Fitch Ratings assigns a 'BBB' rating to the $300 million 3.375% senior unsecured notes due Jan. 15, 2023 issued by BRE Properties, Inc. (NYSE: BRE). The notes were issued at 99.281% of par.
Net proceeds from the offering are expected to be used for general corporate purposes including the repayment of amounts outstanding on the company's unsecured revolving credit facility and the redemption or repurchase of the 6.75% Series D Cumulative Redeemable Preferred Stock.
Fitch currently rates the company as follows:
--Issuer Default Rating (IDR) 'BBB';
--Unsecured revolving credit facility 'BBB';
--Senior unsecured notes 'BBB';
--Convertible senior notes 'BBB';
--Preferred stock 'BB+'.
The ratings are supported by BRE's high quality portfolio of multifamily assets in supply-constrained markets combined with solid credit metrics. The Positive Outlook is driven by robust multifamily fundamentals in BRE's markets that are fueling improving leverage and coverage metrics. Fitch's expects that BRE's near- to medium-term credit profile will improve to a level more consistent with a 'BBB+' IDR. In conjunction with the second quarter 2012 (2Q'12) earnings release, the company narrowed SSNOI growth guidance, resulting in a lower mid-point that remains consistent with Fitch's expectations.
BRE has meaningfully reduced debt on an absolute and relative basis since 2007 through raising equity, selling non-core assets and reducing development spending. Leverage improved to 7.0 times (x) as of Dec. 31, 2011 from 8.1x and 8.5x as of Dec. 31, 2010 and Dec. 31, 2009, respectively. Leverage continues to decline and was 6.8x as of June 30, 2012, based on annualized 2Q'12 EBITDA. Fitch expects BRE's leverage to stabilize between mid-6.0x to 7.0x, a range appropriate for a 'BBB+' rating. In a stress case not anticipated by Fitch resulting in negative same-store NOI, leverage could sustain above 8.0x, which would be appropriate for a 'BBB-' IDR. Fitch defines leverage as net debt divided by recurring operating EBITDA.
Additionally, BRE's fixed charge coverage ratio has improved to 2.4x for trailing 12 months (TTM) ended June 30, 2012, as compared to 1.9x for 2010. The continued improvement is attributable to improving fundamentals and lower preferred dividends. Fitch expects this metric to improve to between 2.5x to 3.0x as fundamentals improve and the company redeems higher-cost preferred stock, a range appropriate for a 'BBB+' IDR. In a stress case not anticipated by Fitch resulting in negative same-store NOI, fixed-charge coverage could sustain below 2.0x, which would be appropriate for a 'BBB-' IDR. Fitch defines fixed charge coverage as recurring operating EBITDA less renewal and replacement capital expenditures, divided by total interest incurred and preferred stock dividends.
The company has improved the quality of its portfolio over the last few years through approximately $200 million of dispositions in non-core markets. As such, the vast majority of assets are now located in supply constrained, coastal California markets. Fitch views the strategy of owning assets in supply-constrained coastal markets as a credit positive as these markets also exhibit solid demand factors such as high cost of for-sale single-family housing and proximity to solid job growth markets.
BRE has traditionally focused on development as an essential component for growth. The sizeable scale of BRE's development pipeline has historically been a credit concern and negatively impacted the company's leverage ratios. In 2011, citing positive market fundamentals, the company restarted its development pipeline. Although not all costs are contractual nor within Fitch's time horizon, the pipeline's costs will total $1.3 billion of which $845 million remains unfunded. BRE's management intends to front-end its development activity and indicated future development advances will not surpass $200-$250 million annually. Fitch does not view the current pipeline as a significant concern given the positive operating fundamentals, project-specific sub-market supply and strong liquidity profile, although Fitch notes the inherent risks in development.
The company's geographic concentration offsets to a degree the credit positive of the company's supply-constrained market focus strategy. California comprised 84% of total NOI in 2Q'12 with the San Francisco Bay Area and San Diego accounting for 25% and 20%, respectively. While BRE's SSNOI performance has been in line with a market-weighted PPR index, Fitch notes the seismic risks of the state and the potential for government budget dynamics to pressure property taxes.
The Positive Outlook centers on Fitch's expectation that BRE's credit profile will improve to be consistent with a 'BBB+' rating, supported by management's commitment to reduce leverage through equity raises to offset development risks or should operating fundamentals deteriorate.
Further, BRE continues to access various sources of capital and maintain a healthy liquidity profile. For the period of July 1, 2012 to Dec. 31, 2014, Fitch calculates that BRE's sources of liquidity exceed uses of liquidity by 1.6x driven by BRE's minimal near term maturing debt. The next large debt maturity is a $300 million unsecured notes maturity in 2017. Fitch defines liquidity coverage as sources (cash, availability under the unsecured revolving credit facility and projected retained cash flows from operating activities after dividends and distributions) divided by uses (debt maturities and amortization, development spending and projected renewal and replacement capital expenditures).
In addition, BRE maintains a strong level of unencumbered assets that provides solid coverage of unsecured debt for the rating category. Fitch calculates that BRE's ratio of unencumbered operating real estate to net unsecured debt (UAUD), ranges from 2.3x to 2.8x using a range of capitalization rates from 6.5% to 8%. The midpoint has improved from 2.4x and 1.9x as of Dec. 31, 2010 and Dec. 31, 2009, respectively, providing increasing cushion to unsecured bondholders.
The two-notch differential between BRE's IDR and its preferred stock ratings is consistent with Fitch's criteria for corporate entities with a 'BBB' IDR. Based on Fitch's report 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis', 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.
The following factors may result in an upgrade to 'BBB+':
--Fitch's expectation of leverage sustaining below 7.0x for several quarters ((leverage was 6.8x at June 30, 2012 based on annualized 2Q'12 EBITDA);
--Fitch's expectation of fixed charge coverage sustaining above 2.5x for several quarters (coverage was 2.4x for the TTM ended June 30, 2012).
The following factors may result in negative momentum on the ratings and/or Rating Outlook:
--Fitch's expectation of leverage sustaining above 8.0x for several consecutive quarters;
--Fitch's expectation of fixed-charge coverage sustaining below 2.0x for several consecutive quarters;
--If operating fundamentals relapse similar to the environment of 2009 in the near term, rather than remaining strong.
Additional information is available at 'www.fitchratings.com'. The ratings above were unsolicited and have been provided by Fitch as a service to investors.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology,' Aug. 8, 2012.
--'Recovery Ratings and Notching Criteria for Equity REITs' (May 3, 2012);
--'Criteria for Rating U.S. Equity REITs and REOCs,' Feb. 27, 2012;
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis,' Dec. 15, 2011.
Applicable Criteria and Related Research:
Corporate Rating Methodology
Recovery Ratings and Notching Criteria for Equity REITs
Criteria for Rating U.S. Equity REITs and REOCs
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT
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