Fitch Affirms DDR's IDR at 'BBB-'; Outlook Stable
KEY RATING DRIVERS
The affirmation of the IDR at 'BBB-' takes into account DDR's credit strengths including ongoing improvements in the quality of the company's retail property portfolio and the management team's focus on refining the asset base and simplifying the business. DDR benefits from strong expected fixed-charge coverage for the rating, a granular tenant roster with select quality credit tenants, and proven access to various sources of capital. Leverage is anticipated to remain at the higher end of the range Fitch considers appropriate for the 'BBB-' rating over the next 12-to-24 months.
Credit concerns include a liquidity coverage ratio of below 1.0x assuming no access to external capital sources and when taking into account the company's development pipeline. In addition, DDR continues to grow its unencumbered pool, but Fitch projects that unencumbered asset coverage of unsecured debt will remain weak for the 'BBB-' rating.
Improving Asset Quality
DDR is executing on its strategic plan, which entails owning and operating market-dominant power centers in select markets with favorable population demographics and thereby generating consistent cash flow, while opportunistically engaging in capital recycling. Portfolio transformation is evidenced by the presence of more market-dominant power centers, with the average property size increasing to approximately 325,000 square feet as of March 31, 2015 compared to approximately 190,000 square feet as of Dec. 31, 2008. In addition, the leased rate improved to 95.5% as of March 31, 2015 from 92.2% in 2008, and average rent per square foot increased to \\$14.02 in first quarter 2015 (1Q'15) from \\$12.34 as of Dec. 31, 2008.
DDR, led by its new Chief Executive Officer and Chief Financial Officer, initiated changes in its investment strategy by accelerating disposition plans for lower quality assets, and expected sales should result in an improved credit profile. In 1Q'15, the company incurred \\$279 million of non-cash impairment charges related to 25 operating shopping centers and five parcels of land, which management has identified as disposal candidates over the next two years. These impairments did not impact key credit metrics and the company estimates that the to-be-sold assets are located in markets with weaker demographics with household income and population levels that are approximately 20% to 30% lower than the remaining assets. Net proceeds from asset sales will be used primarily towards funding acquisitions and development.
Ongoing Portfolio Review and Simplification
DDR segmented the portfolio by examining market and asset factors. This analysis was predicated on the company's focus on power centers based on the belief that they have greater scale, a larger mix of tenants and serve larger trade areas than grocery-anchored neighborhood shopping centers. Currently, DDR's portfolio demographics are weaker than those of other U.S. shopping center REITs, as measured by population density and average household income.
The company continues to simplify the business as evidenced by a settlement agreement announced in 1Q2015 involving the Coventry II Fund whereby DDR acquired its partner's 80% interest in Buena Park Place in Orange County, California and transferred its 20% ownership interest in 21 of the remaining 22 assets of the Coventry II Fund investments. This announcement resolves the lawsuit filed by Coventry Real Estate Advisors L.L.C. and its affiliates in 2009 and underscores that going forward, DDR's joint ventures will primarily be maintained with large institutional partners such as affiliates of The Blackstone Group LP (Fitch IDR of 'A+' with a Stable Outlook) and affiliates of TIAA-CREF Life Insurance Company (Fitch IDR of 'AAA' with a Stable Outlook), which Fitch views favorably.
Strong Leasing Spreads and Fixed Charge Coverage
Blended leasing spreads on new and renewal leases were 9.9% in 1Q'15 following 9.1% growth in 2014, 8.3% growth in 2013 and 6.7% growth in 2012. New lease rates on comparable space averaged \\$17.79 in 1Q'15. Though this level is below expiring rents for the remainder of 2015, it exceeds the weighted average for 2016-2017 lease expirations, indicative of future positive leasing spreads. As of March 31, 2015, 4.9% of leases expire for the remainder of 2015 followed by 12.4% in 2015 and 13.4% in 2016. Consolidated same-store NOI grew by 2.7% in 1Q2015, 2.9% in 2014, 3.1% in 2013 and 3.7% in 2012.
