NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the ratings of Lexington Realty Trust (NYSE:LXP) and Lepercq Corporate Income Fund L.P., including the Long-Term Issuer Default Ratings (IDR) at 'BBB'. A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS
The affirmation of LXP's IDR at 'BBB' is based on its granular portfolio of predominantly single-tenant, triple-net leased assets that generate consistent cash flow growth, growing unencumbered pool, and conservative financing strategy. Fitch expects asset quality to improve over the next several years as a result of LXP's capital recycling strategy of selling non-core and underperforming office, retail, multitenant and vacant properties, while funding build-to-suit developments and forward acquisition commitments.
Credit concerns center on the company's exposure to single-tenant offices, which Fitch views to be on the weaker end of the net lease spectrum; a weaker liquidity position before proceeds from asset sales; and still developing access to the unsecured bond market. The liquidity and access to capital risks are partially mitigated by the expectation that LXP will use dispositions as a liquidity source over the next few years. While LXP endeavours to utilize a more unsecured funding model, its progress has stalled since its first two bond issuances, and access to unsecured capital is dependent in part on frequency of issuances and issuance size.
LXP owns a diversified portfolio across 40 states totalling 213 consolidated properties (mostly office and industrial assets), the vast majority of which were single-tenant and triple-net leased as of May 2016. The portfolio was 96.7% leased based upon net rentable square feet as of March 31, 2016. LXP's largest market, the greater New York area, represents 15.6% of annual base rents, followed by Houston (6.8%) and Dallas (6.5%).
LXP's largest tenant, FedEx Corporation, represented 3.5% of cash based rent in 1Q2016, and the top 10 tenants totalled 24.9% of cash based rent. The company currently generates 67.2% of its rent from below investment grade rated tenants or unrated tenants, indicative of heightened tenant credit risk.
Growing Unencumbered Pool
LXP continues to increase the percentage of net operating income generated from unencumbered assets, from 22.9% in 2010 to 69.2% in 2015. The company's repayment of secured debt with new unsecured bonds, and conversion of its revolver and term loans to unsecured from secured starting in 2013 improved financial flexibility, which Fitch views favorably.
Long-Term Lease Strategy
Fitch has a more favorable view toward triple-net leases than gross leases as triple-net leases typically have longer durations and less cash flow volatility. While single-tenant assets contain an inherent binary exposure to tenant renewal decisions, LXP's granular and diversified portfolio mitigates the risk exposure to any single non-renewal or tenant bankruptcy. The company has extended its weighted average lease term on a cash basis to 12.7 years as of March 31, 2016 from 6.9 years as of Dec. 31, 2012, which further improves cash flow predictability absent tenant bankruptcies. The lengthening of the lease tenor was driven in part by the exceptionally long-term land leases, and thus this metric will decline as LXP sells these investments.
Capital Recycling Improves Portfolio Mix
LXP expects to dispose of approximately $600-$700 million of assets in 2016 and reinvest some of the proceeds into build-to-suit developments which should improve the age and mix of the portfolio. The office to industrial revenue mix in LXP's portfolio historically had been running about 3:1, and the company has managed the ratio below 2:1 over the past several years. The continued targeted sale of certain office buildings will make the portfolio less capital intensive to manage over time.
Cost to complete for in-progress developments represent 3.8% of undepreciated assets as of March 31, 2016, a manageable level.
Fitch expects leverage to sustain in the mid-5x range as the company funds accretive acquisitions and build-to-suit development projects with proceeds from dispositions on lower yielding assets. This compares to LXP's leverage of 5.8x for trailing 12 months ended March 31, 2016 (5.6x in 1Q2016)and 5.8x and 5.4x for 2015 and 2014, respectively. This range is appropriate for the 'BBB' rating. In Fitch's stress case, leverage would remain in the 5.5x-6.0x range, which would remain consistent with the rating. Fitch defines leverage as debt less readily available cash divided by recurring operating EBITDA including recurring cash distributions from unconsolidated entities.
Fitch recently revised the treatment of REIT cumulative perpetual preferred stock to 50% equity credit from 100%. LXP's leverage based on net debt including 50% of preferred stock was 5.9x for trailing 12 months ended March 31, 2016 (5.6x in 1Q2016), compared with 6.0x and 5.5x for the years ended 2015 and 2014, which remains appropriate for the 'BBB' rating.
Consistent Cash Flow
Fitch projects that fixed-charge coverage (FCC) will sustain in the 3.0x to 3.5x range over the next several years as LXP refinances higher coupon debt and capital expenditures moderate as the company looks to sell more capital-intensive assets. This compares to FCC of 2.9x for the trailing 12 months ended March 31, 2016 (3.3x in 1Q2016), as compared to 2.8x in 2015 and 3.0x in 2014. Fixed-charge coverage has improved due to EBITDA growth (approximately half of the portfolio has annual rent escalators), lower interest expense and reduced preferred dividends due in part to preferred stock redemptions in 2012.
