NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a credit rating of 'BBB' to the GBP500 million 4.50% senior notes due December 2034 issued by Health Care REIT, Inc. (NYSE: HCN or the company). The notes were priced at 98.843% of their face amount to yield 4.538% to maturity, or 190 basis points over the benchmark rate. The company intends to use the net proceeds from the offering to repay advances under its primary unsecured credit facility, if any, and for general corporate purposes, including investing in health care and seniors housing properties.
Fitch anticipates that the company will utilize a portion of the 2034 notes to fund HCN's acquisition of HealthLease Properties Real Estate Investment Trust (TSX: HLP.UN) for $950 million at an initial 7% cash yield announced in August 2014. Also in August, HCN entered into a partnership with Mainstreet Property Group, HealthLease's external manager, by which HCN will acquire a pipeline of healthcare communities for approximately $369 million, representing a 7.5% initial cash yield. HCN also entered into an agreement with Mainstreet to provide mezzanine financing for an additional 45 developments, representing a $1 billion acquisition pipeline at a 7.7% initial cash yield, which is anticipated to close through the beginning of 2016.
KEY RATING DRIVERS
The 'BBB' Issuer Default Rating (IDR) reflects HCN's broad healthcare real estate platform, which generates largely predictable cash flow principally from private pay sources in markets with strong demographics. The company has strong projected fixed charge coverage and low leverage for a 'BBB' rated healthcare REIT. HCN also has strong access to capital and a solid liquidity position, including contingent liquidity from unencumbered assets, and a strong management team. Credit concerns center on operational volatility associated with the company's REIT Investment Diversification and Empowerment Act of 2007 (RIDEA)-structured investments, modest operator concentration, an elevated albeit declining adjusted funds from operations payout ratio and event risk related to the company's international expansion.
Stable Cash Flow
HCN's portfolio largely features long-term leases that create a recurring stream of cash flows to service fixed charges. Approximately 27% of third quarter 2014 (3Q'14) net operating income (NOI) was derived from triple-net seniors housing, 18% from skilled nursing/post-acute assets, 15% from medical office buildings, and 3% from hospitals and life science collectively. Further, the company's leases have structural protections including parent guarantees, letters of credit/security deposits, and master leases/cross-collateralization agreements, which limit operators' ability to selectively renew leases for better performing assets.
Strong Portfolio Demographics
The company's RIDEA structured investments (33% of NOI) are supported by favorable demographics in HCN's markets with household incomes and home values that are 63% and 31% above the broader United States, respectively. These favorable qualities may mitigate inherent volatility in the RIDEA portfolio and have led to strong quarterly same store net operating income (SSNOI) growth for seniors housing operating assets of 7.6% in 3Q'14, 7.7% in 2Q'14 and 8.1% in 1Q'14, following 7.4% and 8.3% average quarterly growth in 2013 and 2012, respectively.
Modest Government Reimbursement Risk
HCN has a favorable payor mix with private pay sources representing 87% of 3Q'14 revenues. As a result, Fitch does not expect that rules by the Centers for Medicare and Medicaid Services (CMS) for fiscal year 2015 will have a material impact on the company's cash flow. In August 2014, CMS published its final rule for the Prospective Payment System for skilled nursing facilities for fiscal year 2015, increasing the payment rate by 2%. CMS also increased the payment rate for inpatient rehabilitation facilities for fiscal year 2015 by 2.2%. CMS estimates that the Medicare payment rate will increase by 0.9% for long term care hospitals in fiscal year 2015. CMS also finalized a number of changes to comply with the Health Reform Laws.
Strong SSNOI Growth Expected to Decelerate in 2015
SSNOI growth has been solid overall, growing 4.3% in 3Q'14, 4.4% in both 2Q'14 and 1Q'14 following 3.5% and 4.0% average quarterly growth in 2013 and 2012, respectively. Fitch expects that SSNOI growth will moderate in 2015-2016 to the low-single digits, driven by deceleration in RIDEA-driven growth to approximately 3%-4%.
Strong Credit Metrics for 'BBB'
Leverage of 5.6x at Sept. 30, 2014 pro forma for the bond offering and HealthLease transaction announced in August 2014 (pro forma) is low for the rating, up slightly from 5.3x for the trailing 12 months (TTM) ended Sept. 30, 2014 but down from 6.7x in 2013 and 6.1x in 2012. The company's $1.1 billion common stock offering in September 2014 along with EBITDA growth drove the decline in leverage. Fitch defines leverage as total debt less readily available cash divided by recurring operating EBITDA including recurring cash distributions from unconsolidated entities.
