NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned first-time ratings to VEREIT, Inc. (NYSE: VER) including an Issuer Default Rating (IDR) of 'BBB-'. The Rating Outlook is Stable. A full list of ratings follows at the end of the release.
KEY RATING DRIVERS
VER's ratings are based on the company's improving credit metrics, strong management team, well diversified portfolio of predominantly single-tenant, net leased assets that generate consistent cash flow growth, and good recent and expected access to capital. Fitch expects asset quality to improve over the next several years as a result of VER's capital repositioning strategy of disposing of select non-core single tenant assets, and culling non-controlled joint ventures, as well as assets with underlying flat leases.
These strengths are balanced by potential negative implications of ongoing litigation against the company, the extent and timeline of which are uncertain. Negative momentum for the ratings and/or Outlook could result if Fitch expects leverage to exceed 7.0x, which could be driven by a debt-funded settlement, deterioration in property-level fundamentals, changes in capital allocation strategies, or a combination thereof.
IMPROVING CREDIT PROFILE BEFORE POTENTIAL SETTLEMENT PAYOUTS
Since mid-2015 VER has focused on deleveraging and maintaining strong fixed charge coverage as part of management's push towards improving the company's credit profile. VER has reduced leverage to 5.5x for the annualized quarter ended Sept. 30, 2016 from 7.9x for the year ended Dec. 31, 2014. Additionally, fixed charge coverage (FCC) has improved to 2.8x for the year ended Sept. 30, 2016 from 2.3x for the year ended Dec. 31, 2014. When including 50% of the company's preferred stock as debt, leverage increases by approximately 0.4x, which remains strong for the 'BBB-' rating.
Fitch expects leverage and FCC to center at about 6x and 3x, respectively, during our forecast horizon. The role of asset sales, as well as equity issuances and accessing low-cost debt, play key roles in driving Fitch's assumptions.
As of Sept. 30, 2016 VER owned a diversified portfolio across 49 states, as well as Puerto Rico and Canada comprised of 4,213 retail, restaurant, office and industrial real estate properties with an aggregate of 96.9 million square feet. The portfolio was 98% leased, the vast majority under triple-net leases to single tenants. VER's largest market, Chicago, represents 5.7% of annual base rents, followed by Dallas (4.7%) and Houston (2.6%). The portfolio is well diversified across over 700 different tenants and many industry classifications, and key tenant risk is moderate with the largest tenant (Red Lobster) accounting for 8.6% of revenues at Sept. 30, 2016.
The company's portfolio generates predictable cash flows, absent tenant bankruptcies and lease rejections, as evidenced by annual rent bumps of 1% to 2% over a 10- to 20-year lease term at the onset and consistent occupancy. From 2011 to 2016, occupancy did not fall below 97% and stood at 98% as of Sept. 30, 2016. VER's weighted average remaining lease term is in line with the net lease peer average at 10.0 years. Fitch expects this may increase slightly as the company completes its asset repositioning plans.
ADEQUATE LIQUIDITY BEFORE POTENTIAL SETTLEMENT PAYOUTS
Fitch calculates that VER's liquidity coverage ratio is 1.8x for the period Oct. 1, 2016 to Dec. 31, 2018. Fitch defines liquidity coverage as sources of liquidity (unrestricted cash, availability under the unsecured revolving credit facility, expected retained cash flows from operating activities after dividend payments) divided by uses of liquidity (debt maturities, development expenditures and capital expenditures).
VER maintains a conservative payout ratio, paying out 67.2% of its adjusted funds from operations (AFFO) in dividends in 3Q16, compared with 71.1% in the previous quarter and 65.4% in 2015. Fitch expects the company's payout ratio will sustain in the mid to high 60% range on a long-term basis, a credit positive allowing for internally generated liquidity.
