OREANDA-NEWS. Fitch Affirms American Assets Trust's IDR at 'BBB'; Outlook Stable New York Fitch Ratings has affirmed the ratings of American Assets Trust, Inc. (NYSE: AAT) and American Assets Trust, L. P., including the Long-Term Issuer Default Ratings (IDR) at 'BBB'. The agency has also assigned a 'BBB+' rating to AAT's $100 million unsecured term loan B due March 1, 2023. A full list of rating actions follows at the end of this release.

KEY RATING DRIVERS

The affirmation of AAT's IDR at 'BBB' is based on the company's credit strengths, which include a portfolio focus on high barrier-to-entry U. S. west coast markets that Fitch expects will result in growing cash flow in excess of fixed charges, appropriate leverage achieved through organic delevering, good unencumbered asset coverage of unsecured debt, and a long management track record. While most REITs tend to eschew property type diversification, AAT has aggregated a portfolio of retail, office, multifamily and mixed-use assets in markets that have historically demonstrated strong property-level fundamentals. Further, AAT's retail and office segments have outperformed the company's public office and retail REIT peers due to the sustained demand for AAT's properties, combined with limited supply.

Credit concerns include the company's exposure to below-investment-grade and unrated tenants, including the largest retail tenant, Kmart, which represented 6.2% of retail rent and 2.6% of total rent in first quarter 2016 (1Q16). In addition, while AAT continues its evolution towards a more unsecured funding model, it has issued only three series of private placement bonds since its 2011 IPO.

High Barrier-to-Entry West Coast Focus

As of March 31, 2016, AAT's portfolio included 101 retail buildings totaling 3 million square feet (sf), 26 office buildings, totaling 2.7 million sf, as well as 1,579 multifamily units and Waikiki Beach Walk, a retail/hotel mixed-use property in Honolulu. The company's core markets include San Diego (32.7% of 1Q16 cash NOI), Oahu, Hawaii (24.6%), the San Francisco Bay Area (17.1%), Portland, Oregon (9.2%) and Bellevue, Washington (8.9%). Fitch has a more favorable view toward companies that own properties in high-barrier-to-entry markets such as San Francisco when compared with other markets, due to consistently strong asset liquidity and leveragability.

Growing Fixed-Charge Coverage (FCC)

AAT's FCC was 2.6x for the trailing 12 months (TTM) ended March 31, 2016, compared to 2.5x in 2015 and 2.3x in 2014. FCC has improved due to cash-basis same-store (SSNOI) growth (7.1% in 1Q16, 7.7% in 2015 and 1.9% in 2014), cash flow from the company's Torrey Reserve office development in San Diego, and lower interest incurred.

Fitch projects that FCC will sustain in the 2.5x to 3.0x range over the next several years as AAT continues to refinance higher-coupon debt with lower-cost unsecured notes. For example, in April 2015, American Assets Trust, L. P. issued $100 million of 10-year 4.50% senior notes and used the proceeds in part to repay a 5.61% mortgage on The Landmark at One Market. Other drivers of expected improving FCC are positive, releasing spreads that should drive SSNOI growth and the lease-up of other developments, including the Torrey Point office building in San Diego and Lloyd District Phase I mixed-use project in Portland.

Fitch defines FCC as recurring operating EBITDA less straight-line rents and recurring capital expenditures divided by total cash interest incurred.

Appropriate Leverage

AAT's net debt-to-recurring operating EBITDA was 6.4x for the trailing 12 months ended March 31, 2016, as compared to 6.5x and 6.6x for 2015 and 2014, respectively. Fitch expects leverage to sustain at around 6.0x over the next 12-to-24 months, primarily due to organic EBITDA growth and cash flow from development, as opposed to via de-levering equity offerings. This level is appropriate for the 'BBB' rating. Fitch defines leverage as debt less readily available cash divided by recurring operating EBITDA.

Slightly Low Liquidity Position

For the period April 1, 2016 to Dec. 31, 2017, AAT's liquidity coverage ratio is 1.1x. This ratio represents sources of liquidity (unrestricted cash, availability under the unsecured revolving credit facility and projected retained cash flows from operating activities after dividends) divided by uses of liquidity (debt maturities, projected maintenance capital expenditures and development expenditures). Fitch does not expect the company to refinance secured debt maturities through 2017 with new secured debt. For illustrative purposes, however, assuming an 80% refinance rate on secured debt maturities through 2017, liquidity coverage improves to 2.6x.

AAT's organic liquidity is moderate as its AFFO payout ratio was 74.0% in 1Q16, compared to 73.8% in 2015 and 74.7% in 2014. Based on the current payout ratio, AAT retains approximately $20 million annually in organic liquidity.

Transition to Unsecured Funding Profile

To date, the company has only issued three series of private-placement unsecured notes. Other unsecured borrowings include the $250 million revolver and two $100 million unsecured term loans. Unsecured debt represents 53.5% of total debt. As of March 31, 2016, the company's implied value of unencumbered assets (defined as unencumbered NOI divided by a stressed 8% capitalization rate) covered net unsecured debt by 2.7x. Fitch projects that unencumbered asset coverage should remain in the 2.5x to 3.0x range through 2018, which is strong for the rating.

