OREANDA-NEWS. Fitch Ratings has assigned first-time ratings to Spirit Realty Capital, Inc. (NYSE: SRC), including an Issuer Default Rating (IDR) of 'BBB-'. The Rating Outlook is Stable. A full list of ratings follows at the end of the release.


SRC's ratings reflect the issuer's solid credit metrics, strong management team, differentiated investment strategy and diversified portfolio. These strengths are balanced by unproven access to non-bank / non-convertible unsecured debt capital and the implications of the Master Trust debt facility. The principal considerations are that a significant percentage of SRC's NOI is collateralized by the Trust facility, providing incentive for SRC to support it more so than traditional single asset mortgages. Moreover, should SRC look to unwind the structure as the notes issued through it are either prepaid or mature, there are structural elements that will result in the structure becoming over-collateralized and by extension weakening unencumbered asset coverage until the final dollar of Trust debt is repaid.


SRC is a triple-net lease REIT focusing on middle-market unrated tenants through sale-leaseback transactions with an emphasis on non-cyclical industries. The portfolio is well-diversified geographically across many industry classifications, and lease maturities are long dated. The portfolio is well diversified across 438 different tenants and key tenant risk is moderate with the largest tenant (Shopko Stores) accounting for 9.1% of revenues at Dec 31, 2015.

The Company's portfolio generates predictable cash flows as evidenced by annual rent bumps of 1.25% to 2.0% over a 15-to-20-year lease term at the onset and consistent occupancy. From 2003 to 2015, occupancy did not fall below 96.0% and stood at 98.6% as of Dec. 31, 2015. SRC's weighted average remaining lease term is long at 10.7 years, signalling durability in cash flows, absent tenant bankruptcies. As SRC's tenants are typically non-rated thereby limiting Fitch's ability to assess tenant credit quality, weighted average four-wall coverage ratios provide some indication of default probability and are good at 2.9x at Dec. 31, 2015.


Since 2013 SRC has focused on deleveraging and improving fixed charge coverage as part of management's commitment towards achieving an investment grade rating. Fitch projects SRC will operate with leverage near 6x through 2018 (6.8x for FY15 and 6.3x pro forma for the recent equity issuance). Reported metrics may be weaker due to the timing effects of acquisitions. SRC's tenant diversification, contractual rental increases and long-dated lease maturities improve the durability and predictability of operating cash flows and provide a cushion for the issuer to maintain its metrics in the event of tenant credit issues.

Similarly, Fitch projects SRC will operate with fixed-charge coverage (FCC) in the mid to low-3x range through 2018 as compared to 2.7x in 2015. Contractual rental increases could be offset by higher interest expense on future debt issuances should interest rates increase. The role of equity issuances and accessing affordable debt play key roles in driving these improvements throughout the forecast horizon. Fitch calculates leverage as total debt less readily available cash to recurring operating EBITDA. Fitch calculates FCC as recurring operating EBITDA less straight-line rent and recurring maintenance capital expenditures to total interest incurred.


Historically the majority of SRC's debt financing was secured, with a significant portion comprised of the Master Trust funding program, a conduit through which SRC issued ABS debt. Upon the contribution of new properties and the issuance of a new series of debt under this program, the entire collateral pool (including the newly added real estate) was pledged to secure all of the notes (i.e. the existing and new series) on a pro rata basis.

The effects of Master Trusts are three-fold. First, the large portion of NOI that the Master Trust comprises and the cross-collateralization features provide more incentive for SRC to support Master Trust debt than other REITs have with single asset mortgages. Second, the existence of cash-trap provisions could result in a scenario whereby there are reported earnings at the REIT from the trust without cash flows, potentially causing required dividends to exceed corresponding operating cash flows. As a key feature of the Master Trust is the ability to sell or swap assets into the trust, there is the potential for adverse selection between the unencumbered and encumbered asset pools.

