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Fitch Downgrades Duke Realty's IDR to 'BBB-'; Outlook Revised to Stable

^{Published on 2011-04-21 15:41:11 - Market Wire}
 

NEW YORK--([ BUSINESS WIRE ])--Fitch Ratings has downgraded the following credit ratings of Duke Realty Corporation (NYSE: DRE) and its operating partnership, Duke Realty Limited Partnership (collectively, Duke Realty):

Duke Realty Corporation

--Issuer Default Rating (IDR) to 'BBB-' from 'BBB';

--Preferred stock to 'BB' from 'BB+'.

Duke Realty Limited Partnership

--IDR to 'BBB-' from 'BBB';

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

--Senior unsecured exchangeable notes to 'BBB-' from 'BBB';

--Unsecured revolving credit facility to 'BBB-' from 'BBB'.

The Rating Outlook has been revised to Stable from Negative.

The rating actions reflect Fitch's view that the company's credit profile is more consistent with a 'BBB-' rating; in particular, Duke Realty's fixed charge coverage ratio is low for the rating category. The actions also reflect continued weakness in suburban office fundamentals that may adversely impact the portfolio, even as Duke Realty continues to shift its portfolio away from suburban office to a higher percentage of industrial and medical office properties. The rating also takes into account the company's credit strengths, which include moderate leverage for the rating level, a large pool of diversified industrial, office and medical office properties, solid unencumbered asset coverage of unsecured debt, and an adequate liquidity position.

Duke Realty's fixed-charge coverage ratio (defined as recurring operating EBITDA less Fitch's estimate of recurring capital expenditures and straight-line rent adjustments divided by total interest incurred and preferred dividends) was 1.5 times (x) in 2010, up slightly from 1.4x in 2009. Coverage has remained in the 1.4x to 1.6x range since 2007, and absent significant delevering transactions, over the next few years, Fitch anticipates that fixed charge coverage will remain at similar levels in the near term.

Duke Realty has a diversified portfolio of 792 bulk distribution, suburban office, medical office and retail properties located across 18 markets, which Fitch views favorably from a property segment and geographical diversification standpoint. The company's portfolio also benefits from a highly diversified tenant base and well staggered lease expiration schedule. Duke Realty's largest 20 tenants represented just 15.2% of annual base rents at Dec. 31, 2010, thus limiting individual tenant credit risk. In addition, lease expirations are less than 10% of total annual base rent in 2011 and 2012, indicating long-term recurring cash flow throughout the portfolio.

Duke Realty has made significant progress on the repositioning of its portfolio, and continues to execute on its strategic plan, which consists of shifting the portfolio mix to increase the exposure to industrial and medical office assets, while reducing the exposure to suburban office. Fitch has a negative outlook on industrial and suburban office fundamentals, and a stable outlook on healthcare fundamentals, and views the company's repositioning strategy positively, although it could take time for such a shift to result in significant improvements in credit metrics absent delevering transactions. There is also the potential for EBITDA dilution from negative spread asset purchases and sales as the company shifts the composition of the portfolio.

The company's leverage, defined as net debt to recurring operating EBITDA, was 7.2x at Dec. 31, 2010, up from 6.7x at Dec. 31, 2009. Fitch expects leverage to fluctuate in the near term as the company continues its portfolio repositioning, but eventually to trend back down below 7.0x, which is appropriate for the 'BBB-' rating. The company has curtailed development activities over the past several years in response to market conditions, as the company's wholly owned development pipeline represented just 1.3% of undepreciated book assets as of Dec. 31, 2010, down from 1.4% and 4.2% as of Dec. 31, 2009 and Dec. 31, 2008, respectively. The company has stated that new development starts will focus on build-to-suit projects and medical office buildings, thus minimizing development risk going forward, which Fitch views positively.

Duke Realty has adequate liquidity and financial flexibility. As of Dec. 31, 2010, the company had 509 unencumbered properties with a gross book value of $5.8 billion. Unencumbered asset coverage of unsecured debt based on applying an 8.5% cap rate to unencumbered net operating income (NOI) was strong for the 'BBB-' IDR at 2.1x as of Dec. 31, 2010. In addition, total sources of liquidity (unrestricted cash, availability under the unsecured revolving credit facility, and projected retained cash flow from operating activities after dividends) exceed uses of liquidity (pro rata debt maturities, expected recurring capital expenditures, and remaining non-discretionary development costs) by 1.1x for the period Jan. 1, 2011 to Dec. 31, 2012 (assuming that Duke Realty is able to refinance maturing mortgage debt at 80% of the maturing amount).

The Stable Outlook is based on Fitch's expectation that leverage and coverage will remain fairly unchanged relative to current levels and the company will maintain adequate liquidity. Fitch's base case assumes that same-store NOI declines by 2% in 2011, grows 1% in 2012 and 2% in 2013.

The two notch differential between Duke Realty's IDR and its preferred stock rating 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'), the company'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.

The following factors may have a positive impact on the ratings and/or Outlook:

--Net debt to recurring operating EBITDA sustains below 6.0x (as of Dec. 31, 2010, leverage was 7.2x);

--Fixed-charge coverage sustains above 2.0x (in 2010, coverage was 1.5x).

The following factors may have a negative impact on the ratings and/or Outlook:

--Fixed-charge coverage sustains below 1.3x;

--Net debt to recurring operating EBITDA sustains above 8.0x.

Duke Realty is a self-managed REIT headquartered in Indianapolis that specializes in the ownership, management and development of bulk industrial, suburban office, and medical office buildings. The company owns, maintains an interest in, or has under development 792 properties containing more than 139 million rentable square feet in 18 major U.S. cities. As of Dec. 31, 2010, the company had approximately $8.9 billion in undepreciated book assets.

Additional information is available at '[ www.fitchratings.com ]'. The issuer did not participate in the rating process, or provide additional information, beyond the issuer's available public disclosure.

Applicable Criteria and Related Research:

--'Criteria for Rating U.S. Equity REITs and REOCs', March 15, 2011;

--'Corporate Rating Methodology', Aug. 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:

Criteria for Rating U.S. Equity REITs and REOCs

[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=610687 ]

Corporate Rating Methodology

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

Equity Credit for Hybrids & Other Capital Securities - Amended

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

Rating Hybrid Securities

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

Recovery Rating and Notching Criteria for REITs

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

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