OREANDA-NEWS. Fitch Ratings has placed the ratings of Sovran Self Storage, Inc. (NYSE: SSS) and its operating partnership, Sovran Acquisition, L.P. on Rating Watch Negative.


The Rating Watch Negative reflects that the weakening of the issuer's key credit metrics upon the closing of the LifeStorage acquisition and execution risk to restore metrics, more than offset the headline improvements in portfolio quality. Fitch could affirm the ratings with a Stable Outlook should the issuer complete additional transactions that allow it to fund consistent with its recent growth funding and with long-term debt proceeds. Should the issuer be unable or unwilling to do so, or Fitch expects operating fundamentals will decelerate meaningfully, Fitch could downgrade the ratings to 'BBB-' or revise the Outlook to Negative.


The LifeStorage portfolio is stronger than SSS' existing portfolio as measured by asset age, rent per square foot and surrounding population demographics which is a credit positive and could help narrow the quality gap between Sovran's portfolio and its public peers. Nonetheless, Sovran paid a premium price in Fitch's view. The transaction is expensive considering how few REITs trade at similar valuations across all asset classes and quality despite the fact that the initial 4.8% cap rate is comparable to the implied cap rates for other self-storage REITs.


The low going-in yield along with the transaction being initially funded with less equity (50%) than Sovran's typical 70%, results in headline metrics weakening materially upon the closing of the transaction. If SSS enters into additional transactions (e.g. issuing equity or selling assets) that allow it to fund with closer to 70% equity, leverage metrics should return to the low 4x range in late 2017.

Assuming no additional delevering transactions, Fitch projects leverage will increase towards 6x at the closing (mid-5x range on a run-rate basis) and improve towards the mid 4x range in 2017, assuming operating fundamentals remain strong, which would be more appropriate for a 'BBB-' IDR. This compares to the 4.2x quarterly average from 4Q12 - 1Q16, 3.9x for both 1Q16 and full year 2015 and Fitch's previous projections of 4x through 2017.

Similarly, Fitch projects fixed-charge coverage (FCC) will decline below 4x assuming the transaction is funded with new debt at a 4.5% coupon and no incremental proceeds. Lower than the 5.2x FCC for the trailing twelve months ended March 31, 2016 (LTM), pro forma FCC remains strong. Fitch defines leverage as debt less readily available cash to recurring operating EBITDA including cash distributions from joint venture operations. Fitch defines FCC as recurring operating EBITDA less recurring maintenance capital expenditures to total interest incurred.


Sovran has sufficient liquidity to close the transaction after the $665 million common equity issuance and the $1.35 billion bridge financing and $325 million supplementary facility. Sovran will need to refinance the remaining portion of the $1.33 billion acquisition with some combination of an inaugural public bond issuance(s), private placement(s), bank debt or additional equity issuances. There is moderate execution risk surrounding Sovran issuing a public unsecured bond given the lack of inaugural REIT issuers since early 2015. Over the long term, Sovran's primary sources of internal liquidity are its $500 million unsecured revolving credit facility, readily available cash and retained cash flow from operating activities.

Fitch estimates the contingent liquidity provided to Sovran's unsecured bondholders will decline to 2.3x pro forma from 3.2x at Sept. 30, 2015 assuming a 9% stressed cap rate with no incremental equity proceeds. While still appropriate for 'BBB' category REITs, Fitch believes self-storage REITs should have higher contingent liquidity ratios than similarly rated REITs in other asset classes, as asset granularity increases the time and number of properties necessary to aggregate a collateral pool and self-storage has relatively less institutional interest compared to other asset classes.


Fitch's key assumptions within the rating case for SSS include:

--SSS closing the LifeStorage acquisition in 2H16;
--SSS completing long-term debt transactions that allow it to avoid extended use of the bridge facility or high balances on the revolving credit facility;
--SSS financing the transaction consistent with its financial policies of closer to 70% equity.


Removal of the Rating Watch Negative and affirmation of the IDR at 'BBB' will be driven by the company's ability to reduce debt via transactions such as incremental equity issuance or asset sales, and improvements in SSS's debt maturity profile by issuing long-term debt to limit the usage of the revolving credit facility or bridge facility. At that point, SSS' 'BBB' IDR would reflect:

--Fitch's expectation of leverage sustaining in the 4x - 4.5x range;
--Fitch's expectation of fixed-charge coverage sustaining above 3x;
--A liquidity coverage ratio sustaining above 1.0x.

Fitch would expect to maintain the watch, downgrade SSS's IDR to 'BBB-' or revise the Outlook to Negative absent the company achieving long-term debt transactions and raising equity consistent with its financial policies.


Fitch has placed the following ratings for SSS on Rating Watch Negative:

Sovran Self Storage, Inc.
--IDR 'BBB';
--Unsecured revolving credit facility 'BBB';
--Unsecured term notes 'BBB'.

Sovran Acquisition, L.P.
--IDR 'BBB';
--Unsecured revolving credit facility 'BBB';
--Unsecured term notes 'BBB'.

In accordance with Fitch's policies the Issuer appealed and provided additional information to Fitch that resulted in a rating action that is different than the original rating committee outcome.