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Fitch Downgrades Equity Residential's IDR to 'BBB+'; Outlook Stable

^{Published on 2010-11-12 10:06:05 - Market Wire}
 

NEW YORK--([ BUSINESS WIRE ])--Fitch Ratings has downgraded the Issuer Default Ratings (IDRs) and obligation ratings of Equity Residential (NYSE: EQR) and ERP Operating Limited Partnership, EQR's principal operating subsidiary (collectively, EQR), as follows:

Equity Residential

--IDR to 'BBB+' from 'A-';

--Preferred stock to 'BBB-' from 'BBB'.

ERP Operating Limited Partnership

--IDR to 'BBB+' from 'A-';

--Senior unsecured notes to 'BBB+' from 'A-';

--Exchangeable senior notes to 'BBB+' from 'A-'.

The Rating Outlook has been revised to Stable from Negative.

The rating actions are based on Fitch's expectation that EQR's near- to medium-term credit profile, particularly its leverage, will be consistent with an IDR of 'BBB+'.

EQR's net debt to 12 months (ended Sept. 30, 2010) recurring operating EBITDA was 8.9 times (x), up from 8.1x and 7.7x as of Dec. 31, 2009 and 2008, respectively. During 2010 the company has acquired several near-vacant assets, and this weighs upon Fitch's primary measurement of leverage. However, Fitch expects that net proceeds from near-term asset sales will be used to repay debt, which will have an immediate positive impact on leverage. The company's risk-adjusted capitalization ratio was adequate for the 'BBB' rating category at 1.3x as of Sept. 30, 2010, relatively unchanged since Dec. 31, 2007.

Credit strengths include EQR's solid franchise, consistent cash flow coverage metrics and strong liquidity management. Franchise strength is evident in EQR's broad geographic diversification, focus on longer-term supply-constrained high-growth markets, demonstrated access to multiple forms of capital, consistent operating strategy and an adequate level of unencumbered assets covering unsecured debt.

EQR's ratings are supported by the company's cash flow granularity, as each of EQR's top 10 markets generated net operating income (NOI) between 4.7% and 11.8% of total third quarter 2010 (3Q'10) NOI. EQR's operating strategy of focusing on owning assets in supply-constrained coastal destination markets is a credit positive. These markets tend to exhibit relatively strong long-term demand, limited buildable land and high construction costs, curtailing substantial supply growth.

For the 12 months ended Sept. 30, 2010, EQR maintained fixed charge coverage (recurring operating EBITDA less capital expenditures divided by interest incurred and preferred distributions) of 1.9x, which is consistent with a 'BBB+' IDR. Fixed charge coverage was 1.8x and 1.9x for the years ended Dec. 31, 2009 and 2008, respectively.

EQR maintains unencumbered assets that provide solid coverage of unsecured debt for the rating category. Per the company's bond covenant calculations, EQR's unencumbered assets covered unsecured debt by 2.4x and 2.6x as of Sept. 30, 2010 and Dec. 31, 2009, respectively, up from 2.2x as of Dec. 31, 2008. EQR's 3Q'10 annualized unencumbered NOI, capitalized at a 7.0% capitalization rate, covered its unsecured debt net of excess cash by approximately 2.1x at Sept. 30, 2010.

The ratings are supported by moderating property-level fundamentals. EQR's 3Q'10 same property NOI increased by 0.9% relative to 3Q'09, and Fitch anticipates that fundamentals will improve from current levels due to modest job growth, household formation and limited new supply in EQR's markets.

Offsetting these rating strengths are the company's elevated leverage and sizeable near-term debt maturities.

Fitch calculates that EQR's sources of liquidity (unrestricted cash, availability under its unsecured revolving credit facility, expected retained cash flows from operating activities after dividends and distributions) are exceeded by uses of liquidity (debt maturities and expected capital expenditures) by over $875 million from Oct. 1, 2010 to Dec. 31, 2012, resulting in a liquidity coverage ratio of 0.7x. This liquidity deficit is due in large part to over $2.5 billion of debt maturities in 2011 and 2012, or nearly 25% of EQR's total indebtedness. Assuming EQR is able to refinance 80% of its maturity secured indebtedness, liquidity coverage improves to 1.0x. EQR has demonstrated strong access to both unsecured and secured debt, mitigating refinance risk to a large degree.

Further, the financial covenants in the company's unsecured debt agreements do not limit EQR's financial flexibility.

The two-notch differential between EQR's IDR and its preferred stock ratings is consistent with Fitch's criteria for corporate entities with a 'BBB+' IDR. Based on Fitch's criteria report ('Equity Credit for Hybrids & Other Capital Securities'), EQR's preferred stock is 75% equity-like and 25% debt-like, since it is perpetual and has no covenants but has a cumulative deferral option in a going concern. Net debt plus 25% of preferred stock to recurring EBITDA was 8.9x as of Sept. 30, 2010, compared with 8.1x as of Dec. 31, 2009.

The Stable Outlook reflects Fitch's expectation that multifamily operating fundamentals will have an upward trajectory to 2012. Over the next two years, absent significant deleveraging equity offerings, the company's leverage will likely trend to between 7.5x and 8.0x. Fixed charge coverage is likely to stay relatively flat due to slightly elevated refinancing costs relative to maturing debt, assuming the company refinances maturing unsecured debt with new 10-year unsecured notes.

The following factors may have a positive impact on EQR's ratings or Outlook:

--Fixed charge coverage sustaining above 2.0x (for the trailing 12 months ended Sept. 30, 2010, fixed charge coverage was 1.9x);

--Net debt to recurring operating EBITDA sustaining below 7.5x (as of Sept. 30, 2010, net debt to LTM recurring operating EBITDA was 8.9x);

--Unencumbered asset coverage sustaining above 2.5x (as of Sept. 30, 2010, unencumbered asset coverage was 2.1x assuming a 7.0% capitalization rate on annualized 3Q'10 unencumbered NOI).

The following factors may have a negative impact on EQR's ratings or Outlook:

--Fixed charge coverage sustaining below 1.8x;

--Net debt to recurring operating EBITDA sustaining above 8.5x;

--Unencumbered asset coverage sustaining below 1.8x.

Headquartered in Chicago, IL, Equity Residential is a company focused on the acquisition, development and management of high-quality apartment properties in top U.S. growth markets. As of Sept. 30, 2010, Equity Residential owned or had investments in 471 properties totaling 133,029 units.

Additional information is available at '[ www.fitchratings.com ]'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology', Aug. 16, 2010;

--'Criteria for Rating U.S. Equity REITs and REOCs', April 16, 2010;

--'Equity Credit for Hybrids & Other Capital Securities - Amended', Dec. 29, 2009;

--'Rating Hybrid Securities', Dec. 29, 2009;

--'Recovery Rating and Notching Criteria for REITs', Dec. 23, 2009.

Applicable Criteria and Related Research:

Recovery Rating and Notching Criteria for REITs

[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=492828 ]

Rating Hybrid Securities

[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=493086 ]

Equity Credit for Hybrids & Other Capital Securities - Amended

[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=493112 ]

Criteria for Rating U.S. Equity REITs and REOCs

[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=510465 ]

Corporate Rating Methodology

[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=546646 ]

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