments for the majority of EPR's properties, and for each of EPR's tenants.

Steady Theatre Business

North American box office revenue has grown at a compound annual growth rate of nearly 4% over the past 25 years. While revenue was down in 2014, due to a historically poor summer season with a strong rebound in fall and winter, box office revenues were resilient throughout the global financial crisis and ensuing recovery. Revenue increased or stayed flat in every year from 2005 to 2013, with the exception of 2011. Since the company's formation in 1997, no theatre tenant has missed a lease payment, and no tenants on a portfolio-wide basis have EBITDAR coverage of rent below 1x.

Niche Sectors with Idiosyncratic Risks

The ratings reflect EPR's focus on investing in non-core property types that are likely less liquid or financeable during periods of market stress. In addition, certain investments are exposed to idiosyncratic risks, such as the gaming properties associated with the Adelaar casino project (previously the site of the Concord resort in the Catskills, New York) that EPR is developing along with Empire Gaming.

While the company's entertainment, education and recreation properties are typically well-located and have high-quality amenities, alternative uses of space may be limited and may require significant capital expenditures to attract alternate tenants.

Management intends to continue to focus on its three investment segments, which Fitch views positively. Management has specialized knowledge within these non-commodity commercial real estate segments which helps shape the company's longer term strategy.

Education Segment Evolving

EPR is highly focused on the burgeoning market for education investments. The company's education segment included investments in 62 public charter schools, five early education centers and two private schools in New York and California, as of Dec. 31, 2014. This portfolio consists of 3.3 million square feet and is 100% leased. Additionally, EPR has construction in progress for three public charter schools, eight early education centers and one private school.

EPR has been able to work through most of the 12 school closings or charter non-renewals with Imagine, its largest charter school tenant. The charters were revoked due to poor academic performance; however, EPR resolved many of the problems though asset swaps, subleases and sales. Because of the structural protections with the Imagine master lease, including an unused $9 million letter of credit and a $7.4 million escrow reserve, EPR did not miss any rental payments from Imagine.

Preferred Stock Notching

The two-notch differential between EPR's IDR and its preferred stock rating is consistent with Fitch's 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' Criteria Report dated Nov. 25, 2014, as EPR's preferred securities have cumulative coupon deferral options exercisable by EPR and thus have readily triggered loss absorption provisions in a going concern.

Stable Outlook

The Stable Outlook reflects that leverage is expected to sustain around 5.3x while FCC continues to improve. These strong credit metrics are offset by the unique risks to EPR's specialty property types such as liquidity and alternative use. The Stable Outlook further reflects EPR's adequate liquidity coverage and minimal refinancing risk.

KEY ASSUMPTIONS

Fitch's key assumptions for EPR in Fitch's base case include:

--Annual same-store NOI growth of 1.5%;

--$1 billion of total investments from 2015-2016;

--Investments consistent with historical acquisition strategy - well-known tenants at high single-digit yields;

--$400 million-$500 million of total equity issuance from 2015-2016.

RATING SENSITIVITIES

The following factors may have a positive impact on the ratings and/or Outlook:

--Greater institutional acceptance of the asset classes which EPR owns;

--Fitch's expectation of leverage sustaining below 4x (leverage was 5x as of Dec. 31, 2014);

--Fitch's expectation of FCC sustaining above 3x (coverage was 2.7x at Dec. 31, 2014).

The following factors may have a negative impact on the ratings and/or Outlook:

--Fitch's expectation of leverage sustaining above 5.5x;

--Fitch's expectation of FCC sustaining below 2.2x;

--Liquidity coverage sustaining below 1.25x, coupled with a strained unsecured debt financing environment.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--EPR Properties-Ratings Navigator, Feb. 26, 2015;

--Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis, Nov. 25, 2014;

--Recovery Ratings and Notching Criteria for Equity REITs, Nov. 18, 2014;

--Corporate Rating Methodology, May 28, 2014.

Applicable Criteria and Related Research:

Recovery Ratings and Notching Criteria for Equity REITs

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=813628

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=821568

EPR Properties - Ratings Navigator

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=862133

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=981068

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Contacts

Fitch Ratings
Primary Analyst
Steven Marks
Managing Director
+1 212-908-9161
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Sean Pattap
Senior Director
+1 212-908-0642
or
Committee Chairperson
Michael Weaver
Managing Director
+1 312-368-3156
or
Media Relations, New York
Sandro Scenga
+1 212-908-0278
sandro.scenga@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Steven Marks
Managing Director
+1 212-908-9161
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Sean Pattap
Senior Director
+1 212-908-0642
or
Committee Chairperson
Michael Weaver
Managing Director
+1 312-368-3156
or
Media Relations, New York
Sandro Scenga
+1 212-908-0278
sandro.scenga@fitchratings.com