Nov 19 - Fitch Ratings has revised the Rating Outlook on DDR Corp. (NYSE: DDR) to Positive from Stable. In addition, Fitch affirmed the following credit ratings of DDR:
--Issuer Default Rating (IDR) at ‘BB+';
--Senior unsecured revolving credit facilities at ‘BB+';
--Senior unsecured term loans at ‘BB+';
--Senior unsecured notes at ‘BB+';
--Senior unsecured convertible notes at ‘BB+';
--Preferred stock at ‘BB-'.
The Positive Outlook reflects Fitch’s expectation that DDR’s credit profile will improve to a level consistent with a ‘BBB-’ IDR over the next 12-24 months. The Outlook reflects the expansion of net operating income from a prime shopping center portfolio, a granular roster of retailer tenants that are well positioned entering the holiday season, and a fixed-charge coverage ratio that is expected to sustain at levels appropriate for the ‘BBB-’ rating due to upward leasing spreads and joint venture cash flow growth. The Outlook also takes into account the company’s good access to capital on increasingly favorable terms, and adequate liquidity position including a large unencumbered pool. Leverage remains consistent with a ‘BB+’ rating, although Fitch anticipates that DDR’s management team will continue to utilize equity issuance and retained cash flow from organic growth and redevelopment to reduce leverage to a level consistent with a ‘BBB-’ IDR.
The prime portfolio, which consists of assets in higher barrier to entry markets with strong household income profiles, represented 89.3% of total net operating income in third quarter 2012 (3Q‘12), up from 81.6% at the beginning of 2010 and 70.0% at the beginning of 2009. DDR continues to acquire prime assets on balance sheet and in joint ventures while selling non-prime assets, and Fitch expects this strategy of portfolio recycling to continue going forward.
A strong tenant roster further evidences high-quality cash flow. As of Sept. 30, 2012, top tenants by base rental revenue were Wal-Mart Stores, Inc. (3.1% of rental revenues, Fitch IDR of ‘AA’ with a Stable Outlook), TJX Companies (2.5%), PetSmart (2.2%), Bed Bath & Beyond (2.2%), and Kohl’s Corporation (2.1%, Fitch IDR of ‘BBB+’ with a Stable Outlook). For 2012 year-to-date, weighted average lease terms were 8.3 years on new leases and 5.3 years on renewals, signaling cash flow stability absent tenant bankruptcies. Fitch’s most recent U.S. Retail Stats Quarterly report noted generally steady operating and credit trends across the U.S. retail sector.
Fixed-charge coverage continues to improve and was 2.0x in 3Q‘12, up from 1.9x in 2Q‘12, 1.8x in 1Q‘12 and 1.7x in 2011. Fitch defines fixed-charge coverage as recurring operating EBITDA including Fitch’s estimate of recurring cash distributions from unconsolidated entities less recurring capital expenditures and straight-line rent adjustments divided by total interest incurred and preferred stock dividends.
New supply is limited, resulting in improved property-level fundamentals. Same-store net operating income (NO)I grew by 3.7% in 3Q‘12, 3.1% in 2Q‘12 and 2.3% in 1Q‘12 due to continued positive leasing spreads of 7.0% in 3Q‘12, 6.8% in 2Q‘12 and 6.4% in 1Q‘12, coupled with occupancy gains. Recent same-store NOI results exceeded the 10-year average of 1.5% from 2002-2011 and contributed towards the improvement in coverage.
Additionally, DDR’s 2012 joint venture with Blackstone Real Estate Partners VII and growth in Sonae Sierra Brasil BV Sarl distributions resulted in recurring unconsolidated entity cash flow to DDR of $37.3 million annually, more than 2x levels achieved in 2011 and bolstering corporate earnings power going forward.
Fitch anticipates that low same-store NOI growth as well as incremental earnings from re-development will result in fixed-charge coverage sustaining in the low 2x range, which is appropriate for a ‘BBB-’ rating. In a stress case not anticipated by Fitch in which DDR’s results revert to 2009 levels, coverage would fall below 2x, which would be more consistent with a ‘BB+’ rating.
