TEXT-Fitch rates Essex Portfolio L.P.
March 16 - Fitch Ratings has assigned a 'BBB' rating to the $200 million senior unsecured private placement notes issued by Essex Portfolio L.P., the operating partnership of Essex Property Trust, Inc. (NYSE: ESS). The private placement notes have a nine-year term and a delayed funding schedule as follows: --$100 million on April 30, 2012 at a rate of 4.27%; --$50 million on June 29, 2012 at a rate of 4.30%; --$50 million on August 30, 2012 at a rate of 4.37%. The company plans to use the proceeds for general corporate purposes including the repayment of a portion of the outstanding balance on its unsecured line of credit. Fitch currently rates the company as follows: Essex Property Trust, Inc. --Issuer Default Rating (IDR) 'BBB'; --Preferred stock 'BB+'. Essex Portfolio L.P. --IDR 'BBB'; --Unsecured revolving credit facility 'BBB'; --Senior unsecured notes 'BBB'; --Senior unsecured term loans 'BBB'. The Rating Outlook is Positive. The Positive Outlook is driven by Fitch's expectation that ESS' near- to medium-term credit profile will improve to a level more consistent with a rating of 'BBB+', due to healthy apartment fundamentals combined with management's commitment to a conservative balance sheet, and growth in the unencumbered asset pool. ESS' leverage levels have declined, fixed charged coverage has improved, and the company maintains strong level of unencumbered assets that provides solid coverage of unsecured debt. Further supporting the ratings are the company's solid management team and long-term track record as astute operators and capital allocators in the multifamily sector. ESS' ratings are also supported by its strategy of owning assets in supply constrained, high barrier to entry, West Coast 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. For full-year 2011, fixed-charge coverage (defined as recurring operating EBITDA less Fitch's estimate of recurring capital improvements divided by interest incurred and preferred stock distributions) was 2.6 times (x), which is strong for the 'BBB' rating, and is expected to rise to 2.8x in 2013 and 3.1x in 2014. Fixed-charge coverage was 2.4x and 2.1x for the years ended Dec. 31, 2010 and 2009, respectively. In a stress case not anticipated by Fitch resulting in negative same-store NOI, fixed-charge coverage could sustain below 2.3x, which would be appropriate for a 'BBB' IDR. ESS' net debt to recurring LTM operating EBITDA for the year ended Dec. 31, 2011 was 7.6x, and was 6.9x based on annualized 4Q'11 EBITDA due to significant acquisitions and development completions during the course of the year. Leverage was 8.3x, 7.1x and 6.4x as of Dec. 31, 2010, 2009 and 2008, respectively. Fitch projects that leverage will decline to 6.7x in 2013 and 6.2x in 2014, which is more appropriate for a 'BBB+' rated multifamily REIT with ESS' geographic concentration. 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. Further supporting the ratings is a high ratio of unencumbered assets to unsecured debt. Based on applying a 7.5% cap rate to annualized fourth-quarter 2011 unencumbered net operating income (NOI), ESS' unencumbered assets covered unsecured debt 3.0x. The unencumbered pool is growing as the company replaces maturing secured debt with unsecured debt and funds new acquisition and development with equity and unsecured debt. ESS has a manageable debt maturity schedule with only 13.4% of total debt (including pro rata share of JV debt) maturing from Jan. 1, 2012 through Dec. 31, 2013. Fitch calculates that ESS' sources of liquidity (unrestricted cash, availability under its unsecured revolving credit facility, and expected retained cash flows from operating activities after dividend distributions) exceed uses of liquidity (pro rata share of debt maturities, remaining non-discretionary development expenditures and expected recurring capital expenditures) by $552 million from Jan. 1, 2012 through Dec. 31, 2013, resulting in a liquidity coverage ratio of 1.2x, which is appropriate for the 'BBB' rating. The ratings are supported by strong multifamily fundamentals in ESS' markets. ESS' same-property NOI increased by 5.5% in 2011. Fitch anticipates that fundamentals will remain strong due to moderate job growth, limited new supply, and a high cost of for-sale single-family housing in ESS' markets. The ratings also point to the strength of ESS' long-tenured management team, including senior officers and property and leasing managers. Offsetting these credit strengths are the company's high levels of secured debt, geographically concentrated portfolio, and growing active development pipeline. ESS historically has been primarily a secured borrower but began shifting in 2011 to an unsecured funding model. Including $150 million outstanding in its line of credit, the company currently has $615 million (26% of total debt) of unsecured debt on its balance sheet, compared to total debt of $2.4 billion. The 26% is low relative to multifamily REIT peers that generally maintain 50% or more of total debt as unsecured. Essex's current unsecured debt consists of term loans, private placement notes, and its unsecured credit facility. Fitch anticipates that the company will raise additional term loans and private placement notes in 2012 before completing a standard, public REIT unsecured bond offering in 2013. Although Fitch highlights the company's supply-constrained market focus strategy as a credit positive, this is somewhat offset by the geographic concentration in Southern California (47.3% of NOI including JV's at 100%), San Francisco Bay Area (32.5%), and the Seattle metropolitan area (16.8%). 79.8% of same store NOI in 2011 was derived from the state of California (Fitch rates California's general obligation bonds 'A-'; Outlook Stable). While ESS' SSNOI performance has exceeded 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 company maintains an active development pipeline, with total development cost representing 10.5% of total consolidated assets, with $282.6 million remaining to be spent, or 7% of total assets as of Dec. 31, 2011. However, all of the current development pipeline is within JV's, and based on Essex's pro rata share, remaining costs to Essex are $148 million, or 3.7% of total assets. These ratios were as large as 20.5% total cost and 13.2% remaining cost in first-quarter 2008. Should demand decrease in Essex's markets prior to completion, these projects could serve as a drag on cash flows due to longer than projected lease-up at less favorable rental rates. The two-notch differential between ESS' IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with a 'BBB' IDR. Based on '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+': --Net debt to recurring operating EBITDA sustaining below 7.0x (as of Dec. 31, 2011 leverage was 6.9x based on annualized 4Q'11 EBITDA); --Fixed charge coverage sustaining above 2.5x (coverage in 2011 was 2.6x); --Consistent access to multiple sources of capital, including unsecured notes, term loans and common equity. The following factors may result in negative momentum on the ratings and/or Outlook: --Leverage sustaining above 8.0x; --Coverage sustaining below 2.0x; --If operating fundamentals relapse similar to the environment of 2009 in the near term, rather than remaining strong as currently expected; --A liquidity shortfall.
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