Fixed charge coverage was 3.2x for 3Q'14 pro forma, up from 2.9x for the TTM ended Sept. 30, 2014, 2.7x in 2013 and 2.4x in 2012. Fitch expects that HCN's fixed charge coverage will remain around this level over the next 12-24 months, as accretive growth from acquisitions and developments is mitigated by increasing capital expenditures and higher interest expense related to debt incurrence from the 2034 notes. Fitch defines fixed-charge coverage as recurring operating EBITDA, less recurring capital expenditures and straight-line rent adjustments, divided by total interest incurred and preferred dividends. These metrics are strong for the 'BBB' rating.
Strong Access to Capital
HCN raised approximately $2.2 billion of common stock for 2014 year-to-date, after issuing $1.9 billion in common stock and $1.8 billion in senior unsecured notes during 2013. In July 2014, HCN closed on a new unsecured credit facility that includes a $2.5 billion revolving credit line, a $500 million term loan and a $250 million Canadian denominated term loan. The applicable margin on the revolver was 1.05% at Sept. 30, 2014 (compared to 1.175% previously) and on the term loans was 1.15% at Sept. 30, 2014 (compared to 1.35% previously).
Robust Financial Flexibility
HCN's liquidity position pro forma for the 2034 notes and HealthLease transaction is adequate, with total sources of liquidity covering uses by 1.2x for the period Oct. 1, 2014 to Dec. 31, 2016. Sources of liquidity include unrestricted cash, availability under the unsecured revolving credit facility, and projected retained cash flow from operating activities after dividends. Uses of liquidity include pro rata debt maturities, recurring capital expenditures, and remaining development costs. HCN also has strong contingent liquidity with unencumbered assets (3Q'14 annualized unencumbered NOI pro forma divided by a stressed 8.5% capitalization) coverage of net unsecured debt of 2.3x.
Elevated AFFO Payout Ratio
Health Care REIT paid out 91.1% of adjusted funds from operations (AFFO) in 2013, 95.2% in 2012 and 94.5% in 2011, indicating moderate internally generated liquidity. However, the AFFO payout ratio declined to 87.3% for the TTM ended Sept. 30, 2014, lower but still elevated. Based on the current payout ratio, the company retains approximately $145 million in organic liquidity annually.
Modest Tenant Concentration
As of Sept. 30, 2014, Sunrise Senior Living was the company's largest tenant at 18.5% of invested capital, with the five largest tenants representing 44.2%. This concentration is high relative to other asset classes but strong relative to peers Ventas, Inc. ('BBB+'/Outlook Stable) and HCP, Inc. ('BBB+'/Outlook Stable), whose five largest tenants comprise 61.8% and 59.4%, respectively. The concentration is also mitigated by the solid performance of these tenants, which operate in well-diversified, attractive high-barrier-to-entry markets, and with cross-collateralized lease structures.
International Expansion Presents Event Risk
HCN has accelerated its growth in Canada and the United Kingdom via various acquisitions over the past several years, highlighted by relationships with Revera, Chartwell Retirement Residences and Sunrise Senior Living. Canada and United Kingdom comprised 5.5% and 6.8% of 3Q'14 NOI, respectively. The cash flow diversification and favorable demographics underlying the transactions are credit positives. However, event risk arises from future uncertainties related to regulatory and entitlement risk in these markets. Fitch expects that the company will continue to grow in Canada and the U.K. and potentially enter new markets over the next 12-24 months, which further exacerbates these risks. Nevertheless, Fitch has a favorable view of HCN's management team, which has prudently entered new markets in a disciplined, well-executed manner.
The following factors may result in positive momentum in the ratings and/or Outlook:
--Fitch's expectation of fixed-charge coverage sustaining above 3.0x (pro forma fixed charge coverage is 3.2x);
--Fitch's expectation of leverage sustaining below 5.5x (pro forma leverage is 5.6x);
--Fitch's expectation of unencumbered assets to unsecured debt based on an 8.5% capitalization rate sustaining above 2.5x (pro forma UA/UD is 2.3x).
The following factors may result in negative momentum in the ratings and/or Rating Outlook:
--Fitch's expectation of fixed charge coverage sustaining below 2.5x;
--Fitch's expectation of leverage sustaining above 6.5x;
--Fitch's expectation of unencumbered assets to unsecured debt sustaining below 2.0x.
In addition to the 4.50% senior notes due 2034, Fitch currently rates HCN as follows:
--Issuer Default Rating (IDR) 'BBB';
--$2.5 billion senior unsecured revolving credit facility 'BBB';
--$723.1 million senior unsecured term loans 'BBB';
--$7 billion senior unsecured notes 'BBB';
--$227.4 million senior unsecured convertible notes 'BBB';
--$1 billion preferred stock 'BB+'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 28, 2014);
--'Rating U.S. Equity REITs and REOCs: Sector Credit Factors' (Feb. 26, 2014);
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' (Dec. 23, 2013);
--'Recovery Ratings and Notching Criteria for Equity REITs' (Nov. 19, 2013).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
Rating U.S. Equity REITs and REOCs (Sector Credit Factors)
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis
Recovery Ratings and Notching Criteria for Equity REITs