TEXT - Fitch affirms EastGroup Properties
Jan 9 - Fitch Ratings affirms the following credit ratings of EastGroup Properties Inc. (NYSE: EGP) and assigns ratings to its operating partnership, EastGroup Properties, LP (collectively EastGroup, or the company): EastGroup Properties, Inc. --Long-term Issuer Default Rating (IDR) at 'BBB'; --Unsecured revolving credit facility at 'BBB'; --Unsecured term loans at 'BBB'. EastGroup Properties, LP (as co-borrower with EastGroup Properties, Inc.) --Long-term IDR at 'BBB'; --Unsecured revolving credit facility at 'BBB'; --Unsecured term loans at 'BBB'. The Rating Outlook is Stable. The rating affirmations reflect EastGroup's credit strengths, including its granular tenant base, modest business risk and appropriate fixed charge coverage ratio. Offsetting these strengths are the company's relatively high leverage for the rating, sizable near-term lease maturities and relatively small size. The Stable Outlook considers the strong unencumbered asset coverage of unsecured debt, adequate liquidity ratio and conservative business profile. EastGroup is small relative to its industrial and REIT peers with undepreciated book assets of $1.8 billion as of Sept. 30, 2012. The company has historically been a property-level secured borrower but has begun transitioning to an unsecured funding structure. Currently, 78% of debt is secured; however, EGP's secured debt to undepreciated assets ratio is 34%, leaving a significant amount of unencumbered operating assets. EastGroup's portfolio is focused primarily in the Sunbelt region with over 86% of annual base rent derived from the states of Texas (30.9%), Florida (30.5%), California (17.1%), and Arizona (8.3%), as of Sept. 30, 2012. The largest individual market exposures by contribution to base rent are Houston (18.3%), Tampa (12.7%), Orlando (8.3%), San Antonio (7.5%) and Los Angeles (7.4%). Many of these markets have been negatively impacted by the recent recession and are prone to overdevelopment, which Fitch views negatively. However, this risk is partially offset by the relative strength of the Houston market through the most recent economic cycle. EGP's operating fundamentals continue to be mixed. Occupancy has improved to 94.3% at Sept. 30, 2012 from 89.8% at Dec. 31, 2010. However, rent trends continue to be negative and Fitch expects this pattern to continue over the near term, as expiring rents signed during the market peak continue to see negative mark-to-market re-leasing spreads in the current difficult leasing environment. That said, spreads have seen improvement during 2012, with negative rent spreads of 6.1% year to date compared to negative 14.8% in 2011, negative 16.8% in 2010 and negative 10.1% in 2009. Fitch expects the company will continue to experience negative, but improving leasing spreads well into 2013, given market forecasts for improved asking rents. Fitch notes that a disproportionate amount of 2013 lease maturities are from weaker performing Florida markets, which is likely to pressure same-store performance. This will be offset somewhat by sizable expirations in stronger Texas markets, as well as a reduction in expiring rents that were signed during the market peak. Same-store net operating income (SSNOI) growth for the third quarter 2012 was 0.8%, excluding straight-line rent adjustments, compared with 2.2% in 2Q12 and 4% in 1Q12. The slowing growth is attributed to the aforementioned weak leasing spreads and a reduction in the benefit from previous occupancy gains. Fitch expects that the difficult leasing environment and elevated lease expirations will pressure same-store growth in 2013 despite the recovery in occupancy levels. EastGroup's portfolio benefits from tenant diversification with the top 10 tenants representing less than 10% of annual base rent as of Sept. 30, 2012. The company focuses on users of smaller industrial space sizes - typically in the range of 5,000 to 50,000 square feet - which enables the company to maintain its extensive tenant roster with minimal exposure to any one tenant. EGP's tenants, whether national or local, tend to be location sensitive, and primarily distribute to the metro area in which the space is located rather than to a much larger region or the entire country. EastGroup's fixed charge coverage levels have improved in recent years, driven by growth in same-store NOI, ramp up of acquisitions and development completions, and moderating capex. Fixed charge coverage troughed in 2010 at 2.0x from 2.4x the prior two years. For the 12 months ended Sept. 30, 2012, fixed charge coverage