NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the ratings for Federal Realty Investment Trust (NYSE: FRT), including the Long-Term Issuer Default Rating (IDR) at 'A-'. A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS
The consistent and steady cash flow growth provided by Federal's high-quality, well-located community shopping centers underpins Fitch's ratings and Outlook, together with the company's track record of prudent balance sheet management and creative redevelopment and mixed-use development.
The potential for near-term weakness in Federal's Washington, D.C. portfolio (approximately 31% of annualized base rent [ABR]) and some remaining execution risk and leasing related to its mixed-use developments under construction balance these credit positives.
Fitch views positively Federal's buy-and-hold strategy, which targets premier retail properties in supply-constrained markets with above average demographics. This strategy, augmented by the company's redevelopment activities, has enabled Federal to produce consistently robust operating performance, which has historically been stronger and more stable through the cycle than the retail real estate market generally, and its public shopping center REIT peers specifically.
Consistent and Superior Growth
Federal's property management expertise of its 96 properties comprising 22.3 million square feet as of June 30, 2016 is evidenced by consistently positive same store net operating income (SSNOI) growth, excluding redevelopments, through multiple cycles. Within the last 10 years, the lone exception was 2009 when SSNOI declined 0.3%. This compares to the average decline of 4.6% in 2009 amongst its public shopping center REIT peers.
When including NOI from redevelopment properties, Federal's SSNOI growth has not declined below 1.6% in any year over the last decade, resulting in year-over-year recurring operating EBITDA growth significantly stronger than its peers.
Federal's consistently strong rent growth on expiring leases largely reflects the high quality infill locations of its properties. Federal's releasing spreads have been higher than peers during this economic and commercial real estate recovery, and Fitch expects the company to continue to outperform its peers and the market broadly. Moreover, the company was unique among shopping center REITs in its ability to maintain positive leasing spreads throughout the economic downturn.
Fitch expects Federal's leverage to sustain in the mid 5x range, throughout the ratings horizon as the company's larger developments come online and begin to contribute to portfolio cash flows during the next two to three years. Leverage was 5.3x for the trailing-12-months (TTM) ending June 30, 2016 compared to 5.4x and 5.2x in 2015 and 2014, respectively. Federal has historically managed leverage at conservative levels, ranging between the mid-4x and mid-5x during the last 10 years.
Strong Fixed-Charge Coverage
Fitch expects fixed-charge coverage to improve modestly and remain in the low 4.0x range through 2018-end, which is strong for the rating. Federal's fixed-charge coverage was 4.1x for the TTM ending June 30, 2016 compared to 3.9x in 2015 and 3.5x in 2014.
Strong Contingent Liquidity
Federal's sizeable unencumbered asset pool provides additional protection to unsecured debt holders. As of June 30, 2016, 89% of the company's property EBITDA was unencumbered. Fitch calculates the company's unencumbered asset value coverage of unsecured debt (UA/UD) was 3.3x at June 30, 2016, based on applying a stressed 7% capitalization rate to the second quarter 2016 (2Q'16) unencumbered NOI.
Fitch's ratings for Federal incorporate the high quality of its unencumbered asset pool, which includes the company's three largest (by ABR) and most valuable properties: Santana Row (San Jose, CA), Bethesda Row (Bethesda, MD) and Assembly Row/Assembly Square Marketplace (Somerville, MA), which together comprise 14% of ABR.
Granular Tenant Base
High tenant credit quality and granularity within Federal's portfolio help mitigate tenant bankruptcy risk. Only one tenant (grocer Ahold USA, Inc.; 'BBB' IDR) represents more than 3% of ABR, and the top 25 tenants represent a relatively low 29.8% of total ABR as of June 30, 2016.
The company maintains well laddered lease expirations by year with average annual lease expirations of 8.7% of ABR between 2016 and 2025 and a maximum of 12.6% of ABR expiring in a single year (excluding tenant lease extension options).
Adequate Liquidity Coverage; But Development A Factor
Fitch's base case analysis shows liquidity coverage, pro forma for the July 2016 unsecured bond offering, of 1.6x through the end of 2018. However, liquidity coverage declines to 0.8x when incorporating the cost to complete the development pipeline, which is weak for the rating. Development exposure, measured by cost-to-complete divided by total undepreciated assets, was 7.2% as of June 30, 2016, well above 'A'-rated peers' average of approximately 3.0%.
