Fitch Upgrades SL Green's IDR to 'BBB-'; Outlook Stable

NEW YORK--()--Fitch Ratings has upgraded the credit ratings for SL Green Realty Corp. (NYSE: SLG) and its subsidiaries SL Green Operating Partnership, L.P., and Reckson Operating Partnership L.P. as follows:

SL Green Realty Corp.

--Issuer Default Rating (IDR) to 'BBB-' from 'BB+';

--Senior unsecured notes to 'BBB-' from 'BB+' (as co-obligor);

--Perpetual preferred stock to 'BB' from 'BB-'.

SL Green Operating Partnership, L.P.

--IDR to 'BBB-' from 'BB+';

--Unsecured revolving credit facility to 'BBB-' from 'BB+';

--Senior unsecured notes to 'BBB-' from 'BB+';

--Exchangeable senior notes to 'BBB-' from 'BB+';

--Junior subordinated notes to 'BB+' from 'BB'.

Reckson Operating Partnership, L.P.

--IDR to 'BBB-' from 'BB+';

--Senior unsecured notes to 'BBB-' from 'BB+' (as co-obligor for certain issuances);

--Exchangeable senior debentures to 'BBB-' from 'BB+'.

The Rating Outlook has been revised to Stable from Positive.

KEY RATINGS DRIVERS

The upgrades reflect the company's credit strengths, including its high-quality New York office portfolio, manageable lease maturity and debt expiration schedules, growing unencumbered asset pool and the company's improving credit metrics. These positive rating elements are also supported by expectations for further strengthening in SLG's fixed-charge coverage ratio. These positive elements are balanced by concerns regarding the Midtown Manhattan office leasing environment, which remains somewhat dependent on the growth of large financial institutions and supporting industries such as law and accounting firms.

APPROPRIATE LEVERAGE

SLG's leverage ratio is consistent with a 'BBB-' rating for a REIT owning primarily Midtown Manhattan office assets, as the company's leverage ratio (excluding the effects of consolidating 388-390 Greenwich Street) was 7.1x as of June 30, 2014, down from 7.4x and 7.6x as of Dec. 31, 2013 and 2012. Leverage was 8.5x as of June 30, 2014 when including the debt and net operating income (NOI) from 388-390 Greenwich Street. Leverage has been aided by the incremental NOI from repositioning and leasing of assets within the company's growth portfolio, which consists of value-add properties purchased over the past few years. Fitch expects that leverage will decline modestly from current levels due to incremental NOI from the company's redevelopment/growth portfolio. Fitch defines leverage as net debt divided by recurring operating EBITDA, including Fitch's estimate of recurring cash distributions from joint ventures.

APPROPRIATE FIXED-CHARGE COVERAGE

The company's fixed-charge coverage ratio was 2.1x for the 12 months ended June 30, 2014 and Dec. 31, 2013, up from 1.6x in 2012. The improvement in coverage has been driven by the reduction in free rent periods offered to tenants, combined with slightly lower leverage and improved funding costs. Fitch expects coverage to improve slightly as growth in cash flow is partially offset by a slowly recovering Manhattan leasing environment in which landlords will continue to offer attractive tenant improvement packages. Fixed-charge coverage is defined as recurring operating EBITDA - including Fitch's estimate of recurring cash distributions from joint ventures - less recurring capital expenditures and straight-line rents, divided by interest incurred and preferred stock distributions.

STRONG, ALBEIT RELATIVELY CONCENTRATED TENANT BASE

The company's portfolio has a modest degree of tenant concentration, with the top 10 representing 35% of annual base rent. This compares to 32% for the top 20 tenants for Boston Properties, and 23% for Vornado. Despite the concentration, the largest tenant, Citigroup, Inc. (rated 'A' IDR with a Stable Outlook by Fitch) contributes 11.2% of SLG's share of annual cash rent. The top three tenants, and all five of SLG's Fitch-rated top 10 tenants have investment grade ratings.

MANAGEABLE LEASE EXPIRATION PROFILE

The company has a manageable lease expiration schedule with only 25% of consolidated Manhattan rents expiring over the next five years. While approximately 52% of the company's consolidated suburban property rents expire over the next five years, the suburban portfolio represents a limited portion of the company's total assets and only 9% of annualized cash rent.

LADDERED DEBT MATURITIES

Further supporting the ratings is the company's manageable debt maturity schedule. Over the next five years, 2017 is the largest year of debt maturities with 19.9% of pro rata debt expiring, with no other year greater than 14%. The 2017 maturities are primarily made up of $1.1 billion of non-recourse mortgage debt and $355 million of unsecured debt. In addition, the company's ratios under its unsecured credit obligation financial covenants do not hinder the company's financial flexibility at this point in time.

SOLID UNENCUMBERED ASSET COVERAGE OF DEBT

The ratings are further supported by SLG's unencumbered asset value coverage of unsecured debt, which gives the company financial flexibility as a source of contingent liquidity. Consolidated unencumbered asset coverage of net unsecured debt (calculated as annualized second quarter 2014 unencumbered property net operating income divided by a stressed 7% capitalization rate) results in coverage of 2x. This ratio is adequate for the current rating, particularly given that Midtown Manhattan assets are highly sought after by secured lenders and foreign investors, resulting in stronger contingent liquidity relative to most asset classes in other markets. Fitch expects this ratio will improve modestly as the company unencumbers additional assets with relatively high debt yields.

