Fitch Affirms DDR's IDR at 'BBB-'; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed the credit ratings for DDR Corp. (NYSE:DDR) including the Issuer Default Rating (IDR) at 'BBB-'. The Rating Outlook is Stable. A full list of rating actions follows at the end of this release.

KEY RATING DRIVERS

DDR's 'BBB-' IDR takes into account the company's credit strengths including ongoing improvements in the quality of the company's retail property portfolio and the management team's focus on refining the asset base and simplifying the business. DDR benefits from strong expected fixed-charge coverage for the rating, a granular tenant roster with select quality credit tenants, and proven access to various sources of capital. Fitch anticipates leverage will be toward the stronger end of the range Fitch considers appropriate for the 'BBB-' rating over the next 12 to 24 months.

Credit concerns include recent management turnover and a liquidity coverage ratio of below 1.0x assuming no access to external capital sources and when taking into account the company's development pipeline. In addition, while DDR continues to grow its unencumbered pool, Fitch projects that unencumbered asset coverage of unsecured debt will remain weak for the 'BBB-' rating.

Improving Asset Quality

DDR is executing on its strategic plan, which entails owning and operating market-dominant power centers in select markets with favorable population demographics and thereby generating consistent cash flow, while opportunistically engaging in capital recycling. Portfolio transformation is evidenced by the presence of more market-dominant power centers, with the average property size increasing to approximately 320,000 square feet as of June 30, 2016 compared to approximately 190,000 square feet as of Dec. 31, 2008. In addition, the leased rate improved to 95.7% as of June 30, 2016 from 92.2% in 2008, and average rent per square foot increased to $14.92 in second quarter 2016 (2Q'16) from $12.34 as of Dec. 31, 2008.

DDR, led by its new CEO and interim Chief Financial Officer, initiated changes in its investment strategy by accelerating disposition plans for lower quality assets, and expected sales should result in an improved credit profile. Net proceeds from asset sales will be used primarily towards delevering.

Ongoing Portfolio Review and Simplification

DDR segmented the portfolio by examining market and asset factors. This analysis was predicated on the company's focus on power centers based on the belief that they have greater scale, a larger mix of tenants and serve larger trade areas than grocery-anchored neighborhood shopping centers, which Fitch views favorably. Currently, DDR's portfolio demographics are weaker than those of other U.S. shopping center REITs, as measured by population density and average household income.

Strong Leasing Spreads and Fixed Charge Coverage

Blended leasing spreads on new and renewal leases were 9.1% in 2Q'16 following 9.5% growth in 2015. As of June 30, 2016, 2.8% of leases expire for the remainder of 2016 followed by 12.3% in 2017 and 14.4% in 2018, which should result in the company reporting stronger same store NOI growth as marks below-market leases upwards. Consolidated same-store NOI grew by 3.1% in 2Q'16 and 3.1% in 2015.

Under Fitch's base case whereby the company generates 3% same-store NOI growth in 2016-2018 (due to positive releasing spreads, minor uptick in occupancy and annual bumps), fixed charge coverage would hit the low 3x range in 2018, which would be strong for the 'BBB-' rating. In a stress case not anticipated by Fitch in which same-store NOI declines by levels experienced in 2009 to 2010, fixed-charge coverage would remain in the mid 2x range, which would remain solid for the 'BBB-' rating. DDR's fixed-charge coverage ratio was 2.6x for the trailing 12 months ended June 30, 2016, up from 2.5x for 2015 and 2.4x in 2014. Organic EBITDA growth and re-development EBITDA growth were the primary contributors to the improvement.

Secular Retailer Trends Favor Power Centers

DDR has limited tenant concentration. Major tenants are TJX Companies (3.5% of rental revenues in 2Q'16), Bed Bath & Beyond (3%), PetSmart (2.9%), Walmart (IDR 'AA'/Outlook Stable at 2.4%), and Dick's Sporting Goods (2.3%). The top 20 tenants comprise 36% of 2Q'16 rental revenues, above the peer average. Numerous retailers are exploring larger footprints, which should bolster power center demand. Value/convenience retailers continue to grow, while non-traditional grocers have gained the market share of traditional retailers, which bodes well for DDR's tenants such as Walmart.

Proven Access to Capital

DDR is a seasoned issuer of multiple sources of capital. Since 2006, the company has issued approximately $4.4 billion of bonds, $350 million of preferred stock, and approximately $4.3 billion of equity via follow-on common offerings and at-the-market program issuance at a weighted average premium to consensus mean net asset value of 3.4% according to SNL Financial. In April 2015, DDR recast its primary $750 million unsecured revolving credit facility, extending the final maturity date to June 2020, including options, and reducing the pricing on the facility by 15 basis points to LIBOR plus 100 basis points. The company also recast its smaller credit facility to $50 million from $65 million under the same pricing terms and entered into a $400 million unsecured term loan, with pricing currently set at LIBOR plus 110 basis points.

Leverage Appropriate for 'BBB-'

Fitch projects that leverage, when excluding the effects of preferred stock, will be in the mid-6.5x range over the next 12 to 24 months, principally due to asset sales and organic EBITDA growth, which would be at the stronger end of the range for the 'BBB-' rating. Leverage was 6.7x in 2Q16 (6.8x for the TTM ended June 30, 2016), down from 7.2x in 2015 and 7.6x in 2014. When including 50% of preferred stock in total debt, DDR's leverage was 6.9x for the quarter and 7.1x for the TTM ended June 30, 2016.

