Fitch Affirms Healthcare Realty's IDR at 'BBB-'; Outlook Stable

Fri Oct 18, 2013 1:34pm EDT

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(The following statement was released by the rating agency) NEW YORK, October 18 (Fitch) Fitch Ratings has affirmed the Issuer Default Rating (IDR) of Healthcare Realty Trust Incorporated (NYSE: HR) as follows: --IDR at 'BBB-'; --Unsecured line of credit at 'BBB-'; --Senior unsecured notes at 'BBB-'. The Rating Outlook is Stable. KEY RATINGS DRIVERS The ratings reflect the expectation for improving leverage and fixed charge coverage metrics, offset in large part by weak contingent liquidity and an adjusted funds from operations (AFFO) payout ratio in excess of 100%. The ratings also reflect the company's geographically diversified portfolio, positive medical office fundamentals, strong liquidity and manageable debt maturity schedule. The Stable Outlook is based on Fitch's expectation that credit metrics will continue to improve; however, positive momentum is restrained by weak unencumbered asset coverage of unsecured debt. Thus the overall credit profile will remain consistent with a 'BBB-' rating. STRENGTHENING CREDIT METRICS Net debt-to-trailing 12 months (TTM) ended June 30, 2013 recurring operating EBITDA was 7.0x as compared to 7.0x and 8.4x at year-end 2012 and 2011, respectively. Fitch forecasts leverage will improve towards 6.5x through 2015, which may be consistent with a higher rating all else being equal. Fixed-charge coverage was 2.0x for the TTM ended June 30, 2013, compared with 1.9x and 1.6x during full years 2012 and 2011 and is forecast to improve towards 2.4x through 2015. The amount and pace by which leverage and fixed-charge coverage improves will be dictated in large part by the lease-up of properties in stabilization. Fitch defines fixed-charge coverage as recurring operating EBITDA less Fitch's estimate of routine capital expenditures less straight-line rent adjustments, divided by total interest incurred. STRONG LIQUIDITY AND MANAGEABLE MATURITY SCHEDULE Healthcare Realty's liquidity coverage ratio is strong for the rating at 3.3x for the period July 1, 2013 to Dec. 31, 2015 and a key credit strength. The ratio is driven primarily by HR's manageable and long-dated debt maturity schedule which does not have a recourse debt obligation maturing until 2017. Fitch calculates liquidity coverage as sources of liquidity (unrestricted cash, availability under its unsecured revolving credit facility, projected retained cash flows from operating activities after dividend payments) divided by uses of liquidity (debt maturities, projected routine capital expenditures and development and construction mortgage funding commitments). PORTFOLIO DIVERSIFICATION The company's portfolio of predominantly on-campus, medical office buildings (MOBs) is geographically diversified save for its exposure to Texas (which comprised 29.8% of square footage at June 30, 2013). Following Texas were Tennessee (10.4%), Virginia (7.6%) and North Carolina (5.5%), with no other state exceeding 5% of the total portfolio. The portfolio is also well diversified by tenant with the top 10 tenants making up less than 28% of leased square footage. Healthcare Realty's portfolio positions the company to benefit from increasing demand for health care services, given Fitch's expectation of continued growth in the health care industry due to demographic trends. WEAK CONTINGENT LIQUIDITY Offsetting these credit strengths is weak contingent liquidity. Unencumbered asset coverage of unsecured debt was 1.3x at June 30, 2013. Fitch has previously stated that maintenance of unencumbered asset coverage below 1.5x may result in negative momentum in the ratings and/or Outlook. However, Fitch notes that incremental EBITDA from the stabilization-in-progress (SIP) portfolio will improve the ratio towards 1.6x, all else being equal. Fitch calculates asset coverage as unencumbered TTM EBITDA, divided by a stressed 9% capitalization rate, divided by unsecured debt. SIP LEASING CHALLENGES DRIVE AFFO PAYOUT RATIO ABOVE 100% Over the past few years, expiring master leases were converted to operating leases with underlying tenants, driving a near-term