Federal's demonstrated access to multiple forms of capital offsets its refinancing and development funding risk. In addition, Federal's retained operating cash flow after dividend payments provides approximately $75 million of internally generated capital annually that can be used to fund investment activity and/or satisfy its financing obligations. Fitch calculates that the company's dividends represented 79.6% adjusted funds from operations during the LTM period ending June 30, 2016, in-line with the broader equity REIT median payout.
Fitch defines liquidity coverage as sources of liquidity (unrestricted cash, availability under the company's unsecured revolving credit facility pro forma for the recent commitment size increase, projected retained cash flows from operating activities after dividends and distributions) divided by uses of liquidity (pro rata debt maturities and projected recurring capital expenditures) for July 1, 2016 to Dec. 31, 2018.
The portfolio's moderate asset and market concentrations and continued industry-wide weakness among select retailer tenants -- primarily local small-shop tenants -- are moderate credit concerns. Also, Federal generates approximately 31% of its ABR from the D.C. Metro market where commercial real estate market conditions weakened due to cutbacks in U.S. government spending, but more recently have recently stabilized. The company may also face near-term headwinds at Santana Row due to new supply pressures.
Preferred Stock Notching
The two-notch differential between Federal's IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'A-'. Based on Fitch research titled 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis', available on Fitch's web site at 'www.fitchratings.com', these preferred securities are deeply subordinated and have loss absorption elements that would likely result in poor recoveries in the event of a corporate default.
The Stable Outlook centers on Fitch's expectation that Federal's credit profile will remain appropriate for the 'A-' rating through economic cycles, barring any significant changes in the company's capital structure. The Stable Outlook reflects the high quality of management and consistency of cash flows resulting in stable credit metrics, in line with an 'A-' rating. Further, Federal continues to access various sources of capital and maintains a solid unencumbered asset base and liquidity profile.
Fitch's key assumptions within Fitch's rating case for the issuer include:
--GAAP SSNOI will grow by approximately 3% per year through 2018, primarily due to strongly positive leasing spreads.
--Acquisitions of $380 million combined 2016 - 2018.
--No dispositions 2016 - 2018.
--Annual development and redevelopment capex of $300 million in 2016, $250 million in 2017 and $250 million in 2018.
--Maintenance capex spending of $55 - $65 million per annum for tenant improvements, leasing costs and maintenance capex in 2016 - 2018.
--Federal issues $250 million and $300 million of senior unsecured notes in 2017 and 2018, respectively, each at rates of 3.75%.
--Federal issues $245 million, $50 million and $50 million of equity during 2016, 2017 and 2018, respectively.
While Fitch does not expect near-term positive momentum on the rating, the following factors may have a positive impact on Federal's ratings and/or Outlook:
--Fitch's expectation of leverage sustaining below 4.5x (leverage was 5.3x at June 30, 2016);
--Fitch's expectation of fixed charge coverage sustaining above 3.5x (coverage was 4.1x at June 30, 2016);
--Reduction in development exposure to a level more consistent with 'A'-rated peers;
--Greater asset diversification of the portfolio via growth (Federal's three largest assets generate roughly 14% of total ABR).
The following factors may result in negative momentum on the rating and/or Outlook:
--Shift in management strategy away from owning and redeveloping retail assets in infill locations;
--Unencumbered asset coverage of unsecured debt below 2.5x (coverage was 3.3x at June 30, 2016 utilizing a stressed 7% capitalization rate);
--Fitch's expectation of leverage above 5.5x;
--Fitch's expectation of fixed charge coverage sustaining below 2.5x.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
--Long-Term Issuer Default Rating (IDR) at 'A-';
--Unsecured revolving credit facility at 'A-';
--Senior unsecured term loan at 'A-';
--Senior unsecured notes at 'A-';
--Redeemable preferred shares at 'BBB'.
The Rating Outlook is Stable.
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;
--50% of cumulative perpetual preferred stock is included as debt to calculate leverage ratios.
Additional information is available on www.fitchratings.com.
Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
Recovery Ratings and Notching Criteria for Equity REITs (pub. 03 Dec 2015)
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis (pub. 29 Feb 2016)
Dodd-Frank Rating Information Disclosure Form
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