NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'BB+' Issuer Default Ratings (IDRs) of Sabra Health Care REIT, Inc. (NASDAQ: SBRA) and its operating partnership, Sabra Health Care Limited Partnership.
Fitch has also assigned a 'BB+/RR4' rating to the CAD$90 million term loan entered into by Sabra Canadian Holdings, LLC, which will be used to partially fund a portfolio transaction in Canada.
The Rating Outlook is Stable. A full list of rating actions follows at the end of the release.
KEY RATING DRIVERS
Sabra's 'BB+' IDR reflects its investment grade capitalization (based on its unsecured borrowing strategy and strong key credit metrics), offset by portfolio factors such as asset and tenant concentration. Such factors increase the risk to operating cash flows (and in turn to unsecured bondholders) and are manageable in isolation but inconsistent with investment grade ratings in the aggregate. Sabra's ratings are underpinned by certain expectations such as continued diversification, the stabilization of the Forest Park Medical Centers (FPMC) with appropriate coverage, and material improvement in the facility level coverage for the Holiday portfolio. Failure to achieve these benchmarks could result in negative momentum on the ratings and/or Outlook. The Stable Outlook reflects Fitch's belief that despite the expectation of continued diversification, it will be insufficient to warrant positive ratings momentum over the next 12 to 24 months.
ENTRY INTO CANADA
Fitch views SBRA's entry into the Canadian market (detailed below) as a rating neutral event. The dollar value of the investment falls within our $250 million expectation for the year and many of SBRA's peers, such as Health Care REIT (IDR 'BBB+') and Ventas, Inc. (IDR 'BBB+') have made investments in Canada noting the private payments and, therefore, lessened regulatory risk. The 6% cash acquisition cap rate appears rich considering the 1.11x implied EBITDAR coverage.
In 2Q15, SBRA announced that it had acquired nine senior housing facilities in Canada for CAD$170.5 million (USD$137.1 million). The acquisition will be funded in part via a CAD$90 million term loan issued by Sabra Canadian Holdings, LLC. The term loan matures in 2020 and bears interest at Canadian Dollar Offer Rate (CDOR) +2% - 2.6% (currently 3.09%). SBRA plans to enter into swap agreements to fix CDOR. The remainder of the purchase price will be funded by a mortgage assumption and the revolving line of credit. The term loan is guaranteed by Sabra Health Care REIT, Inc. and Sabra Health Care Limited Partnership.
SBRA concurrently announced $25.8 million of other investments with a weighted-average yield of 9.6% through 2Q15 and a forward purchase program with Leo Brown Group. Through 1Q17, SBRA will have the right to provide a portion of equity financing for up to 10 developments (totalling $250 million) through a preferred equity structure with a purchase option for each facility. The agreement follows similar ones by SBRA that Fitch has viewed favorably as the equity investments are generally modest in size and secure a forward acquisition pipeline without direct development risks.
ASSET CONCENTRATION KEY RISK
Asset concentration is a key negative factor for the ratings as it increases the magnitude of the downside risk to recurring operating EBITDA should there be a lease default. SBRA has investments in three acute-care hospitals that operate under Forest Park Medical Center (FPMC), all within the greater Dallas, TX area. These assets comprise roughly 12% of revenues combined pro forma for the aforementioned investment activity, 2% to 6% individually and could comprise a greater percentage upon the exercise of purchase options. The risk posed by each hospital is increased by the limited operating histories, proximity to each other and lease structures.
All of the assets are new and in various stages of stabilization providing a limited track record at best to determine the robustness and volatility of facility level coverage. In 1Q15, SBRA agreed to rent and interest deferrals totalling $2.5 million due to issues at FPMC. The deferrals highlight the asset concentration risk despite the negligible effect on headline metrics and the issuer's expectation that the underlying causes (i.e. lower acuity patient volumes and expense considerations) are being addressed by the operator.