STRONG MANAGEMENT TEAM

The ratings also point to the strength of SLG's management team given their knowledge of the Manhattan office sector, and their ability to maintain occupancy and liquidity throughout the downturn. This expertise has also been demonstrated by the company's ability to identify off-market acquisition opportunities, and its maintenance and growth of portfolio occupancy and balance sheet liquidity throughout the downturn and into the current cycle.

MIDTOWN LEASING CONCERNS

Offsetting these strengths are Fitch's concerns regarding the uncertain Midtown Manhattan leasing environment. While the New York City leasing environment has strengthened over the last few years, the company continues to incur significant costs in the form of tenant improvements, leasing commissions and free-rent incentives as tenant inducements, which has placed pressure on fixed charge coverage. A downturn in space demands from the financial services industry, which accounts for 36% of SLG's share of base rental revenue, may result in reduced cash flows or values of SLG's properties. Further, emerging competitive pressure from the Hudson Yards development and newer and redeveloped downtown assets (i.e. Brookfield Place and World Financial Center assets) could result in larger tenants vacating Midtown. Despite these headwinds, SLG had maintained strong leasing volume.

LIQUIDITY COVERAGE SHORTFALL

The company has weak liquidity under Fitch's base case analysis. For the period July 1, 2014 to Dec. 31, 2016, the company's sources of liquidity (cash, availability under its unsecured revolving credit facility, and Fitch's expectation of retained cash flows from operating activities after dividends and distributions) covered uses of liquidity (pro rata debt maturities, Fitch's expectation of recurring capital expenditures, and non-discretionary development expenditures) by 0.8x. This stressed analysis assumes that no additional capital is raised to repay obligations; SLG has demonstrated good access to a variety of capital sources over time, mitigating refinance risk. Under a scenario where the company refinances 80% of the secured debt it does not intend to repay at maturity, liquidity coverage improves to 1.1x, which would be adequate for the rating.

The company's liquidity is also strengthened by its conservative common dividend policy, which enables it to retain substantial operating cash flow. Fitch expects SLG's projected AFFO payout ratio to center around 45%, which is low relative to the broader equity REIT universe and provides the company with additional financial flexibility, particularly as it will need to fund over $300 million of capital costs related to recently-signed renewal leases for Viacom and Citibank prior to year-end 2016.

RECKSON'S IDR LINKED TO SLG'S

Consistent with Fitch's criteria, 'Parent and Subsidiary Rating Linkage' dated May 28, 2014, and available on 'www.fitchratings.com', Reckson's IDR is linked and synchronized with SLG's due to strong legal, operational and strategic ties between the two, including each entity guaranteeing certain corporate debt of the other.

JUNIOR SUBORDINATED NOTES NOTCHING

The one-notch differential between SLG's IDR and junior subordinated notes (trust preferred securities) is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB-'. Based on Fitch Research on 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis', available on Fitch's Web site at www.fitchratings.com, these securities are senior to SLG's perpetual preferred stock but subordinate to SLG's corporate debt. Holders of such notes have the ability to demand full repayment of principal and interest in the event of unpaid interest.

PREFERRED STOCK NOTCHING

The two-notch differential between SLG's IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB-'. Based on Fitch Research on 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis', also available 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.

STABLE OUTLOOK

The Stable Outlook is driven by Fitch's expectation that SLG will maintain a strategy and leverage and coverage metrics consistent with a 'BBB-' IDR. While these quantitative metrics are nominally weaker than most REIT issuers with investment-grade ratings, it considers that Midtown Manhattan office assets consistently trade at lower capitalization rates and are more liquid and financeable in economic downturns than typical office assets.

RATING SENSITIVITIES

The following may have a positive impact on SLG's Outlook or Ratings:

--Fitch's expectation of leverage sustaining below 7x for several quarters. (leverage was 8.5x as of June 30, 2014 and 7.1x excluding the effects of 388-390 Greenwich Street);

--Fitch's expectation of fixed-charge coverage sustaining above 2.25x for several quarters (coverage was 2.1x for the 12 months ended June 30, 2014);

--Growth in the size of the unencumbered pool.

The following may have a negative impact on SLG's ratings and/or Outlook:

--Fitch's expectation of leverage sustaining above 8.0x for several quarters;

--Fitch's expectation of fixed charge coverage sustaining below 1.5x for several quarters;

--A sustained liquidity shortfall (base-case liquidity coverage was 0.7x for July 1, 2014 to Dec. 31, 2016).

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage' (May 28, 2014);

--'Rating U.S. Equity REITs and REOCs: Sector Credit Factors' (Feb. 26, 2014);

--'Treatment and Notching of Hybrids in Non-financial Corporate and REIT Credit Analysis' (Dec. 23, 2013);

--'Recovery Ratings and Notching Criteria for Equity REITs' (Nov. 19, 2013).

Applicable Criteria and Related Research:

Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=726863

Rating U.S. Equity REITs and REOCs (Sector Credit Factors)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=737957

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Recovery Ratings and Notching Criteria for Equity REITs

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=722363

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=892374

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Contacts

Fitch Ratings
Primary Analyst
Steven Marks
Managing Director
+1 212-908-9161
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Stephen Boyd, CFA
Director
+1 212-908-9153
or
Committee Chairperson
Sean Pattap
Senior Director
+1 212-908-0642
or
Media Relations, New York
Sandro Scenga, +1 212-908-0278
sandro.scenga@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Steven Marks
Managing Director
+1 212-908-9161
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Stephen Boyd, CFA
Director
+1 212-908-9153
or
Committee Chairperson
Sean Pattap
Senior Director
+1 212-908-0642
or
Media Relations, New York
Sandro Scenga, +1 212-908-0278
sandro.scenga@fitchratings.com