TEXT - S&P rates FelCor Lodging LP senior notes 'B-'
Overview -- U.S.-based FelCor Lodging L.P. is issuing $500 million senior secured notes due 2022 and using the proceeds to repay debt. -- We are assigning the notes our 'B-' issue-level rating with a recovery rating of '3'. -- The stable outlook reflects credit measures that we expect to be in line with the current rating through 2013. Rating Action On Dec. 12, 2012, Standard & Poor's Ratings Services affirmed all existing ratings, including the 'B-' corporate credit rating, on Irving, Texas-based FelCor Lodging L.P. The outlook is stable. At the same time, we assigned the company's proposed $500 million senior secured notes due 2022 its 'B-' issue-level rating (at the same level as our 'B-' corporate credit rating on FelCor Lodging Trust Inc.). We also assigned this debt a recovery rating of '3', indicating our expectation for meaningful (50% to 70%) recovery for lenders in the event of a payment default. The company expects to use the proceeds from the proposed notes to repay the $186.5 million outstanding principal on its mortgage debt due 2015, pay a portion of the company's 10% senior secured notes due 2014, and pay fees and expenses related to the transaction. We also placed our issue-level rating on the company's 10% senior secured notes on CreditWatch with positive implications. The repayment of a portion of the company's 10% senior secured notes using the proposed notes proceeds would result in a lower level of secured debt outstanding under our simulated default scenario compared with our previous analysis. This would increase the recovery prospects for the 10% senior secured notes enough to warrant an upward revision to our recovery rating on the notes. Upon closing of the proposed senior secured notes, we expect to revise our recovery rating on the 10% senior secured notes to '1' (90% to 100% recovery expectation) from '3' (50% to 70% recovery expectation) and raise our issue-level rating to 'B+' (two notches higher than the corporate credit rating) from 'B-' (the same as the corporate credit rating), in accordance with our notching criteria. Rationale Our corporate credit rating reflects our assessment of the company's financial risk profile as "highly leveraged" and our assessment of the company's business risk profile as "fair," according to our criteria. Our assessment of FelCor's financial risk profile as highly leveraged reflects very high debt levels, with our measure of lease- and preferred stock-adjusted total debt to EBITDA in the low-10x area (pro forma for the proposed transaction) and funds from operations (FFO) coverage of interest and preferred dividends anticipated to be in the low-1x area at the end of 2012. We expect leverage to improve to the low-9x area and coverage to remain in the low-1x area at the end of 2013. These measures incorporate the completed sale of 10 hotels in 2012 for an estimated $207 million in gross proceeds, and the expected sale of an additional 10 hotels in 2013 for approximately $235 million in gross proceeds based upon FelCor's current estimates. Slightly offsetting high leverage and weak coverage measures is our expectation for revenue per available room (RevPAR) growth in the U.S. lodging industry through 2014. Our assessment of FelCor's business risk profile as fair is based on its geographically diversified hotel portfolio in the U.S. and its good relationships with key brand owners. Risk factors include FelCor's reliance on external sources of capital for growth as a REIT, the cyclical nature of the lodging industry, and the associated revenue and earnings volatility of the company's owned hotel portfolio. Additionally, concurrent with completed and planned hotel sales, the company recently completed hotel acquisitions at high multiples and is investing in hotel development in order to expand its presence in the Manhattan hotel market. While we view the demand characteristics of the Manhattan market favorably, we believe FelCor's use of its balance sheet to pursue growth initiatives at high multiples will limit leverage reduction through 2013 stemming from the company's current significant asset sale program. Earlier this year, FelCor said it expects the Knickerbocker to be its last acquisition in this cycle. Through the first nine months of 2012, same-store consolidated RevPAR at FelCor increased 5.1%, driven by a 5.8% increase in ADR and partially offset by a 50-basis-point decrease in occupancy. Displacement from renovations was the primary cause for the occupancy decline. Same-store adjusted EBITDA (excluding hotels sold or acquired during the year) increased approximately 8%. FelCor recently lowered its guidance for 2012 same-store RevPAR to 5.25% to 5.75% from 5.5% to 6% due to the effects of Hurricane Sandy on some of the company's properties. Over the past year, FelCor completed several hotel transactions: -- In February 2012, FelCor announced the acquisition and redevelopment of the Knickerbocker Hotel in Times Square in a joint venture with manager Highgate Partners (FelCor owns 95%). The joint venture paid $115 million for the Knickerbocker land and shell currently in place, and will spend approximately $115 million to develop the hotel for a late-2013 opening. The aggregate cost is approximately $700,000 per key, and FelCor expects the property to generate $14 million in EBITDA in its first year of operation in 2014 and ramp up to $25 million in 2016. -- In June 2012, FelCor announced that it completed the sale of six out of a total 16 currently listed non-strategic hotels for $103 million as part of its planned asset sale program. FelCor said the purchase price represented a 6.8% capitalization rate based on 2011 net operating income. The company used the proceeds to repay $73 million in secured debt and other costs at closing and used the remaining $30 million of proceeds to pay down a portion of its $67.7 million in accrued preferred dividends on July 31, 2012. -- In August 2012, the company sold one hotel for $25.5 million and in October 2012, the company sold two hotels for $70 million. The proceeds were used to repay a portion of the CMBS loan due 2013 and the remaining $38 million of accrued preferred dividends on Oct. 31. In addition, the company closed five single asset mortgage loans totaling $160.8 million that mature in 2022. A portion of the proceeds from the new loans was used to repay the $107 million balance of the mortgage loan due 2014 and the remaining balance of the