2017 to 2018 Debt Maturities & Development Negatively Impact Liquidity

Liquidity coverage is weak at 0.5x for the period July 1, 2016 to Dec. 31, 2018. The liquidity coverage ratio is weighed down by 2017 and 2018 pro rata debt maturities, which total 14.6% and 13.9% of total pro rata debt, respectively. Fitch defines liquidity coverage as sources divided by uses. Liquidity sources include readily available cash; availability under the company's unsecured revolving credit facilities and projected retained cash flows from operating activities. Liquidity uses include pro rata debt maturities, projected recurring capital expenditures and cost to complete development through 2018.

The company's AFFO payout ratio was 63.3% in 2Q'16, down from 65.3% in 2015 and up from 60.2% in 2014. Based on the current payout ratio, the company retains approximately $120 million annually in internally generated liquidity.

Cost-to-complete development represented 2% of undepreciated assets as of June 30, 2016, down from 2.3% as of year-end 2015 and well below the 3.5% level as of year-end 2007. Overall, redevelopment should improve asset quality and cash flow growth as DDR generally targets unlevered cash on cost in excess of 10%.

Low Unencumbered Asset Coverage

As of June 30, 2016, DDR's unencumbered assets (defined as unencumbered NOI divided by a stressed 8% capitalization rate) covered net unsecured debt by 1.7x, which is low for the 'BBB-' rating. Unencumbered asset coverage has trended around 1.6x-1.8x over the past several years. DDR continues to add quality assets to the unencumbered pool and the quality of the unencumbered pool is similar to that of the encumbered pool.

Management Turnover a Concern

In July 2016, David Oakes was terminated as CEO of DDR Corp. DDR Board member Thomas August was named President and Chief Executive Officer, making him the fourth CEO since 2009. While Fitch acknowledges Mr. August's extensive REIT experience, he has no prior experience running a retail REIT. Christa Vesy, DDR's current CAO, was named interim CFO, but the search for a permanent CFO continues. Additionally, the company is searching for a permanent Chief Investment Officer. Should management be unable to execute on strategy, it could result in negative rating momentum.

Preferred Stock Notching

The two-notch differential between DDR's IDR and its preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB-'. Based on Fitch's criteria report, 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis,' dated Feb. 29, 2016, the company's preferred stock is deeply subordinated and has loss absorption elements that would likely result in poor recoveries in the event of a corporate default.

KEY ASSUMPTIONS

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

--3% same-store NOI growth in 2016-2018;

--G&A to decline slightly relative to total revenues as the company endeavors to focus on fewer larger assets via expected asset sales;

--$800 million of dispositions in 2016 and $670 million in 2017, followed by $100 million total in 2018. Net proceeds from asset sales will be used primarily towards delevering;

--$225 million of acquisitions and development each year from 2016-2018;

--Debt repayment with the issuance of new unsecured bonds;

--Recurring capex divided by recurring operating EBITDA in the 7% to 8% range;

--Fitch assumes no equity issuance in our rating case. Equity issuance is at management's discretion, and DDR's common shares are currently trading at an 8.2% discount to consensus mean net asset value according to SNL Financial.

RATING SENSITIVITIES

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

--Fitch's expectation of leverage sustaining below 6.5x is the primary factor for positive momentum on the ratings and/or Outlook (June 30, 2016 TTM leverage was 6.8x);

--Fitch's expectation of growth in the size and quality of the unencumbered pool with unencumbered assets (unencumbered NOI divided by a stressed capitalization rate of 8%) covering net unsecured debt by 2.5x (this metric is 1.7x as of June 30, 2016);

--Fitch's expectation of fixed-charge coverage sustaining above 2.3x is a less meaningful ratings sensitivity for positive momentum as it is less consistent through interest rate cycles (TTM fixed-charge coverage is 2.6x).

The following factors may result in negative momentum in the ratings and/or Rating Outlook:

--Fitch's expectation of leverage sustaining above 7.5x;

--Fitch's expectation of fixed-charge coverage sustaining below 2.0x;

--Base-case liquidity coverage sustaining below 1.0x (this ratio is 0.5x for July 1, 2016 to Dec. 31, 2018);

--Unencumbered assets to net unsecured debt sustaining below 2.0x;

--Continued management turnover, which reduces market confidence on the company's ability to execute on strategy.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings:

DDR Corp.

--IDR at 'BBB-';

--Unsecured revolving credit facilities at 'BBB-';

--Unsecured term loan at 'BBB-';

--Senior unsecured notes at 'BBB-';

--Senior unsecured convertible notes at 'BBB-';

--Preferred stock at 'BB'.

The Rating Outlook is Stable.

Summary of Financial Statement Adjustments - Financial statement adjustments that depart material 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.

--Recurring joint venture distributions are added to EBITDA to calculate leverage and fixed-charge coverage.

--Fitch adjusted the historical and projected net debt by assuming the issuer requires $15 million of cash for working capital purposes, which is otherwise unavailable to repay debt.

Additional information is available on www.fitchratings.com

Applicable Criteria

Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)

https://www.fitchratings.com/site/re/885629

Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 05 Apr 2016)

https://www.fitchratings.com/site/re/879564

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1012821

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Contacts

Fitch Ratings
Primary Analyst
Daniel Kornblau
Associate Director
+1-646-582-4946
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Steven Marks
Managing Director
+1-212-908-9161
or
Committee Chairperson
Stephen Boyd
Senior Director
+1-212-908-9153
or
Media Relations
Sandro Scenga, +1 212-908-0278
sandro.scenga@fitchratings.com