TEXT-S&P raises Forest City Enterprises notes to 'B'
Overview -- We affirmed our corporate credit rating on Forest City Enterprises at 'B+'. -- We revised our recovery rating on Forest City's senior unsecured debt to '5' from '6', indicating our expectation of a modest recovery (10%-30%) in the event of a payment default. This improvement prompted us to upgrade Forest City's senior unsecured notes to 'B' from 'B-'. -- Our outlook on the company is stable because we expect the company's diverse portfolio to continue to produce modestly positive same-store net operating income through 2013. Rating Action On Nov. 28, 2012, Standard & Poor's Ratings Services affirmed its 'B+' corporate credit rating and stable outlook on Forest City Enterprises Inc. . At the same time, we revised our recovery rating on the rated senior unsecured notes to '5' from '6', indicating that lenders can expect a modest recovery (10%-30%) in the event of a payment default. This improvement resulted in the upgrade of the company's senior unsecured notes to 'B' from 'B-'. We also affirmed our 'CCC+' rating on the company's convertible preferred stock. Rationale Standard & Poor's ratings on Forest City Enterprises Inc. reflect a "highly leveraged" financial risk profile with modestly improved, but still low, Standard & Poor's-derived debt coverage measures (due to sizeable investments in nonrevenue-generating development pursuits) and a fully encumbered operating portfolio. We consider the company's business risk profile to be "fair," reflecting Forest City's well-diversified (office, retail, multifamily) operating portfolio, which has generated low-single-digit same-property net operating income (NOI) growth this year. Forest City's capital-raising activities since the downturn and pared development pursuits improved the company's liquidity, which we believe is adequate to meet funding needs through year-end 2013. Once completed, development projects will begin to contribute to earnings. While we expect investment yields on Forest City's development pipeline will likely be low (due to lower rents and less-robust tenant demand than originally contemplated), as projects stabilize and contribute to cash flow, we expect Forest City's fixed-charge coverage (currently 1.2x) and debt-to-EBITDA (14x) metrics to improve over the next one to two years. Cleveland-based Forest City has a large, diverse portfolio of real estate properties. Forest City has renewed its strategic focus on its rental properties in the office (35.7% of total NOI), retail (33.2%), and apartment (23.3%) sectors. Military housing (4.1%), land (2.4%), and hotels (1.3%) contribute the remaining NOI, although the company's decision to strategically exit the land business, through asset sales, resulted in impairments of $119.3 million in the fiscal year ended Jan. 31, 2012 and $41.9 million from Jan. 31, 2012 through July 30, 2012. Same-property NOI within Forest City's operating portfolio increased 5.0% in the company's fiscal second quarter ended July 31, 2012. Same-property NOI within the company's conventional apartment portfolio showed comparative strength, rising 10.3% year-over-year. We expect same-store NOI to rise in the low-single digits during the next six quarters. We expect the company to continue pursuing development, a core competency of Forest City; however, we expect management to limit the size (less than 15% of balance sheet assets), scope (smaller projects with shorter cycle times and improved visibility), and risk profile (less speculative development through greater preleasing) of development going forward. Following the September opening of the Barclay's arena, Forest City's seven remaining projects under construction have a total cost at full consolidation of $374 million ($309 million at the company's stake). We expect the company will fund its remaining costs with a combination of in-place construction loans and additional equity. Our base-case assumptions for the second half of 2012 and full-year 2013 include: development investment (including leasing related costs at properties that were completed but are not yet stabilized) of roughly $50 million in the second half of 2012 and $150 million next year, which the company would fund largely with asset recycling (sale or joint venture) proceeds. We believe that capital costs upon the refinancing of nonrecourse debt at maturity are flat (at 5.05%) and that same-store NOI rises in the low single-digit area. We expect earnings from newly completed projects and continued internal growth will support modestly improved EBITDA coverage measures over the next six quarters. Forest City was in compliance with the covenants that govern its bonds as of July 31, 2012 including a 1.30x minimum consolidated EBITDA-to-interest ratio (actual coverage was 1.73x). Forest City was also in compliance with the covenants that