GOOD UNENCUMBERED ASSET COVERAGE
As of Sept. 30, 2016, VER's unencumbered assets (defined as unencumbered NOI divided by a stressed 9% capitalization rate) covered net unsecured debt by 2.3x, which is good for the 'BBB-' rating. Unencumbered asset coverage has improved from 1.1x in 1Q'14.
CAPITAL REPOSITIONING IMPROVES ASSET QUALITY
After joining VER as CEO in 2015, Glenn Rufrano implemented a portfolio enhancement strategy focused on culling the portfolio of non-core and lower growth assets, and reducing exposure to restaurant, office and non-controlled joint ventures. The first stage initially called for dispositions of $1.8 to 2.2 billion by the end of 2016, but has subsequently been raised to $2.2 to $2.4 billion. The company has since disposed of over $2 billion in assets, reducing Red Lobster tenant concentration to 8.6% of revenues in 3Q16 from 11.9% in 2Q15 and office exposure to 23% of revenue, close to VER's target of 15 to 20%. The continued targeted reduction of office assets will make the portfolio less capital intensive over time, which Fitch views positively. Fitch expects the company to acquire select retail and industrial assets in 2017 and 2018, as the next phase of repositioning.
ONGOING LITIGATION REPRESENTS THE LARGEST DOWNSIDE RISK
VER is currently subject to government investigations and litigation relating to overstatements of AFFO in certain of its 2014 financial statements. Fitch has made no assumption regarding the timing, course of litigation or potential settlement amounts. The company could preserve or increase liquidity ahead of any potential payout, given the duration of legal matters.
PREFERRED STOCK NOTCHING
The two-notch differential between VEREIT'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.
The Stable Outlook reflects Fitch's expectation that VER will operate within its targeted leverage metric of 6.0 to 6.5x through the rating horizon and the company will have sufficient liquidity and access to capital to address a litigation payout while maintaining investment grade, albeit weaker, metrics and any potential tenant credit issues.
Fitch's key assumptions within the rating case for VER include:
--Annual same-store NOI growth of 1.5% in 2016-2018. These increases reflect contractual rent escalations;
--$1 billion, $600 million and $1 billion of unsecured bond issuances in 2016, 2017 and 2018, respectively;
--Equity issuances of $700 million and $250 million in 2016 and 2018, respectively;
--Acquisitions of $20 million, $1.5 billion and $1.5 billion in 2016, 2017 and 2018, respectively;
--Divestments of $900 million, $1 billion and $500 million in 2016, 2017 and 2018, respectively.
Fitch does not expect any positive near-term momentum for the ratings and/or Outlook given the current litigation risk overhang. In the absence of such overhang, Fitch would consider the following as potential positive rating and/or Outlook drivers:
--Fitch's expectation of leverage sustaining below 6.0x (leverage was at 5.5x at Sept. 30, 2016);
--Fitch's expectation of FCC sustaining above 3.5x (FCC was 2.8x for the LTM ended Sept. 30, 2016);
--Fitch's expectation of a 2.5x UA/UD ratio at a 9% stressed cap rate (UA/UD was 2.3x as of Sept. 30, 2016).
The following factors could result in negative momentum on the ratings and/or Outlook:
--Fitch's expectation of leverage sustaining above 7.0x.
--Fitch's expectation of FCC sustaining below 2.5x;
--Fitch's expectation of a liquidity shortfall;
--A significant debt-funded litigation settlement that places pressure on liquidity and/or leverage.
FULL LIST OF RATING ACTIONS
Fitch has assigned the following ratings:
--Preferred stock 'BB'.
VEREIT Operating Partnership, L.P.:
--Unsecured revolving credit facility 'BBB-';
--Senior unsecured term loan 'BBB-';
--Senior unsecured notes 'BBB-';
--Senior unsecured convertible notes '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;
--Recurring JV 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 $20 million of cash for working capital purposes, which is otherwise unavailable to repay debt.
--Fitch also calculates select leverage metrics to include 50% debt for preferred stock.
Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
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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