NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a 'BBB-' rating to the $200 million 4.73% private placement senior unsecured notes due 2026 issued by STORE Capital Corporation (NYSE: STOR). Fitch expects the company to use proceeds of the issuance to repay debt and for general corporate purposes. The Rating Outlook is Stable. A full list of STOR's ratings follows at the end of the release.
KEY RATING DRIVERS
STOR's ratings reflect the issuer's strong management team, differentiated investment strategy, diversified portfolio and solid credit metrics. These strengths are offset in part by the cross-collateralization features and reputational risk associated with the master funding conduit which may restrict STOR's financial flexibility and provide material economic incentives for the issuer to prioritize the encumbered asset pool, making the facility 'recourse-like.' The conduit acts as a credit positive during favorable markets, providing STOR with an incremental and flexible source of capital and contingent liquidity. However, in more stressed markets, the conduit may limit financial flexibility as compared to REITs with more traditional debt structures.
DIFFERENTIATED STRATEGY; DIVERSIFIED PORTFOLIO
STOR is a triple-net lease REIT that focuses on originating sale-leasebacks with non-rated middle-market companies on the real estate where they conduct their business (e.g. retail or service but not office headquarters). The portfolio is well-diversified by location and tenant (STOR's largest tenant comprised 2.7% of revenues as of Dec. 31, 2015) and lease maturities are long-dated given the strategy and age of the portfolio.
STOR's asset class focus and ability to originate the majority of its acquisitions enables it to acquire net lease assets at yields approximately 50 basis points (bps) - 300bps wider than marketed portfolios leased predominantly to investment-grade tenants. As STOR's tenants are typically non-rated, thereby limiting Fitch's ability to assess tenant credit quality, median four-wall coverage ratios provide some indication of default probability and are appropriate at 2.64x at Dec. 31, 2015. While STOR is a relatively new company and thus the performance to-date of its underwriting is not a meaningful indicator of its sufficiency; its senior management previously founded and ran two public companies (Franchise Finance Corporation of America - NYSE: FFA, and Spirit Finance - NYSE: SFC). Fitch views management favorably but notes the FFA and SFC track records are mixed from a credit perspective. Fitch estimates FFA's conduit trusts incurred realized losses of more than 7% of original loan balance while SFC's losses were more than 3%.
Fitch attributes the improving collateral performance amidst a more severe economic backdrop to better underwriting and 'lessons learned' (e.g. reduced sector concentration and lower loan-to-values [LTVs]) and would expect STOR's performance to be closer to that of SFC than FFA. Further, many of the losses were incurred after FFA and Spirit were sold.
INVESTMENT-GRADE METRICS
Fitch projects STOR will operate with leverage between 6x - 7x through 2017, consistent with the issuer's targets. Leverage was 6.0x for fourth-quarter 2015 (4Q15) and 5.7x when adjusting for the timing effects of acquisitions. Fitch notes that reported metrics may be weaker than the projections due to the timing effects of acquisitions. STOR's tenant diversification, contractual rental increases and long-dated lease maturities improve the durability and predictability of operating cash flows and provide a cushion for the issuer to maintain its metrics in the event of tenant credit issues. Whether STOR's metrics deviate from its targets will be conditioned by the amount and timing of equity issuances relative to acquisitions, assuming no material tenant issues over the next one to two years.
Similarly, Fitch projects STOR will operate with fixed-charge coverage (FCC) in the low-3x range through 2017 as compared to 3.5x for 4Q15. Contractual rental increases could be offset by higher interest expense as revolving line of credit balances are term financed with higher cost, longer tenor debt. Fitch currently places a lower importance on FCC given the low interest rate environment. Fitch calculates leverage as total debt less readily available cash-to-recurring operating EBITDA. Fitch calculates FCC as recurring operating EBITDA less straight-line rent and recurring maintenance capital expenditures-to total-interest incurred.
MASTER FUNDING INTEGRAL TO STRATEGY, IMPACTS FINANCIAL FLEXIBILITY
The majority of STOR's debt financing comes through the STORE master funding debt program, a conduit through which STOR issues ABS debt. Upon the contribution of new properties and the issuance of a new series of debt under this program, the entire collateral pool (including the newly added real estate) is pledged to secure all of the notes (i.e. the existing and new series) on a pro rata basis.
The master funding program has mixed implications for STOR's credit profile. As the buyers are typically ABS-focused and not traditional commercial real estate lenders, STOR has access to an incremental source of capital as compared to its peers, a credit positive. Moreover, as the structure is more flexible than CMBS in regard to asset sales and substitutions it allows STOR to re-tenant or dispose of underperforming assets with greater ease than if held in a CMBS structure, thus better matching the investment strategy of focusing on non-rated entities. Further, master funding demonstrates leveragability and contingent liquidity for the company's portfolio, and there is no adverse selection between assets financed with master funding as compared to the unencumbered pool.