was 2.4x and Fitch expects this metric to remain around this level through 2014. Fitch defines fixed charge coverage as recurring operating EBITDA less recurring capital expenditures (tenant improvements and leasing commissions) less straight line rent adjustments, divided by total interest incurred. In a downside case not expected by Fitch in which same-store NOI declines are consistent with EastGroup's performance in 2009 and 2010, fixed charge coverage would approach 2.1x, which would be weak for the current rating. EastGroup has been cautious with development projects and is prudently developing build to suit projects or buildings co-located to other properties that have solid demand and growth prospects. The company has managed its development activities such that the total estimated cost of its wholly owned development pipeline represented only 3.7% of total undepreciated assets, while the cost-to-complete was only 1.5% as of Sept. 30, 2012. Fitch would view negatively a material increase in speculative development, particularly if it were focused on geographic regions outside of management's area of expertise, although this is not currently a rating concern. Leverage (net debt to recurring operating EBITDA) was 6.5x as of Sept. 30, 2012, compared with 7.3x and 6.6x at Dec. 31, 2011 and 2010, respectively. Leverage is high for the 'BBB' rating due to recent acquisitions and developments funded with limited equity raises. Sustained leverage at this level could have negative rating implications. Fitch forecasts leverage to remain relatively stable through 2014 due to improving fundamentals, a normalized run rate on NOI from recent acquisitions, and stabilization of development projects, offset by incremental unsecured debt borrowings to finance investments and development. In a downside case not expected by Fitch in which same-store NOI declines are consistent with EastGroup's performance in 2009 and 2010, leverage would trend over 7.5x, which would be more consistent with a 'BBB-' rating. Although the company is small, it maintains 45% of its square footage unencumbered as of Sept. 30, 2012. As such, the company maintains strong contingent liquidity measured by unencumbered assets to unsecured debt. Unencumbered assets (calculated as unencumbered NOI divided by a stressed capitalization rate of 9%) covered unsecured debt by 3.6x, which is strong for a 'BBB' rating. The company has a base case liquidity coverage ratio of 1.1x as measured by sources of liquidity (unrestricted cash, availability from the company's unsecured revolving credit facility, projected retained cash flows from operating activities after dividends) divided by uses of liquidity (debt maturities and projected recurring capital expenditures) for the period from Oct. 1, 2012 to Dec. 31, 2014. If EastGroup refinanced 80% of its secured debt maturing through Dec.31, 2014, liquidity coverage would be 2.3x. The Stable Outlook reflects Fitch's view that EGP will maintain strong coverage of unsecured debt by unencumbered assets and an adequate liquidity ratio and conservative business profile that will result in credit metrics remaining appropriate for the 'BBB' rating. Fitch expects the company to maintain appropriate fixed charge coverage near 2.4x, and for leverage to remain around 6.5x. In addition, EastGroup has exhibited good access to the secured debt market and Fitch expects that the company will continue to access more unsecured debt and further establish itself in that market, which will provide additional financial flexibility. While Fitch does not expect near-term positive rating momentum, the following factors may result in positive momentum in the ratings and/or Rating Outlook: Fitch's expectation of net debt to recurring operating EBITDA sustaining below 5.5x for several quarters (leverage was 6.5x as of Sept. 30, 2012); Fitch's expectation of fixed-charge coverage sustaining above 2.8x for several quarters (coverage was 2.4x for the 12 months ended Sept. 30, 2012); Demonstrated access to the unsecured bond market The following factors may result in negative momentum on the ratings and/or Rating Outlook: Fitch's expectation of leverage sustaining above 6.5x for several quarters; Fitch's expectation of fixed-charge coverage sustaining below 2.0x for several quarters; Fitch's expectation of unencumbered asset to unsecured debt ratio sustaining below 3.0x (this ratio was 3.6x as of Sept. 30, 2012); An AFFO payout ratio in excess of 100% (payout was 89% for the 12 months ended Sept. 30, 2012)
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