TEXT-S&P summary: AvalonBay Communities Inc.
We viewed the company's recently announced agreement to acquire 40% of Archstone Enterprises L.P. from Lehman Brothers Holdings for roughly $6.9 billion (excluding transaction costs) as a strategic positive for AVB with limited integration risk. After the transaction closes (scheduled for the first quarter of 2013), we believe AVB's expanded platform should also provide a greater cushion for the company's historically sizeable development pipeline. We further expect AVB to continue pursuing strategies that will return key credit metrics to pre-Archstone announcement levels by the end of 2013.
As of Sept. 30, 2012, Alexandria, Va.-based AVB was the third-largest multifamily REIT that we rate, with a $9.9 billion real estate portfolio (on an undepreciated cost basis). The Archstone transaction will expand AVB's asset base by roughly 70% to $16.8 billion. Operationally, AVB will be adding 66 communities totaling 22,222 units (about $275,000 per unit) to its existing platform of 205 communities with 60,101 units (includes properties under development or reconstruction). Since the properties AVB is acquiring are located in the company's existing markets, consistent with the company's coastal market strategy, we believe the transaction makes sense from both a business and portfolio perspective.
Pro forma for the acquisition, AVB's exposure in Southern California will increase to 20% of net operating income (NOI; from 14%). This is a region in which AVB has wanted to increase its footprint. We note that exposure to Washington, D.C., will rise to 18% (from 13%). This market has experienced some softness recently and we expect the D.C. market to continue to face pressure in 2013. The transaction will also modestly reduce AVB's exposure in New England to 14% (from 19%) and reduce exposure to the metro New York/New Jersey area to 25% (from 29%). In our view, property integration risk is limited given geographic market and operating systems overlap. In addition, the transaction could provide certain operating efficiencies to AVB, particularly as the company spreads overhead across a larger asset base and pursues some rebranding initiatives within the combined property portfolio.
Assuming the Archstone transaction proceeds as expected, our base-case scenario analysis for the rest of 2012 and 2013 anticipates continued strong occupancy levels in the mid-90% area with some moderation in rent growth, resulting in same-store NOI growth of 7%-8% and 4%, respectively. Following recent common equity and unsecured note issuances (completed to fund AVB's equity portion of the transaction), we estimate incremental debt by year-end 2013 of roughly $2 billion (bringing total debt to $6 billion) and EBITDA of around $950 million). We estimate key credit metrics will end 2013 at levels near current, pretransaction levels, including debt-to-EBITDA in the low 6x area and fixed-charge coverage (FCC) in the mid-3x range. After adjusting for one-time expected transaction costs and an assumed dividend increase in 2013, we estimate the company will adequately cover its common dividend, as well.
We view AVB's liquidity position as "adequate" relative to our assessment of its capital needs through 2013. Our liquidity assessment is based on the following factors and assumptions:
-- We expect the company's liquidity sources over the next 12 months to exceed its uses by 1.2x or more;
-- AVB's near-term debt maturities are manageable, in our view, at about 15% of total debt;
-- Secured debt levels will rise with the Archstone transaction, but expected secured debt repayment over the next two years should restore unencumbered NOI close to pretransaction levels;
-- There is sufficient covenant headroom for EBITDA to decline by 15% without AVB breaching its debt coverage test; and
-- AVB has good relationships with its banks and, according to our assessment, has a high standing in the credit markets.
As part of the Archstone financing plan, AVB recently tapped the capital markets, raising $2.1 billion in new common equity followed by $250 million in new 2.85% unsecured notes (due 2023). In addition, AVB plans to issue $1.9 billion in additional equity directly to Lehman at closing and will assume more than $2 billion of consolidated debt (adjusted for some expected debt repayment from the equity and debt sale proceeds). Once the transaction closes, we note that the most meaningful debt maturity that AVB will face as part of this transaction will be a roughly $940 million secured loan (6.193%, fixed rate with Fannie Mae ) that is set to mature in November 2015.
Separate from the Archstone transaction, we estimate AVB's capital needs through 2013 will include an estimated $50 million in annual maintenance capital expenditures, $301 million in unsecured note maturities, and an estimated $1.2 billion in development/redevelopment spending. Sources of capital available to the company (at the end of the third quarter) to meet these needs included cash and unrestricted cash in escrow of $714 million and full availability on AVB's $750 million unsecured revolver (expandable to $1.3 billion) which is due in November 2015. We expect roughly $550 million in common dividends to be adequately covered via AVB's funds from operations.
AVB will initially assume a sizeable amount of secured debt with the Archstone transaction and will likely dispose of some unencumbered assets in the coming year as it rebalances its portfolio. As a result, we expect unencumbered NOI levels to decline to 60% (from 73% currently). However, anticipated secured debt repayments and the completion of projects currently under development should restore unencumbered NOI to close to pretransaction levels over the next two years. We note that AVB was comfortably in compliance with all of its bank and bond covenants as of Sept. 30, 2012.
The stable outlook reflects our expectations for continued favorable, albeit modestly decelerating apartment fundamentals. We view AVB's acquisition of the Archstone assets as strategically positive for the business with limited operational integration risk. AVB's key credit metrics will decline over the next two quarters from their strong pretransaction levels, but we expect they will be largely restored by the end of 2013 (with debt-to-EBITDA in the low 6x area and FCC in the mid-3x range). The company has raised the capital required to fund the transaction well in advance of the expected closing and operations should adequately cover the common dividend, which limits near-term downside risk to ratings, in our view. At the same time, we see limited prospects for near-term ratings improvement, given AVB's significant exposure to development activity.