Fitch Rates Terreno's $50MM Senior Unsecured Notes 'BBB-'; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned a 'BBB-' rating to Terreno Realty LLC's $50 million unsecured notes issued through a private placement on Oct. 13, 2015. The notes have a 12-year term and bear interest at a fixed rate of 4.65%. Terreno Realty LLC is a wholly-owned operating subsidiary of Terreno Realty Corporation (NYSE:TRNO [Terreno or the company]).

These notes represent the second closing of a $100 million private placement of senior unsecured notes that the company announced on Sept. 2, 2015. A full list of Fitch's ratings for Terreno and its operating partnership Terreno Realty LLC follows at the end of this release.

The Rating Outlook is Stable.

KEY RATING DRIVERS

Fitch's ratings take into account TRNO's strong portfolio market concentrations, transparent industrial property-focused business model, experienced management, and credit metrics that are moderately strong for the rating. The potential for greater cash flow volatility stemming from market, asset and tenant concentration risk and possible missteps surrounding the company's value added acquisition-led growth strategy balance these credit positives. Also, the company has a less developed and shorter track record as an unsecured borrower.

The Stable Outlook reflects Fitch's expectation that TRNO will maintain credit metrics over the rating horizon (typically one to two years) that are consistent with the 'BBB-' rating, as well as our outlook for positive near- to medium-term industrial property fundamentals.

Portfolio Concentrated in Strong Markets

Fitch expects TRNO's portfolio market fundamentals to outperform the U.S. average over the rating horizon, based on the superior demographics and barriers to new supply. The company's portfolio is located in six of the strongest U.S. industrial markets, characterized by vibrant and growing local and regional economies, favorable population demographics and meaningful barriers to new supply.

The above-average occupancies and rents within Terreno's markets relative to the broader U.S. industrial property base evidences the strong fundamentals. The institutional investor and lender interest in TRNO's assets is likely above its peer average given the desirable market locations supporting the company's contingent liquidity position.

Terreno owned 141 buildings aggregating approximately 10.5 million square feet that were approximately 90.2% leased to 317 customers as of Sept. 30, 2015, as well as two improved land parcels consisting of 3.5 acres.

Transparent Operating Strategy

Fitch views Terreno's transparent and well-defined operating strategy as a credit positive. The company targets 100% fee simple ownership of industrial assets in six key logistics markets that include Northern NJ/NY (24% of annualized base rent [ABR]), D.C./Baltimore (26%), Miami (12%), Los Angeles (16%), San Francisco (12%) and Seattle (10%).

TRNO has not made, nor does its business model contemplate, investments in ground-up development or unconsolidated joint venture partnerships (JVs). The absence of these items helps simplify the company's business model, improve financial reporting transparency and reduce potential contingent liquidity claims, which Fitch views positively.

Fitch's ratings for TRNO include some flexibility for selective ground-up development at existing owned in-fill properties, as well as a limited amount of JVs if, for example, only a partial interest in an attractive industrial portfolio in its markets was available for purchase.

Appropriate Credit Metrics

Fitch expects TRNO's leverage to sustain within a range of 6.0x-6.5x through 2017, on an adjusted basis that includes a full-year's contribution from external investment activity. TRNO's leverage was 6.4x based on an annualized run rate of TRNO's recurring operating EBITDA for the quarter ending Sept. 30, 2015, which is appropriate for the 'BBB-' rating.

Fitch expects the company's fixed-charge coverage (FCC) to moderate, but remain strong over the rating horizon as the company transitions toward more fixed-rate debt. TRNO's FCC was 3.8x for the quarter ending Sept. 30, 2015, compared to 3.3x and 2.0x for year-ended Dec. 31, 2014 and 2013. Fitch's projections show the company's FCC improving to the mid-3.0x range through 2017.

The company has publicly committed to financial policies through the cycle that are consistent to moderately strong for a 'BBB-' rated REIT with TRNO's asset profile. These include maintaining net debt-to-recurring operating EBITDA below 6.5x and FCC above 2.0x. The company's stated policy is to target a dividend payout of 100% of its taxable net income.

Solid Liquidity Position

Fitch estimates TRNO's sources of capital cover its uses by 2.4x for the period Oct. 1, 2015 to Dec. 31, 2017. Several factors support the company's liquidity position, including limited near-term debt maturities, full availability under the company's $100 million revolver and the absence of unfunded development commitments.

Although near-term maturities are modest, the company has a meaningful amount of debt maturing between 2019 to 2021, principally comprised of its three unsecured term loans. Fitch expects the company to refinance these obligations well ahead of their stated maturities, most likely with proceeds from new unsecured private placement notes.

TRNO's unencumbered assets cover its unsecured debt (UA/UD) by 2.5x, pro forma for its $50 million unsecured notes offering. Fitch calculates unencumbered asset value using a direct capitalization approach of TRNO's annualized 3Q'15 unencumbered net operating income (NOI) that assumes a stressed 8.75% through the cycle cap rate. Fitch expects the company's UA/UD to moderate to the low-to-mid 2x range as it progresses in its unsecured borrowing strategy, which would remain appropriate for the 'BBB-' rating.

Experienced Management

TRNO has a strong management team with extensive industrial real estate and capital markets experience. Many of the company's key executives previously held high level executive positions at AMB Property prior to its merger with ProLogis.