govern its credit facility as of July 31, 2012: 1.35x minimum debt service coverage (actual coverage was 1.88x). Standard & Poor's adjusted fixed-charge coverage for the trailing-12-months ended July 31, 2012, while low at 1.2x, has been stable for several quarters. Liquidity Forest City's liquidity position is adequate, as its current capital sources are sufficient relative to the company's capital needs over the six quarters ended Jan. 31, 2014, in our view. Our assessment of Forest City's liquidity profile incorporates the following expectations and assumptions: -- We expect the company's sources of liquidity, including cash and credit facility availability, to exceed uses by 1.2x over the next six quarters; -- Forest City has good relationships with its banks and mortgage lenders, in our view. Forest City's elimination of its completely discretionary common dividend three years ago boosted retained cash by roughly $30 million annually. Forest City's unrestricted cash and equivalents totaled $241 million on July 31, 2012, and the company's $450 million revolving line of credit (due March 30, 2014) had $379 million availability, net of letters of credit outstanding. Further, we assume that Forest City generates net cash proceeds of $160 to $250 million from asset sales over the next six quarters. While asset sales are generally volatile and the timing may be difficult to determine, we acknowledge the company's sales activity over the prior 10 years has generated over $1.2 billion of cash proceeds. Uses of capital through 2013 include Forest City's $146 million of capital investment in development projects. We assume portfolio capital expenditures of roughly $100 million annually during 2012 and 2013. The company faces the maturity of a $29 million subordinated tax revenue bond in 2013, and its next unsecured debt maturity in 2014 ($199 million 3.625% putable equity linked senior notes). The majority of the company's debt (roughly 83%) consists of nonrecourse, long-term property-level mortgages that are not cross-collateralized, which isolates the impact of a mortgage default at the property level. We conservatively assume Forest City refinances its mortgage debt as it matures ($1.05 billion is due in the remaining six months of Forest City's fiscal year ending Jan. 31, 2013, and $0.8 billion is due in the following fiscal year ending Jan. 31, 2014), at similar rates and similar principal amounts, on average, in contrast to the company's previous strategy of raising excess proceeds upon refinancing. Recovery analysis The rating on Forest City's senior unsecured notes is 'B' (one notch below the corporate credit rating), with a recovery rating of '5', which indicates our expectation for a modest recovery (10%-30%) in the event of a payment default. For the complete recovery rating analysis, please see "Forest City Enterprises, Inc.'s Recovery Rating Profile," to be published shortly on RatingsDirect on the Global Credit Portal, at www.globalcreditportal.com. Outlook The outlook is stable. Portfolio performance trends have been strengthening, and we expect same-property NOI to remain positive through 2013. Forest City has also modestly reduced leverage, leading to improved, albeit still slim, fixed-charge coverage. We believe that coverage measures will continue to improve as development projects stabilize and begin to contribute to cash flow over the next one-to-two years. We would consider raising the ratings if Forest City improves its Standard & Poor's-derived fixed-charge coverage measures comfortably above 1.3x, improves debt-to-EBITDA below 12x, reduces leverage, and limits the size, scope, and risk profile of future development. Alternatively, we would lower the ratings if recent improvements in Standard & Poor's-derived fixed-charge coverage were to reverse course, if the company's coverage covenant cushion deteriorates from its current level (1.9x credit facility covenant calculation and 1.7x bond indenture), and/or liquidity becomes constrained. Temporary telephone contact numbers: Beth Campbell (973-986-8052); Lisa Sarajian (917-763-1459). Related Criteria And Research -- Industry Report Card: Strong Capital Access And Gradually Improving Fundamentals Continue To Support North American REITs, Oct. 19, 2012 -- Issuer Ranking: North American REITs and Real Estate Operating Companies, Strongest To Weakest, Oct. 10, 2012 -- Criteria/Corporates/Industrials: Key Credit Factors: Global Criteria For Rating Real Estate Companies, June 21, 2011 Ratings List Ratings Affirmed Forest City Enterprises Inc. Corporate Credit Rating B+/Stable/-- Forest City Enterprises Inc. Preferred Stock CCC+ Rating Raised; Recovery Rating Revised To From Forest City Enterprises Inc. Senior Unsecured B B- Recovery Rating 5 6 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
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