DDR's fixed-charge coverage ratio was 2.4x for the first quarter of 2015 (also 2.4x for the trailing twelve months ended March 31, 2015), up from 2.3x for 2013 and 2.0x in 2012. Organic EBITDA growth and re-development EBITDA growth were the primary contributors to the improvement. Under Fitch's base case whereby the company generates 3% same-store NOI growth in 2015 (due to positive releasing spreads and a minor uptick in occupancy) followed by a slight moderation in 2016-2017, fixed charge coverage would be in the mid-to-high-2x range, which would be strong for the 'BBB-' rating. In a stress case not anticipated by Fitch in which same-store NOI declines by levels experienced in 2009-2010, fixed-charge coverage would remain in the low-to-mid 2x range, which would remain solid for the 'BBB-' rating. Fitch defines fixed-charge coverage as recurring operating EBITDA including recurring cash distributions from unconsolidated entities less recurring capital expenditures and straight-line rent adjustments, divided by total interest incurred and preferred stock dividends.
Secular Retailer Trends Favor Power Centers
DDR has limited tenant concentration. Major tenants are TJX Companies (3.4% of rental revenues in 1Q'15), PetSmart (3.0%), Bed Bath & Beyond (2.9%), Walmart (Fitch IDR of 'AA' with a Stable Outlook at 2.6%), and Kohl's (Fitch IDR of 'BBB+' with a Stable Outlook at 2.4%). The top 10 and 20 tenants comprise 23.9% and 35.7%, respectively, of 1Q'15 rental revenues. Numerous retailers are exploring larger footprints, which should bolster power center demand. Value/convenience retailers continue to grow, while non-traditional grocers have gained the market share of traditional retailers, which bodes well for DDR's tenants such as Walmart and Whole Foods.
Proven Access to Capital
DDR is a seasoned issuer of multiple sources of capital. Since 2006, the company issued approximately \\$4 billion of bonds (the latest of which was a January offering of \\$500 million of 3.625% 10-year notes), \\$350 million of preferred stock, and approximately \\$4.3 billion of equity via follow-on common offerings and at-the-market program issuance at a weighted average premium to consensus mean net asset value of 3.4% according to SNL Financial. In April 2015, DDR recast its primary \\$750 million unsecured revolving credit facility, extending the final maturity date to June 2020, including options, and reducing the pricing on the facility by 15 basis points to LIBOR plus 100 basis points. The company also recast its smaller credit facility to \\$50 million from \\$65 million under the same pricing terms and entered into a \\$400 million unsecured term loan with Wells Fargo Bank, with pricing currently set at LIBOR plus 110 basis points.
Leverage at the High End of Range for 'BBB-'
Leverage was 7.3x in 1Q15 (also 7.3x for the TTM ended March 31, 2015), down from 7.5x in 2014 and 8.2x in 2013. Leverage was skewed upward for full-year 2013 due to the timing of the company's October 2013 acquisition of a portfolio of 30 power centers previously owned by a joint venture with Blackstone Real Estate Partners VII L.P. for \\$1.46 billion. Fitch projects that leverage will be between 7.0x and 7.5x over the next 12-to-24 months, which would be at the high end of the range appropriate for the 'BBB-' rating, principally due to organic EBITDA growth. In the above-mentioned stress case, leverage would exceed 7.5x, which would be inconsistent with an investment-grade rating. Fitch defines leverage as debt less readily available cash divided by recurring operating EBITDA including recurring cash distributions from unconsolidated entities.
2015 Debt Maturities and Development Negatively Impact Liquidity
Liquidity coverage is weak at 0.8x for the period April 1, 2015 to Dec. 31, 2016. Fitch defines liquidity coverage as sources divided by uses. Liquidity sources include readily available cash, availability under the company's unsecured revolving credit facilities pro forma for the amendments (pro forma), the company's committed but undrawn term loan commitment, and projected retained cash flows from operating activities. Liquidity uses include pro rata debt maturities, projected recurring capital expenditures and cost to complete development through 2016. The liquidity coverage ratio is weighed down by 2015 debt maturities, which total 17.0% of total debt pro forma. If 80% of secured debt maturities during 2015 - 2016 are refinanced, liquidity coverage would improve to 1.0x, however Fitch does not view this as a likely scenario since the company intends to continue unencumbering the portfolio.
