Correction: Fitch Rates Federal Realty's Senior Unsecured Notes 'A-'; Outlook Stable
Fitch Ratings has assigned an 'A-' rating to the senior unsecured notes due 2046 issued by Federal Realty Investment Trust (NYSE: FRT; Federal). The Rating Outlook is Stable. A full list of ratings follows at the end of this release.
KEY RATING DRIVERS
The ratings are based on Federal's consistent and steady cash flow growth provided by the company's community shopping centers, along with a track record of prudent balance sheet management and creative redevelopment and mixed-use development.
The potential for near-term weakness in Federal's Washington, D. C. portfolio (approximately 32% of annualized base rent [ABR]) due to softer regional economic growth and some remaining execution risk related to Federal's mixed-use developments under construction balance these credit positives.
Fitch views positively Federal's buy-and-hold strategy that targets premier retail properties in supply-constrained markets with above-average demographics. This strategy, augmented by the company's redevelopment activities, has enabled Federal to produce consistently robust operating performance that has historically been stronger and more stable - through the cycle - than the retail real estate market generally and its public shopping center REIT peers specifically.
Consistent and Superior Growth
Federal's expertise in managing its 96 properties, which comprised 22 million square feet as of March 31, 2016, is evidenced by consistently positive same-store net operating income (SSNOI) growth, excluding redevelopment, through multiple cycles. Within the last 10 years, the lone exception was 2009 when SSNOI declined 0.3%. This compares favorably to its public shopping center peers which declined an average of 4.1% in 2009.
Federal's consistently strong rent growth on expiring leases largely reflects the high-quality infill locations of its properties. Federal's releasing spreads have been higher than peers during this economic and commercial real estate recovery. Moreover, the company was unique among shopping center REITs in its ability to maintain positive leasing spreads throughout the recent economic downturn.
Fitch expects Federal's leverage to sustain in the high - to mid-5x range, trending towards the lower end by 2017 as the company's larger developments come on-line and begin to contribute to portfolio cash flows during the next two to three years. Leverage was 5.3x for the trailing 12 months (TTM) ended March 31, 2016, compared to 5.4x and 5.2x at year-end 2015 and 2014, respectively. Federal has historically managed leverage at conservative levels with net debt-to-recurring operating EBITDA levels ranging between the mid-4x and mid-5x range.
Strong Fixed Charge Coverage
Fitch expects SSNOI growth, the stabilization of its phase 1 mixed-use developments, and interest savings from recent debt refinancings to result in fixed charge coverage (FCC) sustaining in the low-4x range through 2017, which is strong for the rating. Federal's FCC was 4x for the TTM ended March 31, 2016, compared to 3.9x in 2015 and 3.5x in 2014. Fitch calculates FCC as recurring operating EBITDA less tenant improvements and incentives, recurring maintenance capital expenditures and straight-line rent adjustments divided by interest incurred and preferred dividends.
Strong Contingent Liquidity
Federal's sizeable unencumbered asset pool provides additional protection to unsecured debt holders. As of March 31, 2016, 88.2 % of the company's property NOI was unencumbered. Fitch calculates the company's unencumbered asset value coverage of unsecured debt (UA/UD) was 3.1x at March 31, 2016 based on applying a stressed 7% capitalization rate to the first quarter 2016 unencumbered NOI.
Fitch's ratings for Federal incorporate the high quality of Federal's unencumbered asset pool which includes the company's three largest (by ABR) and most valuable properties, Santana Row (San Jose, CA), Bethesda Row (Bethesda, MD) and Third Street Promenade (Los Angeles, CA), which together account for approximately 13% of ABR.
Granular Tenant Base
High tenant credit quality and granularity within Federal's portfolio help mitigate tenant bankruptcy risk. Only one tenant (grocer Ahold USA, Inc./not rated) represents more than 3% of ABR, and the top 25 tenants represent a relatively low 29.5% of total ABR at March 31, 2016.
The company maintains well-laddered lease expirations by year with average annual lease expirations of 8.9% of ABR through 2025 and a maximum of 12.5% of ABR expiring in a single year (excluding tenant lease extension options).
Adequate Liquidity Coverage
Fitch's base case analysis shows liquidity coverage of 2.8x through the end of 2017 (1.2x including estimated development expenditures). The company's pro forma liquidity coverage ratio (including development) would improve to 1.7x assuming it refinanced 80% of its secured debt maturing through 2017. However, Fitch recognizes Federal's preference for owning assets on an unencumbered basis, reducing the likelihood of that scenario.
Fitch defines liquidity coverage as sources of liquidity (unrestricted cash, availability under the company's unsecured revolving credit facility pro forma for the upsizing of the facility on April 20, 2016, projected retained cash flows from operating activities after dividends and distributions) divided by uses of liquidity (pro rata debt maturities and projected recurring capital expenditures) for April 1, 2016 to Dec. 31, 2017.
Federal's demonstrated access to multiple forms of capital further supports its liquidity profile and offsets refinancing risk. In addition, Federal's retained operating cash flow after dividend payments provides over $70 million of internally generated capital annually that can be used to make accretive investments, fund development and/or satisfy its financing obligations. Fitch calculates that the company's dividends represented 77% of adjusted funds from operations during the three months ending March 31, 2016.
The portfolio's moderate asset and market concentrations and continued industry-wide weakness among select retailer tenants - primarily local small-shop tenants - are moderate credit concerns. Federal's three largest properties comprise roughly 13% of total ABR. Also, Federal generates approximately 32% of its ABR from the D. C. Metro market where commercial real estate market conditions weakened due to cutbacks in U. S. government spending, but more recently have apparently stabilized.
The Stable Outlook centers on Fitch's expectation that Federal's credit profile will remain appropriate for the 'A-' rating through economic cycles, barring any significant changes in the company's capital structure. The Stable Outlook reflects the quality of management and consistency of cash flows resulting in stable credit metrics, in line with an 'A-' rating. Further, Federal continues to access various sources of capital and maintains a solid unencumbered asset base and liquidity profile.
Fitch's key assumptions within the rating case include:
--Low - to mid-single digit GAAP SSNOI growth (including redevelopments) through 2017, primarily due to positive leasing spreads and, to a lesser extent, occupancy gains;
--Minimal acquisition activity and no incremental dispositions through 2017;
--Secured debt maturing through 2017 will be paid off at expiration date.
While Fitch does not expect a near-term positive change in the rating, the following factors may have a positive impact on Federal's ratings and/or Outlook:
--Fitch's expectation of net debt-to-recurring operating EBITDA sustaining below 4.5x (leverage was 5.3x at March 31, 2016);
--Fitch's expectation of FCC sustaining above 3.5x (FCC was 4.0x for the TTM ended March 31, 2016);
--Greater asset diversification of the portfolio via growth (Federal's three largest assets generate roughly 13% of total ABR).
The following factors may result in negative momentum for the rating and/or Outlook:
--Shift in management strategy away from owning and redeveloping retail assets in infill locations;
--Unencumbered asset coverage of unsecured debt below 2.5x (coverage was 3.1x at March 31, 2016 using a stressed 7% capitalization rate);
--Fitch's expectation of leverage sustaining above 5.5x;
--Fitch's expectation of FCC sustaining below 2.5x.
FULL LIST OF RATING ACTIONS
Fitch currently rates Federal as follows:
--Issuer Default Rating (IDR) 'A-';
--Unsecured revolving credit facility 'A-';
--Senior unsecured term loan 'A-';
--Senior unsecured notes 'A-';
--Redeemable preferred shares 'BBB'.