CMBS loan. The repaid 2014 mortgage loan was secured by a pool of seven hotels, including four of the five hotels mortgaged to support the new loans. The remaining three hotels that secured the repaid loan are now unencumbered. -- In November 2012, the company announced its plan to sell one hotel for $8.7 million. The proceeds of the sale will be used to repay a portion of the company's line of credit. On its third-quarter earnings call, FelCor said it plans to close the sale of the remaining 10 hotels currently on the market in 2013. It has an additional 10 hotels yet to be brought to market. Key aspects of our operating performance expectations for FelCor are: -- The rating is supported by the good expected lodging environment. We expect U.S. RevPAR to increase between 5% and 7% in 2012 and between 3% and 6% in 2013. -- Given U.S. RevPAR strength, we believe management's RevPAR growth guidance for 2012 at FelCor is reasonable, and that the company could produce same-store EBITDA growth in the high-single-digit percentage area this year. We have incorporated into the rating that FelCor's RevPAR grows in the mid-single digits and EBITDA grows in the high-single digits in 2013. -- However, primarily because of increased leverage from the Knickerbocker acquisition and redevelopment and a smaller number of hotel sales in 2012 than we previously expected, we believe FelCor's total lease- and preferred stock-adjusted debt to EBITDA will be in the low-10x (pro forma for the proposed transaction), and that FFO coverage of interest and preferred dividends will be in the low-1x area in 2012, with leverage improving to the low-9x area and coverage remaining in the low-1x area in 2013. -- These measures incorporate the sale of 10 hotels in 2012 for $207 million and the sale of the remaining 10 hotels currently on the market in 2013 for approximately $235 million based upon FelCor's current estimates, and use of proceeds to eliminate the accrued preferred dividend in arrears and for debt repayment. Liquidity Based on its likely sources and uses of cash over the next 12 to 18 months and incorporating our performance expectations, FelCor has an adequate liquidity profile, according to our criteria. Relevant expectations and assumptions in our assessment of FelCor's liquidity profile include: -- We expect sources of liquidity over the next 12 to 18 months to cover uses by at least 1.2x. -- Net sources of liquidity should remain positive, even if EDITDA declines by 15%. -- FelCor's $225 million secured revolving line of credit imposes a minimum debt service coverage ratio (DSCR) of 1.35x between March 5, 2012, and March 4, 2013. Drawings under the revolver were $117 million at September 2012, and coverage of debt service was significantly higher than the covenant level. The DSCR steps up to 1.4x between March 5, 2013, and Aug. 1, 2014, and to 1.5x thereafter. Starting Sept. 4, 2012, an additional financial covenant became effective: the loan-to-value ratio for collateralized properties cannot exceed 60%. -- As a REIT, FelCor pays out at least 90% of its taxable income as dividends, and relies on external sources of liquidity and asset sales to fund growth. As of September 2012, FelCor had $112 million in cash on hand and a $225 million line of credit of which $117 million was drawn. Cash balances do not include restricted cash of $82 million, $65 million of which is currently pledged as collateral for a loan assumed to purchase the Knickerbocker. FelCor expects capital spending in 2012 to be $120 million and we expect FelCor to fund it with operating cash flow and cash balances. In 2011, FelCor generated approximately $46 million in operating cash flow, a decline from $67 million in 2010, primarily on a decrease in accrued expenses and liabilities. In 2011, FelCor generated $161 million in net proceeds from common stock issuance and $133 million in net asset sale proceeds, largely used to finance hotel acquisitions and repay debt balances. In 2012, we expect FelCor to generate between $70 million and $80 million in operating cash flow. We expect approximately $115 million in spending related to the Knickerbocker redevelopment to occur over two years, partly funded with a bank construction loan. Through the nine months ended September 2012, FelCor received $207 million in gross proceeds from asset sales, which it used for debt repayment and to eliminate the preferred dividend in arrears. Pro forma for this transaction, FelCor currently has no debt maturities until 2014. Outlook The stable rating outlook reflects credits measures that we expect to be in line with the current rating through 2013. The company is currently experiencing good operating momentum. However, notwithstanding the company's significant asset sale program, we expect FelCor's recent use of its balance sheet to pursue growth initiatives will likely result in modest leverage reduction through 2013. At the end of 2012, we expect our measure of adjusted leverage to be in the low-10x area (pro forma for the proposed transaction) and FFO coverage of interest and preferred dividends to be in the low-1x area. Also, these measures include a pro forma level of EBITDA from acquired hotels and exclude a pro forma level of EBITDA for planned hotel sales. We anticipate credit metrics will improve modestly in 2013 because of planned asset sales and continued lodging recovery. A lower rating could result from an unexpected significant slowdown or downturn in the U.S. lodging industry, which would likely drive FFO coverage of interest and preferred dividends closer to 1x and strain FelCor's liquidity profile. A one-notch higher rating would require a sustained improvement in FFO coverage of interest and preferred dividends to at least the mid-1x area, as well as a reduction in the company's total adjusted debt to EBITDA to the mid-7x area. Related Criteria And Research -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Use Of CreditWatch And Outlooks, Sept. 14, 2009 -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Ratings Affirmed FelCor Lodging Trust Inc. Corporate Credit Rating B-/Stable/-- FelCor Lodging L.P. Senior Secured B- Recovery Rating 3 FelCor Lodging Trust Inc. Preferred Stock CCC- Ratings Affirmed; CreditWatch Action To From FelCor Lodging L.P. $636 mil. sr sec notes due 2014 B-/Watch Pos B- Recovery Rating 3 3 New Rating FelCor Lodging L.P. Senior Secured US$500 mil nts due 09/01/2022 B- Recovery Rating 3
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