Beyond the current operational headwinds at FPMC; as all of the facilities operate under the same name in relatively close proximity to each other, an operating or regulatory issue at one facility could affect patient volumes and operating performance at the others. While the facilities are affiliated, SBRA does not benefit from structural considerations such as a master lease or cross default or cross collateralization provisions. Moreover, secured mortgage capital is generally less available for hospitals relative to traditional commercial real estate. Thus, if SBRA chooses not to exercise its purchase options on the properties that it is the lender to, it may be more challenging for FPMC to find a new debt or equity capital source to repay SBRA than for other real estate property types. The ratings assume the assets will stabilize with appropriate coverage levels and failure to do so could result in negative momentum on the ratings and/or Outlook.
DIVERSIFYING VIA ACQUISITIONS BUT PAYING TO DO SO
Sabra has actively and effectively used acquisitions to improve portfolio diversification, most recently through the $550 million Holiday transaction. While the Holiday transaction improved SBRA's diversification, it is not without risk. The price paid is noteworthy on an absolute basis and relative to past transaction by other REITs with the initial cash yield of 5.5% and approximately 50 basis points (bps) to 100 bps lower than recent comparable transactions. Moreover, while the guarantor fixed charge coverage is fair at 1.25x and implies a lower probability of lease default, Fitch believes facility level coverage is materially lower and will require significant growth in operating cash flows to maintain and/or improve given annual rental increases. Fitch views facility level coverage as a more meaningful predictor of the probability that the tenant can and would want to renew the lease at maturity especially in instances where the REIT does not control all or practically all of the tenant's real estate such as with SBRA and Holiday.
INVESTMENT GRADE METRICS AND CAPITALIZATION
Sabra's capitalization is consistent with its investment grade peers being predominantly fixed-rate and unsecured and does not require significant mortgage repayments and asset unencumbering to complete the transition. Moreover, SBRA's target leverage (low 4.0x range), average actual leverage (average of all quarters since inception is 5.0x) and Fitch's forecasted leverage (between 5.0x and 5.5x through 2016) are all consistent with investment grade ratings for SBRA's asset composition. Similarly, fixed charge coverage was 2.6x for 1Q'15 pro forma and Fitch expects will sustain around 3.0x through 2016 which is strong for the 'BB+' rating and appropriate for a 'BBB-' IDR.
Fitch calculates leverage as total debt less readily available cash to recurring operating EBITDA, including stock-based compensation and acquisition costs, as senior management has the option to be compensated in cash or shares for a large portion of the bonuses and Board of Directors fees. Acquisition expenses are recurring in nature for issuers such as SBRA that have external growth as an explicit part of its strategy. Combined, the inclusion of these costs provides a more accurate reflection of the annual overhead expenses. Fitch calculates fixed charge coverage as recurring operating EBITDA to total interest incurred and preferred dividends.
ISSUER SIZE AND RATINGS
SBRA is one of the smallest REITs in Fitch's rated universe. However, Fitch views a REIT's size as a determinant of operating efficiencies and the cost of capital not necessarily access to capital. Moreover, the probability of default is aligned with the size and quality of the unencumbered pool from which a REIT would sell assets or encumber in order to repay recourse debt maturities. Fitch views the quality of the underlying real estate as more important factors than sponsor size or quality when accessing secured debt or the transaction market.
PREFERRED NOTCHING AND NOTE COVENANTS
The two-notch differential between SBRA's IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BB+'. Based on Fitch Research on 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis', also available at 'www.fitchratings.com', 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.
Certain of the covenants of SBRA's senior unsecured notes, most notably the limitation on indebtedness and maintenance of total unencumbered assets, can be suspended upon certain events. SBRA would still be subject to the financial covenants in its bank credit facility agreement; however, those may be renegotiated with greater ease and a breach would not trigger a cross-default so long as the bank lending group did not accelerate repayment. While Fitch does not rate to the covenants, the lack of covenants would be a differentiating factor between SBRA's unsecured notes and those of its REIT peers.