In a stress case in which same-store NOI remains flat and the company sells fewer assets than anticipated by Fitch to repay debt and fund build-to-suits, fixed-charge coverage would remain around 3.0x, which would remain commensurate with a 'BBB' rating. Fitch defines fixed-charge coverage as recurring operating EBITDA including recurring cash distributions from unconsolidated entities less straight-line rents and recurring capital expenditures divided by total cash interest incurred and preferred stock dividends.
Transition to Unsecured Funding Stalled
Fitch does not expect LXP will seek to access the unsecured bond market through the rating horizon, instead funding itself with disposition proceeds. To date, the company has only issued two series of unsecured bonds, $250 million of 4.25% 10-year senior notes in 2013 and $250 million of 4.40% 10-year senior notes in 2014. However, other unsecured borrowings include the revolving credit facility, term loans, convertible bonds and trust preferred securities. In 2013, LXP amended its two term loans totalling $505 million to unsecured from secured, and refinanced its $300 million secured revolving credit facility with an unsecured revolving facility and thereafter increased the availability to $400 million. This should improve financial flexibility going forward.
As of March 31, 2016, the company's unencumbered assets (defined as unencumbered NOI divided by a stressed 9% capitalization rate) covered net unsecured debt by 2.5x, which is adequate for the rating. Unencumbered asset coverage has trended in the 2.0x-2.5x range over the past several years.
Build-to-Suit Investments and Forward Acquisition Commitments Negatively Impact Liquidity; Dispositions Expected
For the period April 1, 2016 to Dec. 31, 2017, LXP's sources of liquidity (unrestricted cash, availability under its unsecured revolving credit facility and projected retained cash flows from operating activities after dividends) as compared to its uses of liquidity (pro rata debt maturities, amortization, projected maintenance capital expenditures, build-to-suits and forward purchase commitments) result in a coverage ratio of 1.0x. Should the issuer execute its plans to dispose of $600 million to $700 million, liquidity coverage would improve to 2.4x.
LXP's capacity to retain organic liquidity is moderate with an AFFO payout ratio of 64.2% in 1Q2016 following a payout of 77.8% in 2015 and 73.6% in 2014. Based on the current payout ratio, LXP retains approximately $50 million annually in organic liquidity.
The Stable Outlook reflects Fitch's expectation that LXP will operate within its targeted metrics through the rating horizon and the issuer will have sufficient capacity to address any potential tenant credit issues.
Fitch's key assumptions within the rating case for LXP include:
--1.5% same-store NOI growth through 2018;
--G&A to maintain historical margins relative to total revenues;
--$650 million of dispositions in 2016 followed by $100 million annually in 2017-2018 at an 8% cap rate;
--LXP will use proceeds from asset sales, equity issuances and unsecured debt issuances in 2018 to fund acquisitions on a leverage neutral basis;
--LXP will repay near-term secured debt with asset sales;
--Capex to maintain historical margins relative to recurring operating EBITDA;
--AFFO payout ratio of approximately 65%-70% through 2018.
The following factors may result in positive momentum in the ratings and/or Rating Outlook:
--Fitch's expectation of leverage sustaining below 5.0x for several quarters (leverage, excluding preferreds, was 5.8x for the trailing 12 months ended March 31, 2016 and 5.6x in 1Q2016);
--Fitch's expectation of fixed-charge coverage sustaining above 3.0x for several quarters (fixed-charge coverage was 2.9x for the trailing 12 months ended March 31, 2016 and 3.3x in 1Q2016);
--Fitch's expectation of unencumbered assets to net unsecured debt sustaining above 3.0x (this ratio was 2.5x as of March 31, 2016.
The following factors may result in negative momentum in the ratings and/or Rating Outlook:
--Fitch's expectation of leverage sustaining above 6.5x;
--Fitch's expectation of fixed-charge coverage sustaining below 2.0x;
--Fitch's expectation of unencumbered assets to net unsecured debt sustaining below 2.5x;
--A sustained liquidity coverage ratio below 1.0x (this ratio is 1.0x for the period April 1, 2016 to Dec. 31, 2017).
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
Lexington Realty Trust
--Long-Term IDR at 'BBB';
--Senior unsecured notes at 'BBB'.
Lepercq Corporate Income Fund L.P.
--Long-Term IDR at 'BBB';
--Senior unsecured notes at 'BBB'.
The Rating Outlook is Stable.
Additional information is available on www.fitchratings.com
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.
--Fitch had adjusted the historical and projected net debt by assuming the issuer requires $10 million of cash for working capital purposes, which is otherwise unavailable to repay debt.
--Fitch has included 50% of the company's cumulative perpetual preferred stock as debt.
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
Dodd-Frank Rating Information Disclosure Form