Thirdly, should the issuer look to continue to unencumber and repay Master Trust notes as they mature, there are structural elements that would result in over collateralization in the facility and weakening contingent liquidity for unsecured bondholders. SRC can release collateral from the trust for a 125% premium as notes mature (e.g. for every $1 of secured debt repaid, $0.80 of collateral is released to the unencumbered pool). These premiums will result in collateral being left in the trust until the final notes are repaid. Until that happens, SRC's contingent liquidity, as measured by unencumbered assets to unsecured debt, could weaken as the numerator grows at a slower pace than the denominator, assuming the notes are repaid with incremental unsecured borrowings. A simple stress analysis that isolates only the effects of the overcollateralization potential in the facility indicates coverage could weaken to 1.6x in 2024 from 2.4x at Dec. 31, 2015 pro forma for the recent equity offering.


Fitch views SRC's liquidity to be appropriate for the rating. However, the larger rating consideration is the issuer successfully demonstrating access to the public or private placement bond markets. SRC's access to non-bank and non-convertible unsecured debt is untested and the public markets have been challenging for inaugural issuers. There could be negative momentum on the ratings and/or Outlook should SRC be unable or unwilling to access these markets and reduce its reliance on shorter tenor and bank unsecured debt.

Fitch estimates SRC's sources of liquidity (unrestricted cash, availability of the revolving credit facility and retained cash flow from operations after dividends) cover uses (debt maturities, committed acquisitions, and commitments to fund improvements to real estate) by 1.2x for the period Jan 1, 2016 - Dec 31, 2017 pro forma for the recent equity offering, and 5.1x for the period assuming 80% of debt is refinanced. Fitch views the latter scenario as unlikely given the issuer's plans to continue to unencumber the portfolio.

SRC maintains a sizable pool of unencumbered assets providing contingent liquidity to unsecured creditors. Fitch estimates the value to be $2.3 billion assuming a 10% stressed capitalization rate which would provide a 2.4x UA/UD coverage pro forma for the recent equity offering.


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


Fitch's key assumptions within the rating case for SRC include:
--Leverage sustaining between 6x-7x through sufficient equity issuances and strong free cash flow generation;
--SSNOI growth of 1.8% throughout the forecast horizon;
--SRC will make portfolio acquisitions through the use of proceeds from divestments, equity issuances and unsecured debt issuances;
--SRC issues unsecured debt to repay upcoming debt maturities and unencumber the Master Trust;
--SRC will continue to grow its pool of unencumbered assets and will not demonstrate any adverse selection or utilize the pool as a warehouse facility / back-up liquidity for Master Trusts funding.


The following factors could result in positive momentum in the ratings and/or Outlook:
--Fitch's expectation of leverage sustaining below 6.0x (leverage was at 6.8x at Dec 31, 2015 and 6.3x pro forma for the equity issuance);
--Fitch's expectation of FCC sustaining above 3.0x (FCC was 2.7x for the year ended Dec 31, 2015);
--Fitch's expectation of a 2.5x UA/UD ratio at a 10% stressed cap rate.

The following factors could result in negative momentum on the ratings and/or Outlook:
--Should SRC be unable or unwilling to refinance and rebalance its capitalization via public or private placement debt issuances, Fitch could downgrade the IDR to 'BB+' as SRC would have relatively weaker access to capital and a higher-risk capitalization;
--Fitch's expectation of leverage sustaining above 7.0x;
--Fitch's expectation of FCC sustaining below 2.0x;
--Fitch's expectation of a liquidity shortfall;
--Should contingent liquidity from the unencumbered pool weaken due to adverse selection or overcollateralization in the Master Trust facility.


Fitch has assigned the following ratings:

Spirit Realty Capital, Inc.
--Issuer Default Rating (IDR) 'BBB-';
--Senior unsecured convertible notes 'BBB-'

Spirit Realty, L.P.
--Senior unsecured revolving credit facility 'BBB-';
--Senior unsecured term loan at 'BBB-'.

The Rating Outlook is Stable.