Fitch Rates HCP's Senior Unsecured Notes due 2022 'BBB+'

NEW YORK--()--Fitch Ratings has assigned a 'BBB+' rating to the senior unsecured notes due 2022 issued by HCP, Inc. (NYSE: HCP). Net proceeds are expected to be used to repay outstanding balances on the revolving line of credit and/or the $500 million of 3.75% senior unsecured notes maturing in February 2016.

KEY RATING DRIVERS

The ratings reflect the issuer's traditionally conservative capitalization balanced by current tenant related headwinds. Fitch expects HCP can restore key credit metrics to past levels from the weaker end after the lease amendment with HCR ManorCare (HCR) over the next one-to-two years via organic growth and dispositions, given HCP's largely triple-net lease portfolio with contractual rental escalators.

Notwithstanding the manageable immediate effects, the largest concerns surrounding HCP will be the sufficiency of the previously announced rent reduction for HCR (i.e. HCR's ability to grow enough to improve coverage to industry averages or require additional reductions in the future) and the impact on HCP's equity valuation. While HCP does not need to issue equity to maintain its current capitalization, Fitch views consistent and appropriately priced capital markets access as a key factor for all REIT ratings given distribution requirements. Furthermore, equity issuance has been critical in allowing HCP and its healthcare peers to fund the sizable acquisition volume largely on a leverage-neutral basis.

RENT REDUCTION AT HCR; LONG-TERM SUFFICIENCY UNCERTAIN

On March 30, 2015, HCP announced that it had entered into an agreement to amend the lease with HCR, its largest tenant. The agreement reduces annual cash rent by $68 million ($49.7 million versus 2014 levels), extends the term by five years and provides HCP with $525 million of other considerations (i.e. nine additional facilities and a PIK note). HCP expects the amendments coupled with the sale of 50 underperforming assets operated by HCR should improve coverage metrics by approximately 20% - 30%. Through Nov. 2, 2015, HCP has completed the sale of 12 properties for $130 million and has the remaining 38 facilities under contract for total proceeds exceeding the original $250 million - $350 million guidance and the remaining sales are expected to close over the next six months.

HCP estimates pro forma guarantor fixed-charge coverage will improve to 1.25x from the 1.09x as-reported coverage at Sept. 30, 2015 and facility level coverage will improve to 1x from 0.88x at Sept. 30, 2015. Such levels imply HCR will have sufficient free cash flow to honor the lease though it will still require growth to forestall coverage reversions and to improve towards the industry average. HCR's financial position is further complicated by a consolidated civil complaint filed against the company by the Department of Justice.

LEVERAGE ABOVE NEGATIVE SENSITIVITY; DISPOSITIONS TO REDUCE

HCP's leverage was 6.2x at Sept. 30, 2015 as compared to the 5.0x - 5.5x reported each quarter in 2014. Leverage sustaining above 6x could result in negative momentum on HCP's ratings. As the share price remains more than 30% below its 2015 high, Fitch expects the issuer will use dispositions as its primary mechanism for reducing leverage back to the mid-5x range. Fitch defines leverage as debt less readily available cash to recurring operating EBITDA including recurring cash distributions from joint venture operations.

LONG-TERM IMPACT ON EQUITY VALUATION IS FOCAL POINT

The headwinds facing healthcare REITs generally and HCP specifically and the impact on the price at which HCP can issue equity is one of the largest long-term questions. Fitch views consistent and appropriately priced debt and equity capital as key factors to REIT ratings as distribution requirements necessitate consistent (but not constant) access. Equity issuances have been of increased importance to HCP and its healthcare peers, allowing them to quickly fund their rapid growth largely on a leverage-neutral basis.

CONTINGENT LIQUIDITY DETERIORATES

HCP's contingent liquidity, as measured by unencumbered asset coverage of unsecured debt, was 1.6x - 2.0x at Sept. 30, 2015 assuming a stressed 8%-10% capitalization rate, down from 2.0x - 2.4x at Dec. 31, 2014. As with leverage, contingent liquidity should improve via organic growth.