The company's AFFO payout ratio was 67.8% in 1Q'15, up from 62.6% in 2014 and 61.2% in 2013. Based on the current payout ratio, the company retains approximately \\$120 million annually in internally generated liquidity.
Cost-to-complete development represented 4.2% of undepreciated assets as of March 31, 2015, up from 1.9% as of year-end 2013 and 0.7% as of year-end 2012 and surpassing the 3.5% level as of year-end 2007. Overall, redevelopment should improve asset quality and cash flow growth as DDR generally targets an unlevered cash on cost in excess of 10%.
Low Unencumbered Asset Coverage
As of March 31, 2015, DDR's unencumbered assets (defined as unencumbered NOI divided by a stressed 8% capitalization rate) covered net unsecured debt by 1.7x, which is low for the 'BBB-' rating. Unencumbered asset coverage has trended around 1.6x-1.7x over the past several years and Fitch expects the ratio to remain flat through 2016, absent equity-funded acquisitions of unencumbered real estate. DDR continues to add quality assets to the unencumbered pool and the quality of the unencumbered pool is similar to that of the encumbered pool.
Preferred Stock Notching
The two-notch differential between DDR's IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB-'. Based on Fitch's hybrids criteria, 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
The key assumptions for DDR in Fitch's base case include:
--3% same-store NOI growth in 2015 followed by 2.5% growth in 2016 and 2.0% in 2017;
--Interest income growth to \\$28 million through 2017 stemming from the BRE DDR Retail Holdings III and Blackstone II acquisition transactions in 2014;
--G&A to decline slightly relative to total revenues as the company endeavors to focus on fewer larger assets via expected asset sales;
--\\$437 million of dispositions in 2015 followed by \\$100 million total in 2016 - 2017 at 7.5% cap rates;
--\\$500 million of acquisitions and development in 2015 followed by \\$400 million in 2016 and \\$350 million in 2017 at blended 8.5% stabilized yields;
--Debt repayment with the issuance of new unsecured bonds;
--Recurring capex divided by recurring operating EBITDA in the 7% - 8% range;
--\\$100 million of equity issuance in 2015 with no additional issuance through 2017 and an AFFO payout ratio of approximately 65% - 70% through 2017; however, equity issuance is at management's discretion and Fitch notes that DDR's common shares are currently trading at an 11.5% discount to consensus mean net asset value according to SNL Financial.
RATING SENSITIVITIES
The following factors may have a positive impact on DDR's ratings and/or Outlook:
Fitch's expectation of leverage sustaining below 6.5x is the primary factor for positive momentum on the ratings and/or Outlook, since this metric is more consistent through interest rate cycles (March 31, 2015 TTM leverage was 7.3x);
--Fitch's expectation of growth in the size and quality of the unencumbered pool with unencumbered assets (unencumbered NOI divided by a stressed capitalization rate of 8.0%) to net unsecured debt of 2.5x is another important positive sensitivity (this metric is 1.7x as of March 31, 2015);
--Fitch's expectation of fixed-charge coverage sustaining above 2.3x is a less meaningful ratings sensitivity for positive momentum as it is less consistent through interest rate cycles (TTM fixed-charge coverage is 2.4x).
The following factors may have a negative impact on DDR's ratings and/or Outlook:
--Fitch's expectation of leverage sustaining above 7.5x;
--Fitch's expectation of fixed-charge coverage sustaining below 2.0x;
--Base-case liquidity coverage sustaining below 1.0x (this ratio is 0.8x for April 1, 2015 to Dec. 31, 2016).
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
DDR Corp.
--IDR at 'BBB-';
--\\$800 million unsecured revolving credit facilities at 'BBB-';
--\\$400 million unsecured term loan at 'BBB-';
--\\$343 million senior unsecured convertible notes at 'BBB-';
--\\$2.9 billion senior unsecured notes at 'BBB-';
--\\$350 million preferred stock at 'BB'.
The Rating Outlook is Stable.
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