NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the following credit ratings of Healthcare Realty Trust (Healthcare Realty; NYSE: HR):
--Issuer Default Rating (IDR) at 'BBB-';
--Unsecured revolving credit facility at 'BBB-';
--Senior unsecured notes at 'BBB-'.
The Rating Outlook is Stable.
The affirmation reflects the company's geographically diversified portfolio, positive medical office fundamentals, stable operating cash flows, solid liquidity and manageable debt maturity schedule. The rating is balanced by a focus on shorter-term leases, the slow lease-up of properties in stabilization, an inclination to fund acquisitions and development with debt, and an elevated adjusted funds from operations (AFFO) payout ratio. The Stable Outlook is based on Fitch's expectation that metrics (i.e. leverage, fixed-charge coverage and unencumbered asset coverage of unsecured debt) will remain consistent with a 'BBB-' rating.
The lease-up of assets in stabilization has been slower than Fitch's expectations and serves as a drag on EBITDA. The $379.4 million of assets in stabilization were just 51% leased and 33% occupied as of June 30, 2012. Once fully leased these assets could generate $25 million-$30 million of incremental net operating income. Fitch projects that the properties will not be fully leased until 2014.
Fitch views Healthcare Realty's elevated AFFO payout ratio as a credit concern, as the company consistently pays out more than 100% of AFFO as dividends. The earnings drag from the slow lease-up of properties in stabilization drives this high payout ratio which limits Healthcare Realty's ability to generate internal liquidity. In turn, Healthcare Realty needs to draw on its credit facility or source other forms of liquidity to fund a portion of the common dividend. An AFFO payout ratio in excess of 100% is inconsistent with an investment-grade rating and could have negative rating implications.
Fitch projects that fixed-charge coverage will surpass 2.0x in 2014 as properties in stabilization are leased up and contribute to EBITDA. Additionally, Fitch projects that leverage will rise above 7.0x as new developments and acquisitions are funded with debt. Notwithstanding overall improvements in recurring EBITDA, Fitch projects that the AFFO payout ratio will remain above 100%, which is a credit concern.
The company's portfolio of predominantly on-campus, medical office buildings (MOBs) is geographically diversified. On a square footage basis, 29.8% of the company's properties were in Texas, followed by Tennessee (9.9%), Virginia (7.6%), North Carolina (5.5%) and Florida (5.2%) as of June 30, 2012. No other state exceeded 5% of the total portfolio, giving Healthcare Realty broad exposure to demand for health care real estate. Healthcare Realty's portfolio positions the company to benefit from increasing demand for healthcare services, given Fitch's expectation of continued growth in the healthcare industry due to demographic trends.
Fixed-charge coverage was 1.7x for the 12 months ended June 30, 2012, compared with 1.6x and 1.5x during 2011 and 2010, respectively. This metric is slightly low for the 'BBB-' IDR. Fitch defines fixed-charge coverage as recurring operating EBITDA less Fitch's estimate of routine capital expenditures less straight-line rent adjustments, divided by total interest incurred.
Net debt to recurring operating EBITDA, pro forma for the recent $201.1 million equity offering, was low for the rating at 6.7x as of June 30, 2012. Leverage was 8.4x and 8.7x as of Dec. 31, 2011 and Dec. 31, 2010, respectively.
Pro forma unencumbered asset coverage of unsecured debt was 1.6x as of June 30, 2012, which is slightly low for the rating. Fitch calculates asset coverage as unencumbered LTM EBITDA as of second quarter 2012 (2Q'12), divided by a stressed 9% capitalization rate, divided by unsecured debt.
Healthcare Realty's liquidity coverage ratio is 1.4x for the period July 1, 2012 to Dec. 31, 2014, pro forma, which is strong for the rating. Fitch calculates liquidity coverage as sources of liquidity (unrestricted cash, availability under its unsecured revolving credit facility, projected retained cash flows from operating activities after dividend payments) divided by uses of liquidity (debt maturities, projected routine capital expenditures and development and construction mortgage funding commitments). Additionally, the company's debt maturities are manageable with the first meaningful maturities of $271.7 million occurring in 2014, representing 19.5% of total debt. Maturities tend to be lumpy due to the company's smaller size and the desire to keep bond issuance above $250 million for index inclusion. The bulk of remaining maturities occur in 2016 and beyond.
Portfolio occupancy has declined to 87% as of 2Q'12, from 91% at 2Q'09. Expiring master leases have been converted to operating leases with the underlying tenants, driving a near-term reduction in occupancy as the company becomes responsible for leasing up the vacancy in those properties. The company also faces significant lease expirations over the next few years, as 16.3% and 17.5% of total revenues mature in 2013 and 2014, respectively, before declining to 10.5% in 2015. The lease maturity schedule is driven by management's focus on shorter-term leases (generally five years), seeking to benefit from increasing market MOB lease rates. While the strategy is currently generating positive results as rental rates continue to trend higher and renewal rates remain high, an unexpected decline in demand or rental rates would negatively impact HR's portfolio on an absolute basis - relatively more than its peers whose portfolios have longer average lease terms.
The company has demonstrated an inclination to fund acquisitions and development initially with debt, prior to deleveraging over time through equity issuances and/or the lease-up of development properties. Despite recent investments being funded primarily with equity, a portion of the current properties in stabilization were funded primarily with debt and Fitch projects that future investments may be funded initially with debt. This strategy increases risk, as the capital markets may be expensive or difficult to access when needed or fundamentals may be challenging when development properties need to be leased-up. As such, leverage may remain high and coverage may remain low for extended periods.
The Stable Outlook centers on the expectation that solid fundamentals in the medical office sector will contribute to improving leverage and coverage metrics.
The following factors may have a positive impact on Healthcare Realty's ratings and/or Outlook:
--Fitch's expectation of leverage sustaining below 7.0x (as of June 30, 2012 pro forma leverage was 6.7x on a trailing 12-month (TTM) basis);
--Fitch's expectation of fixed-charge coverage sustaining above 2.0x (TTM ended June 30, 2012, coverage was 1.7x);
--Fitch's expectation of unencumbered asset coverage of unsecured debt sustaining above 2.0x (as of June 30, 2012 this ratio was 1.6x pro forma).
The following factors may have a negative impact on Healthcare Realty's ratings and/or Outlook:
--Leverage sustaining above 8.0x;
--Fixed-charge coverage sustaining below 1.5x;
--Unencumbered asset coverage of unsecured debt sustaining below 1.5x);
--An AFFO payout ratio sustaining above 100%.
Additional information is available at 'www.fitchratings.com'. The ratings above were unsolicited and have been provided by Fitch as a service to investors.
Applicable Criteria and Related Research:
--Corporate Rating Methodology, August 8, 2012.
--Recovery Rating and Notching Criteria for Equity REITs, May 3, 2012.
--Criteria for Rating U.S. Equity REITs and REOCs, Feb. 27, 2012.
Applicable Criteria and Related Research:
Criteria for Rating U.S. Equity REITs and REOCs
Recovery Ratings and Notching Criteria for Equity REITs