While integral to STOR's strategy, the master funding program effectively cross-collateralizes the majority of STOR's assets, which has two potential implications. The first is that should there be losses such that the cash-trap provision is exercised, STOR would lose access to a significant percentage of cash flow with which to address corporate obligations and pay dividends. While cash-trap provisions exist in CMBS and thus are not a risk unique to STOR, they would not impact as large a percentage of a REIT's assets if funding via mortgages or CMBS. Cash flow coverage in the master funding program was more than 1.8x at Dec. 31, 2015, in line with Sept. 30, 2015 versus the covenant at 1.3x, implying the trust would need a loss in revenues well in excess of those of the predecessor entities assuming no substitutions before cash flow would be swept. A loss of this magnitude is unlikely considering the performance history for STOR's predecessor entities and as a result, is not included in Fitch's base case expectations.
The cross-collateralization and reputational risk make the master funding program 'recourse-like,' providing material economic incentives for STOR to support master funding potentially at the expense of the unencumbered pool. Moreover, STOR may be incentivized to support master funding if it were at risk of a downgrade to the conduit's ratings which would likely be before it approached the cash flow sweep levels.
ABOVE-AVERAGE LIQUIDITY & CONTINGENT LIQUIDITY
STOR has solid liquidity following the June 2015 follow-on equity offering, the $375 million of senior unsecured private placements, the expanded credit facility and the term loan issuance. Fitch estimates STOR's sources of liquidity (unrestricted cash, availability under the expanded $500 million revolving credit facility, retained cash flow from operations after dividends and proceeds from the private placement) cover uses (debt maturities, YTD acquisitions and other commitments to fund improvements to real estate) by 2.6x for the period Jan. 1, 2016 - Dec. 31, 2017. Fitch expects STOR will operate with above-average liquidity as its limited operating history naturally results in few near-term debt maturities. Fitch expects STOR's liquidity will moderate towards the REIT average as it seasons and the initial debt issuances come into the rating horizon.
While STOR funds itself principally through secured debt, it nonetheless maintains a sizable pool of unencumbered assets providing contingent liquidity to unsecured creditors. Fitch estimates the current pool has a stressed value of $1.4 billion assuming a 10% capitalization rate, which would provide 3x coverage of the $475 million of unsecured debt pro forma for the private placement and term loan. Fitch expects this metric will decline over time as STOR issues more unsecured debt.
While the unencumbered pool is sizable relative to potential unsecured debt, Fitch does note that the unencumbered pool could be used by management as a warehouse for acquisitions before contributing to subsequent master funding issuances and be at risk of adverse selection. The cross-collateralization and reputational risk are partially addressed by STOR's ability to sell troubled assets directly out of master funding rather than exchanging them for other unencumbered assets and later disposing of them. While substitutions or sales from master funding are limited to 35% of the collateral pool, the protection this provides to unsecured bondholders is diminished by the fact that there are no limitations if the substitution or sale is credit or risk based which are presumably the most common instances when STOR would seek to replace collateral.
Fitch would view favorably the creation of an at-the-market (ATM) equity offering program, though the creation of one is not considered in the base case due to how recent the issuer's initial public offering was. While STOR is still developing access to the traditional REIT sources of capital, Fitch does recognize that the master funding program provides it access to a unique capital source that is generally unavailable to other REITs.
STABLE OUTLOOK
The Stable Outlook reflects Fitch's expectation that STOR will operate within its targeted metrics through the rating horizon and the issuer will have sufficient capacity to address any potential tenant credit issues.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for STOR include:
--Leverage sustaining between 6x - 7x either through sufficient equity issuances to fund acquisitions on a leverage-neutral basis or by lowering acquisition volumes;
--STOR will continue to grow its pool of unencumbered assets and will not demonstrate any adverse selection or utilize the pool as a warehouse facility/back-up liquidity for master funding.
RATING SENSITIVITIES
The following factors could result in positive momentum in the ratings and/or Outlook:
--Fitch's expectation of leverage sustaining below 6x (leverage was 6x at Dec. 31, 2015 and 5.7x pro forma for the timing of acquisitions);
--Fitch's expectation of FCC sustaining above 3x (FCC was 3.5x for the quarter ended Dec. 31, 2015).
The following factors could result in negative momentum on the ratings and/or Outlook:
--A deterioration in the quality, value and/or financeability of the unencumbered pool. Examples could include tenant credit issues, adverse selection between the encumbered and unencumbered assets, and/or the recycling of unencumbered assets into master funding in exchange for challenged assets,
--Fitch's expectation of leverage sustaining above 7x;
--Fitch's expectation of a liquidity shortfall.
FULL LIST OF RATING ACTIONS
Fitch rates STOR as follows:
STORE Capital Corporation
--Long-term Issuer Default Rating (IDR) 'BBB-';
--Senior unsecured revolving credit facility 'BBB-';
--Senior unsecured notes 'BBB- '.
Date of Relevant Rating Committee: April 21, 2016
Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below:
--Historical and projected recurring operating EBITDA is adjusted to add back non-cash stock based compensation and include operating income from discontinued operations.
--Fitch has adjusted the historical and projected net debt by assuming the issuer requires $25 million of cash for working capital purposes which is otherwise unavailable to repay debt.
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. 03 Dec 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=874214
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis (pub. 29 Feb 2016)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=878264
Additional Disclosures
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1003612
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https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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