reduction to occupancy as the company became responsible for leasing up the vacancy in those properties. The stabilized portfolio's occupancy declined to 87% in 2Q'13 from 91% in 4Q'08. HR also faces significant lease expirations through 2014 when 29% of revenues expire. Elevated lease expirations reduce the certainty and durability of the cash flows that support the rating. Finally, leasing for the $449 million of SIP properties has continued to progress slowly, at 69% leased and 45% occupied at June 30, 2013. The aforementioned leasing challenges have resulted in an AFFO payout ratio above 100%, which is a credit concern. Although HR modestly covers its dividend on a funds from operations (FFO) basis with a payout ratio of approximately 98% in 2Q'13 and 92% in 2012, the dividend is not covered when based on Fitch's estimate of AFFO. Fitch calculates AFFO as funds available for distribution less certain adjustments and Fitch's estimate of recurring capital expenditures (tenant improvements, leasing commissions and maintenance capital expenditures). The payout ratio based on AFFO was approximately 114% in 2Q'13 and 113% in 2012. The earnings drag from the slow lease-up of properties in stabilization contributes to this high payout ratio and limits Healthcare Realty's ability to generate internal liquidity. In turn, HR needs to draw on its credit facility or source other forms of liquidity to fund a portion of the common dividend. An AFFO payout ratio in excess of 100% is inconsistent with an investment-grade rating and could have negative rating implications. CREDIT METRIC VOLATILITY The company has periodically funded acquisitions and development initially with debt, prior to deleveraging over time principally through equity issuances and/or the lease-up of development properties. As such, leverage may periodically remain high and coverage may remain low. This has increased risk, as the capital markets may be expensive or difficult to access when needed or fundamentals may be challenging when development properties need to be leased-up. STABLE OUTLOOK The Stable Outlook is driven by Fitch's expectation that HR's forecasted improvements in leverage and fixed-charge coverage in excess of Fitch's rating sensitivities are offset by weak contingent liquidity and maintenance of an AFFO payout ratio above 100% (two rating sensitivities that could result in negative momentum). RATING SENSITIVITIES The following factors may have a positive impact on HR's ratings and/or Outlook: --Fitch's expectation of leverage sustaining below 7.0x (leverage was 7.0x as of June 30, 2013); --Fitch's expectation of fixed-charge coverage sustaining above 2.0x (coverage was 2.0x for the TTM ended June 30, 2013); --Fitch's expectation of unencumbered asset coverage of unsecured debt sustaining above 2.0x (coverage was 1.3x as of June 30, 2013). The following factors may have a negative impact on HR's ratings and/or Outlook: --Unencumbered asset coverage of unsecured debt sustaining below 1.5x); --An AFFO payout ratio sustaining above 100%; --Fitch's expectation of leverage sustaining above 8.0x; --Fitch's expectation of fixed-charge coverage sustaining below 1.5x. Contact: Primary Analyst Britton Costa Associate Director +1-212-908-0524 Fitch Ratings, Inc. One State Street Plaza New York, NY 10004 Secondary Analyst Reinor Bazarewski Associate Director +1-212-908-0291 Committee Chairperson Megan Neuburger Senior Director +1-212-908-0501 Media Relations: Sandro Scenga, New York, Tel: +1 212-908-0278, Email: Additional information is available at ''. Applicable Criteria and Related Research: --'Corporate Rating Methodology,' Aug. 5, 2013; --'Criteria for Rating U.S. Equity REITs and REOCs,' Feb. 26, 2013; --'Recovery Rating and Notching Criteria for Equity REITs,' Nov. 12, 2012. Applicable Criteria and Related Research: Recovery Rating and Notching Criteria for Equity REITs – Effective May 12, 2011 to May 3, 2012 here Criteria for Rating U.S. Equity REITs and REOCs here Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage here Additional Disclosure Solicitation Status here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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