DDR’s funding profile is strong. As of Sept. 30, 2012, the company had no unsecured debt maturities through May 2015. The debt maturity schedule as of Sept. 30, 2012 had 0.4% of pro rata debt maturing in 4Q‘12, 8.1% maturing in 2013, and 7.1% maturing in 2014. Notably, the weighted average debt duration is approximately 5 years as of Sept. 30, 2012, indicating appropriate long-term asset and liability matching.
Capital access remains solid as demonstrated by the June 2012 issuance of $300 million 4.625% senior unsecured notes due 2022 priced to yield 4.865% to maturity, or 325 basis points over the benchmark treasury rate, and the July 2012 issuance of $200 million 6.5% class J preferred stock.
DDR has an adequate liquidity position with liquidity coverage, defined as liquidity sources divided by liquidity uses, of 1.4x for the period from Oct. 1, 2012 to Dec. 31, 2014. Liquidity sources include unrestricted cash, availability under the company’s unsecured revolving credit facilities, and projected retained cash flows from operating activities after dividends and distributions. Liquidity uses include pro rata debt maturities pro forma for expected refinancings prior to year-end and projected recurring capital expenditures and redevelopment expenditures. Assuming a 75% refinance rate on upcoming secured debt maturities, liquidity coverage would be strong at 3.6x.
DDR also has contingent liquidity from a large unencumbered property pool that is consistent with a ‘BB+’ rating. Unencumbered properties valued at an 8% capitalization rate and a 50% haircut on unencumbered land covered unsecured debt by 1.7x as of Sept. 30, 2012 pro forma for expected refinancings prior to year-end. A haircut on land is conservative given impairments incurred on DDR’s land during previous years. The covenants in the company’s debt agreements do not restrict financial flexibility.
Current leverage is consistent with a ‘BB+’ rating, with net debt to recurring operating EBITDA of 7.5x as of Sept. 30, 2012 compared with 8.2x as of Dec 31, 2011 and 8.6x as of Dec. 31, 2010. Organic EBITDA growth and equity-funded acquisitions have resulted in declines in leverage. However, Fitch anticipates that favorable fundamentals and continued ATM utilization will push leverage below 7x over the next 12-to-24 months, which is appropriate for a ‘BBB-’ rating. In a stress case not anticipated by Fitch in which DDR’s results revert to 2009 levels, leverage would sustain above 7x, which would be more consistent with a ‘BB+’ rating.
The two-notch differential between DDR’s IDR and preferred stock rating is consistent with Fitch’s criteria for corporate entities with an IDR of ‘BB+'. Based on Fitch research on ‘Treatment and Notching of Hybrids in Nonfinancial Corporates and REIT Credit Analysis’ dated Dec. 15, 2011, these securities are deeply subordinated and have loss absorption elements that would likely result in poor recoveries in a corporate default.
The Positive Outlook reflects Fitch’s expectation that the portfolio will remain almost entirely prime, coverage will sustain above 2.0x, leverage will sustain below 7.0x, and unencumbered asset coverage will sustain above 2.0x.
The following factors may result in an IDR upgrade to ‘BBB-':
--Fitch’s expectation of fixed-charge coverage sustaining above 2.0x (coverage was 2.0x in 3Q‘12);
--Fitch’s expectation of leverage sustaining below 7.0x (leverage was 7.5x as of Sept. 30, 2012);
--Fitch’s expectation of unencumbered asset coverage of unsecured debt sustaining above 2.0x (unencumbered assets - valued as unencumbered NOI for the trailing 12 months ended Sept. 30, 2012 divided by a stressed capitalization rate of 8% plus a 50% haircut to land - to unsecured debt was 1.7x).
The following factors may have a negative impact on DDR’s ratings and/or Outlook:
--Fitch’s expectation of fixed-charge coverage sustaining below 1.8x;
--Fitch’s expectation of leverage sustaining above 8.5x;
--Base case liquidity coverage sustaining below 1.0x. Contact: