Fitch Expects to Rate Sovran's Inaugural Public Bond 'BBB'; Ratings on Negative Watch

NEW YORK--()--Fitch Ratings expects to rate the inaugural public bond issuance of Sovran Acquisition Limited Partnership, the operating partnership of Sovran Self Storage, Inc. (NYSE: SSS, collectively Sovran) 'BBB'. Sovran Self Storage, Inc. will guarantee the notes.

On May 24, 2016 Fitch placed Sovran's ratings on Rating Watch Negative upon the LifeStorage acquisition announcement.

KEY RATING DRIVERS

The Rating Watch Negative reflects that the weakening of the issuer's key credit metrics upon the closing of the LifeStorage acquisition and execution risk to restore metrics more than offset the headline improvements in portfolio quality. Fitch could affirm the ratings with a Stable Outlook should the issuer complete additional transactions that allow it to fund consistent with its recent growth funding and with long-term debt proceeds. This would be crystalized upon the company successfully completing this inaugural bond deal. Should the issuer be unable or unwilling to do so, or if Fitch expects operating fundamentals will decelerate meaningfully, Fitch could downgrade the ratings to 'BBB-' or revise the Outlook to Negative.

PREMIUM PRICE TO IMPROVE PORTFOLIO QUALITY

The LifeStorage portfolio is stronger than Sovran's existing portfolio as measured by asset age, rent per square foot and surrounding population demographics, which is a credit positive and could help narrow the quality gap between Sovran's portfolio and its public peers. Nonetheless, Sovran paid a premium price in Fitch's view. The transaction is expensive considering how few REITs trade at similar valuations across all asset classes and quality despite the fact that the initial 4.8% cap rate is comparable to the implied cap rates for other self-storage REITs.

HEADLINE METRICS WEAKEN DUE TO FUNDING MIX AND VALUATION

The low going-in yield along with the transaction being initially funded with less equity (50%) than Sovran's typical 70%, results in headline metrics weakening materially upon the closing of the transaction. If Sovran enters into additional transactions (e.g. issuing equity or selling assets) that allow it to fund with closer to 70% equity, leverage metrics should return to the low 4x range in late 2017.

Assuming no additional delevering transactions, Fitch projects leverage will increase to the 5.5x - 6x range at the closing (mid-5x range on a run-rate basis) and improve towards the mid-4x range in 2017, assuming operating fundamentals remain strong, which would be more appropriate for a 'BBB-' Long-Term Issuer-Default Rating (IDR). This compares to the 4.2x quarterly average from 4Q12 - 1Q16, 3.9x for both 1Q16 and full-year 2015 and Fitch's previous projections of 4x through 2017.

Similarly, Fitch projects fixed-charge coverage (FCC) will decline below 4x assuming the transaction is funded with new debt at a 4.5% coupon and no incremental proceeds. Lower than the 5.2x FCC for the trailing-12-months ended March 31, 2016 (LTM), pro forma FCC remains strong. Fitch defines leverage as debt less readily available cash to recurring operating EBITDA including cash distributions from joint venture operations. Fitch defines FCC as recurring operating EBITDA less recurring maintenance capital expenditures to total interest incurred.

COMMITTED FINANCING FOR CLOSING; LONG-TERM FINANCING TO COME

Assuming a successful completion of the bond offering of at least $500 million, Sovran will have completed the majority of the debt financing portion of the acquisition and removed the execution risk surrounding the completion of its inaugural public bond issuance or issuing a significant amount of private placement debt. Over the long term, Sovran's primary sources of internal liquidity are its $500 million unsecured revolving credit facility, readily available cash and retained cash flow from operating activities.

Fitch estimates the contingent liquidity provided to Sovran's unsecured bondholders will decline to 2.3x pro forma from 3.2x at Sept. 30, 2015 assuming a 9% stressed cap rate with no incremental equity proceeds. While still appropriate for 'BBB' category REITs, Fitch believes self-storage REITs should have higher contingent liquidity ratios than similarly rated REITs in other asset classes, as asset granularity increases the time and number of properties necessary to aggregate a collateral pool and self-storage has relatively less institutional interest compared to other asset classes.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for Sovran include:

--Sovran closing the LifeStorage acquisition in 2H16;

--Sovran completing long-term debt transactions that allow it to avoid extended use of the bridge facility or high balances on the revolving credit facility. This assumption will be crystalized upon the company successfully completing its inaugural bond deal;

--Sovran financing the transaction consistent with its financial policies of closer to 70% equity.

RATING SENSITIVITIES

Removal of the Rating Watch Negative and affirmation of the IDR at 'BBB' will be driven by the company's ability to reduce debt via transactions such as incremental equity issuance or asset sales, and improvements in Sovran's debt maturity profile by issuing long-term debt to limit the usage of the revolving credit facility or bridge facility. At that point, Sovran's 'BBB' IDR would reflect:

--Fitch's expectation of leverage sustaining in the 4x - 4.5x range;

--Fitch's expectation of fixed-charge coverage sustaining above 3x;

--A liquidity coverage ratio sustaining above 1.0x.

Fitch would expect to maintain the watch, downgrade Sovran's IDR to 'BBB-' or revise the Outlook to Negative absent the company achieving long-term debt transactions and raising equity consistent with its financial policies.

FULL LIST OF RATING ACTIONS

On May 24, 2016, Fitch Ratings placed Sovern's Ratings on Negative Watch. Fitch currently rates Sovran as follows:

Sovran Self Storage, Inc.

--IDR 'BBB';

--Unsecured revolving credit facility 'BBB';

--Unsecured term notes 'BBB'.

Sovran Acquisition, L.P.

--IDR 'BBB';

--Unsecured revolving credit facility 'BBB';

--Unsecured term notes 'BBB'.

Date of Relevant Rating Committee: May 23, 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 and Fitch's estimate of recurring cash distributions from joint venture operations;

--Fitch has adjusted the historical and projected net debt by assuming the issuer requires $1 million of cash for working capital purposes which is otherwise unavailable to repay debt.

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

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
Senior Director
+1-212-908-9153
or
Committee Chairperson
Michael Weaver
Managing Director
+1-312-368-3138
or
Media Relations:
Sandro Scenga, New York, +1 212-908-0278
Email: 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
Senior Director
+1-212-908-9153
or
Committee Chairperson
Michael Weaver
Managing Director
+1-312-368-3138
or
Media Relations:
Sandro Scenga, New York, +1 212-908-0278
Email: sandro.scenga@fitchratings.com