The Stable Outlook reflects Fitch's belief that SBRA's portfolio diversification will improve but not sufficiently to warrant positive momentum on the ratings over the next 12-to-24 months. Fitch expects SBRA's capitalization will remain consistent with a higher rating.
Fitch's key assumptions within the rating case for SBRA include:
--Same-store net operating income (SSNOI) growth of 2.8% through 2016 to reflect weighted average rental increases;
--Operating margins improve modestly as the issuer achieves economies of scale as it grows but remain lower than peers;
--Net acquisitions of $250 million in 2015 and 2016 at 7.5% cap rate;
--Dividend growth to maintain an 80% AFFO payout ratio;
--Equity issuance to fund assumed acquisitions with 60% equity;
--No material cash flow issues at operator level.
Fitch views SBRA's existing leverage and fixed charge coverage as being consistent with higher ratings. As such, positive momentum on SBRA's ratings and/or Outlook will be driven by continued a material diversification that reduces reliance on individual assets and/or tenants.
The following factors may result in negative momentum on SBRA's ratings and/or Outlook:
--Increasing asset and/or tenant concentration;
--Deteriorating coverage in the Holiday portfolio;
--Forest Park Medical Center assets do not stabilize with sufficient facility-level coverage;
--Fitch's expectation of leverage sustaining above 6.5x (leverage was 6.0x at Mar. 31, 2015 pro forma for the recent investments and issuances announced subsequent to the end of the quarter).
Sabra's corporate liquidity is strong for the rating due to only $186 million of funding obligations for the period April 1, 2015 through Dec. 31, 2016 compared to $551 million of sources, pro forma. SBRA's primary source of liquidity is the $450 million senior unsecured revolving credit facility that matures in September 2018. Fitch defines liquidity coverage as sources (readily available cash, availability under the revolving credit facility, retained cash flow from operations after dividends) divided by uses (debt maturities and amortization, committed development expenditures and acquisition funding).
SBRA's liquidity is driven by its long-dated yet concentrated debt maturity schedule which is somewhat common for smaller REITs (especially those that issue public unsecured bonds as opposed to smaller denomination term loans and private placements). This funding strategy results in a lower probability of default in the initial years but greater bullet maturity risk in the later years. The 'BB+' IDR is predicated on the expectation that SBRA will improve the staggering of its debt maturities going forward. SBRA's nearest debt maturity will be the $200 million term loan and any balance on the revolving line of credit in 2018 (both of which can be extended at SBRA's option to 2019). SBRA's liquidity could be reduced further should SBRA acquire the two Forest Park Medical Centers for which SBRA is the lender. After 2018 when 25% of total debt matures, SBRA's debt maturities are again concentrated in 2021 (42%) and 2023 (17%).
SBRA maintains appropriate contingent liquidity in the form of unencumbered assets which cover unsecured debt net of readily available cash by 1.7x - 2.1x assuming a stressed 8.5% to 10.5% cap rate. Fitch excludes unencumbered interest and other income from coverage and notes that including the debt investments would improve coverage by 0.0x to 0.3x depending on the haircut applied to face value.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
Sabra Health Care REIT, Inc.
--IDR at 'BB+';
--Cumulative redeemable preferred stock at 'BB-/RR6'.
Sabra Health Care Limited Partnership
--IDR at 'BB+';
--Unsecured revolving credit facility at 'BB+/RR4';
--Unsecured term loan at 'BB+/RR4';
--Senior unsecured notes at 'BB+/RR4'.
Fitch has assigned the following ratings:
Sabra Canadian Holdings, LLC
--Senior guaranteed term loan at 'BB+/RR4'.
The Rating Outlook is Stable.
Additional information is available on www.fitchratings.com
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014)
Recovery Ratings and Notching Criteria for Equity REITs (pub. 18 Nov 2014)
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis (pub. 25 Nov 2014)
Dodd-Frank Rating Information Disclosure Form