Portfolio Market and Tenant Concentration

TRNO's concentrated portfolio strategy exposes it to idiosyncratic market and asset risks and could result in above-average property income volatility. Examples could include a regional economic downturn or loss of a significant tenant. Fitch expects the portfolio's asset and tenant granularity to improve as TRNO executes on its value-add acquisition-led growth strategy. However, we do not expect the company to expand beyond its six major markets.

The company's small size and concentration in markets with higher per square foot industrial values relative to its peers has contributed to its below-average asset granularity. Two markets - Northern NJ/NY and D.C./Baltimore - comprised 50.3% of the company's ABR as of Sept. 30, 2015. Moreover, its 10 largest properties (at cost) accounted for roughly 40% of its total investment in real estate. The multiple-building nature of many of its larger assets, as well as their infill locations help to offset the asset concentration risk.

TRNO's top-20 tenants comprised 40.1% of ABR at Sept. 30, 2015, which is meaningfully more concentrated than the comparable 21% median for its peers. Moreover, the company's largest tenant (FedEx Corp.) comprised 4.6% of its ABR versus a comparable median of 2.2% for its peers. Fitch views the company's portfolio tenant concentration as a credit risk that could lead to greater cash flow volatility. However, the generally strong credit quality of its largest tenants and multiple leases with several of these tenants help balance the concentration risk.

Execution Risk in Value-Add Acquisitions

TRNO's external growth strategy centers on the acquisition and stabilization of industrial assets, primarily through some combination of lease-up and property redevelopment. Fitch generally views the value-add strategy as being in between 'core' investments and ground-up development in risk/return space. Value-add acquisitions can entail additional risk given less familiarity with an asset relative to the repositioning of existing owned assets. However, Fitch views TRNO management's extensive industrial property experience and the small dollar value and homogeneity of industrial assets as risk mitigants.

Improving Unsecured Capital Access

TRNO's sale of $100 million of private placement unsecured notes is an important milestone in the company's transition to a predominantly unsecured borrowing strategy that evidences broader access to unsecured debt capital. Prior to the company's inaugural private unsecured notes placement, TRNO's unsecured borrowings were limited to its three term loans, as well as drawdowns under the company's unsecured revolver. However, Fitch continues to view TRNO as a less established unsecured bond issuer pending further private placement issuance.

Preferred Stock Notching

The two-notch differential between TRNO's IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with a 'BBB-' IDR. 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.

KEY ASSUMPTIONS

--GAAP SSNOI growth (excluding redevelopment properties) of roughly 4% in 2015 and 3% in 2016 and 2017;

--Acquisitions of $350 million in 2015, 2016 and 2017 at an approximate 6% stabilized average cap rate;

--Dispositions of $25 million per annum at cap rates of 5.5%;

--Unsecured borrowings of $150 million during 2015, $120 million during 2016 and $115 million during 2017 at rates of 4.25%, 4.5% and 4.75%, respectively;

--Equity issuance of roughly $40 million during 2015, $200 million during 2016 and $150 million during 2017;

--TRNO refinances its preferred equity when it becomes callable in 2017 with new common equity;

--The company unencumbers assets as mortgages mature with the proceeds from new unsecured debt and equity raises.

RATING SENSITIVITIES

The following factors may have a positive impact on the ratings and/or Rating Outlook:

--Further asset and tenant level diversification within the company's concentrated, six-market portfolio;

--Demonstrated access to the unsecured bond market;

--Fitch's expectation of leverage sustaining in the low 6.0x range (leverage was 6.4x for the annualized quarter ended Sept. 30, 2015);

--Fitch's expectation of FCC sustaining above 3.0x (coverage was 3.8x for the quarter ended Sept. 30, 2015).

The following factors may have a negative impact on the ratings and/or Rating Outlook:

--Fitch's expectation of leverage sustaining above 7.0x;

--Fitch's expectation of FCC sustaining below 2.0x.

FULL LIST OF RATING ACTIONS

Fitch currently rates Terreno as follows:

Terreno Realty Corporation

--Issuer Default Rating (IDR) 'BBB-';

--Preferred stock 'BB'.

Terreno Realty LLC

--IDR 'BBB-';

--Senior unsecured revolving line of credit 'BBB-';

--Senior unsecured term loans 'BBB-';

--Senior unsecured notes 'BBB-'.

In addition, Fitch has assigned a rating of 'BBB-' to Terreno Realty LLC's $50 million senior unsecured private placement notes that closed on Oct. 13, 2015.

Date of Relevant Committee: Oct. 7, 2015.

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

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis (pub. 25 Nov 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=821568

Additional Disclosures

Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=996990

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https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
Stephen Boyd, CFA, +1-212-908-9153
Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Steven Marks, +1-212-908-9161
Managing Director
or
Committee Chairperson
Michael Weaver, +1-312-368-3156
Managing Director
or
Media Relations, New York
Sandro Scenga, +1-212-908-0278
sandro.scenga@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Stephen Boyd, CFA, +1-212-908-9153
Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Steven Marks, +1-212-908-9161
Managing Director
or
Committee Chairperson
Michael Weaver, +1-312-368-3156
Managing Director
or
Media Relations, New York
Sandro Scenga, +1-212-908-0278
sandro.scenga@fitchratings.com