FUNDING STRATEGY BASED ON DISPOSITIONS

Fitch projects HCP will operate with a liquidity deficit of 0.7x, in Fitch's base case, for the period Oct. 1, 2015 through Dec. 31, 2017 before the effects of additional dispositions and proceeds from debt repayments. HCP's primary source of liquidity is its $2 billion revolving line of credit due 2019 assuming the issuer exercises its extension option. Fitch calculates liquidity coverage as sources (readily available cash, availability under the unsecured revolving line of credit and retained cash flow from operations) to uses (debt maturities, development expenditures, recurring maintenance capital expenditures and committed acquisitions) pro forma for events announced subsequent to end of 3Q15 including equity issuances, asset sales and loan repayments and assuming $500 million of proceeds from the 2022 offering.

FIXED-CHARGE COVERAGE REMAINS STRONG

Fixed-charge coverage (FCC) will remain strong for the rating at 3.5x for TTM Sept. 30, 2015. FCC was 3.8x for 2014 up from 3.6x and 3.2x for 2013 and 2012, respectively. Fitch defines FCC as recurring operating EBITDA including recurring cash distributions from joint venture operations less recurring maintenance capital expenditures and straight-line rent to interest expense.

STABLE OUTLOOK

The Stable Outlook reflects Fitch's view that HCP's capitalization will remain consistent with the rating over the next one-to-two years and that the issuer will be able to largely improve its metrics away from the weak end of the range via contractual organic growth.

KEY ASSUMPTIONS

--HCR maintains coverage with growth in operating cashflows sufficient to meet contractual rental escalators;

--SSNOI growth in 2016 of low- to mid-single digits;

--HCP funds acquisitions on a leverage-neutral basis largely via proceeds from dispositions;

--HCP's access to the debt and equity capital markets is unchanged.

RATING SENSITIVITIES

The following factors may result in positive momentum in the rating and/or Outlook:

--Reduced risk from skilled-nursing/post-acute operators as measured by reduced exposure or a sustained and material improvement in coverage in whole and in part;

--Reduced tenant concentration;

--Fitch's expectation of FCC sustaining above 3x for several consecutive quarters (coverage was 3.5x for TTM ended Sept. 30, 2015);

--Fitch's expectation of leverage sustaining below 4.5x (leverage was 6.2x at Sept. 30, 2015).

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

--A sustained and material weakening in coverage for skilled-nursing/post-acute operators in whole and in part;

--Fitch's expectation of leverage sustaining above 6x;

--Fitch's expectation of FCC sustaining below 2.5x;

--A liquidity shortfall.

FULL LIST OF RATING ACTIONS

Fitch currently rates HCP as follows:

--Long-term Issuer-Default Rating (IDR) 'BBB+';

--Unsecured bank credit facility 'BBB+';

--Unsecured term loans 'BBB+';

--Senior unsecured notes 'BBB+'.

Date of Relevant Committee: Oct. 7, 2015

Additional information is available on www.fitchratings.com

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Recovery Ratings and Notching Criteria for Equity REITs (pub. 18 Nov 2014)

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

Additional Disclosures

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Contacts

Fitch Ratings
Primary Analyst
Britton Costa, CFA
Director
+1-212-908-0524
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Stephen Boyd, CFA
Director
+1-212-908-9153
or
Committee Chairperson
Michael Weaver
Managing Director
+1-312-368-3156
or
Media Relations
Sandro Scenga, +1 212-908-0278
sandro.scenga@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Britton Costa, CFA
Director
+1-212-908-0524
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Stephen Boyd, CFA
Director
+1-212-908-9153
or
Committee Chairperson
Michael Weaver
Managing Director
+1-312-368-3156
or
Media Relations
Sandro Scenga, +1 212-908-0278
sandro.scenga@fitchratings.com