Offsetting the quality of the unencumbered pool is the fact that a meaningful portion of the unencumbered properties (including Waikele) are subject to a tax protection agreement that may limit the company's willingness and/or ability to sell certain assets. As such, realizing value from these properties may be limited to the mortgage market.

Long Management Track Record and Development Discipline

The company's chief executive officer and executive chairman founded the company's predecessor, American Assets, Inc. in 1967 and the company's chief financial officer has been with the company and its predecessor since 1998.

AAT has successfully overseen development and redevelopment projects over the past several years including the redevelopments of Del Monte Center in Monterrey and Carmel Mountain Plaza in San Diego, and the development of Waikiki Beach Walk in Honolulu. As of March 31, 2016, the development pipeline included one in-process development (the Torrey Point office project in San Diego, which took 17 years to obtain entitlements and permits for construction) and four pipeline projects. Cost-to-complete development totaled $35.6 million as of March 31, 2016, representing 1.5% of undepreciated assets, a manageable level.

Property Type Diversification

AAT's portfolio strategy runs counter to those of the largest REITs in all major sectors that have eschewed property type diversification in the name of specialization. The argument in favor of focused REITs is predicated on the view that specialization provides opportunities for operational outperformance and that optimal portfolio allocations and diversification can be achieved more efficiently at the shareholder's portfolio level. The argument for focused REITs assumes shareholders ascribe a discount to diversified REITs akin to a conglomerate discount. According to SNL Financial, the share prices of diversified REITs are currently trading at a 1.5% discount to median consensus net asset value (NAV) compared to the retail and multifamily issuers, whose common share prices are trading at premiums of 6.4% and 0.1%, respectively. AAT's common shares are currently trading at an 8.4% discount to median consensus NAV according to SNL Financial.

In spite of this phenomenon, AAT has outperformed its peers at the portfolio level, with AAT's office segment SSNOI growth exceeding the office REIT peer average SSNOI by 240 basis points and AAT's retail segment SSNOI exceeding the retail REIT peer average SSNOI by 80 basis points from 2005 to 1Q16.

Exposure to Select Weak Credit Tenants

AAT is materially exposed to below-investment-grade rated and unrated tenants, and its largest tenant in 1Q16 was salesforce. com, representing 7.7% of 1Q16 annualized base rent. Salesforce. com has a growing presence in San Francisco and is expected to continue leasing at AAT's The Landmark at One Market; AAT expects significant rent bumps on upcoming salesforce. com lease expirations. The largest retail tenant, Kmart (rated 'CC' by Fitch) represented 2.6% of total rent in 1Q16 and the top 10 retail and office tenants represented 11.1% and 23% of annualized based rent, respectively.

Only one of these 20 tenants is rated investment grade by Fitch: Nordstrom ('BBB+'; Outlook Stable, 1.1% of total rent). It is possible that certain weak credit tenants will elect not to renew leases upon expiration or default during the lease term, which could provide AAT with the opportunity to push rents given that in-place retail and office rents are below market rents. However, the company would be exposed to downtime and capital expenditures during the vacancy period.

Stable Outlook

The Stable Outlook reflects Fitch's expectation that AAT will operate within its targeted metrics through the rating horizon and the issuer will have sufficient capacity to address any potential tenant credit issues.

KEY ASSUMPTIONS

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

--3% same-store NOI growth through 2018;

--G&A to maintain historical margins relative to total revenues;

--Development expenditures of approximately $20 million for full-year 2016 and $30 million in 2017-2018 annually with development yields ranging from 6.75% to 8.75%;

--No acquisitions or dispositions;

--Secured debt repayment with the issuance of new unsecured bonds;

--Recurring capital expenditures to remain around 20% of recurring operating EBITDA through 2018;

--No equity issuance and an AFFO payout ratio of approximately 75% through 2018.

RATING SENSITIVITIES

The following factors may result in positive momentum in the ratings and/or Rating Outlook:

--Continued access to the unsecured debt markets, in particular, execution of public unsecured debt offerings;

--Fitch's expectation of leverage sustaining below 5.5x for several quarters (leverage was 6.2x for the TTM ended March 31, 2016 and is expected to sustain in the 6.0 - 6.5x range over the next 12 - 24 months);

--Fitch's expectation of fixed-charge coverage sustaining above 2.5x for several quarters (FCC was 2.6x for the TTM ended March 31, 2016).

The following factors may result in negative momentum in the ratings and/or Rating Outlook:

--Fitch's expectation of leverage sustaining above 6.5x for several quarters;

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

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings:

American Assets Trust, Inc.

--Long-Term IDR at 'BBB';

American Assets Trust, L. P.

--Long-Term IDR at 'BBB';

--$250 million unsecured credit facility at 'BBB';

--$100 million unsecured term loan A at 'BBB';

--$350 million unsecured notes at 'BBB'.

The agency has also assigned a 'BBB+' rating to AAT's $100 million unsecured term loan B due March 1, 2023.

The Rating Outlook is Stable.