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Fitch Revises Rating Outlook on Colonial Properties Trust to Positive; Affirms IDR at 'BB+'

^{Published on 2011-08-08 20:41:19 - Market Wire}
 

NEW YORK--([ BUSINESS WIRE ])--Fitch Ratings affirms the following credit ratings of Colonial Properties Trust (NYSE: CLP) and its operating partnership, Colonial Realty Limited Partnership (collectively, Colonial, or the company):

Colonial Properties Trust

--Issuer Default Rating (IDR) at 'BB+'.

Colonial Realty Limited Partnership

--IDR at 'BB+';

--Unsecured revolving credit facilities at 'BB+';

--Senior unsecured notes at 'BB+';

--Preferred operating partnership units at 'BB-'.

The Rating Outlook has been revised to Positive from Stable.

The revision of Colonial's Rating Outlook to Positive from Stable reflects healthy fundamentals across Colonial's multifamily portfolio that are expected to continue their positive trajectory over the near term and materially improve the company's leverage and coverage metrics. The Positive Outlook also takes into account CLP's strong liquidity position, manageable debt maturity schedule, and reduced development risk.

While Fitch anticipates upward rating momentum over the next 12-to-24 months, the company's leverage and coverage are currently more consistent with a 'BB+' rating. In addition, the company has moderate levels of secured debt and an unencumbered asset coverage of unsecured debt ratio that indicates somewhat limited contingent liquidity. The rating takes into account Colonial's focus on markets with lower barriers to entry.

Net debt-to-recurring operating EBITDA (including cash distributions from partially-owned entities) for the 12 months ended June 30, 2011 was 8.8 times (x), down from 9.3x and 9.4x as of Dec. 31, 2010 and Dec. 31, 2009, respectively. Leverage when measured by annualizing second quarter 2011 (2Q'11) EBITDA was 8.2x, and Fitch projects that leverage will fall to below 8.0x over the next 12-to-24 months as fundamentals continue to improve, which would be appropriate for a higher IDR. The repurchase and retirement of unsecured debt, largely with proceeds from the company's at-the-market equity offering program, and increasing same store net operating income have reduced leverage. In a more adverse case than anticipated by Fitch, leverage could rise above 10x over the next 12-to-24 months, which would result in a downgrade to 'BB'.

The company is also well capitalized at a 'BB' rating category stress level, with a risk adjusted capitalization of 1.4x as of June 30, 2011, and is also adequately capitalized at a 'BBB' rating category stress level with a risk-adjusted capitalization of 1.1x as of June 30, 2011.

In general, multifamily fundamentals in CLP's markets are experiencing a positive inflection point. CLP's same store net operating income (SSNOI) grew 7.5% in 2Q'11, 5.7% in 1Q'11, and 3.5% in 4Q'10, after seven quarters of SSNOI declines. Furthermore, occupancy is strong at 96.2%, compared with 95.9% at Dec. 31, 2010 and 94.7% at Dec. 31, 2009. The company is currently experiencing rent growth on renewals and new leases over 5.0%, which will drive solid growth over the next 12 months. Fitch anticipates that fundamentals will continue to improve from current levels due to moderate job growth, limited new supply, and favorable demographics across the Sunbelt region.

Colonial's liquidity position is strong. Sources of liquidity (unrestricted cash, availability under the company's unsecured revolving credit facility and expected retained cash flows from operating activities after dividends and distributions), divided by uses of liquidity (pro rata debt maturities, expected recurring capital expenditures and in-process development expenditure) for July 1, 2011 to Dec. 31, 2012 result in a liquidity coverage ratio of 3.5x. Liquidity coverage for July 1, 2011 to Dec. 31, 2013 is 2.4x. Assuming the line of credit capacity is reduced by 25% upon renewal in 2012, liquidity coverage would be 2.7x through 2012 and 1.9x through 2013, which would still be strong for the current rating category. Furthermore, the company's debt maturity schedule is well laddered with no more than 20% of debt maturing annually for the next five years.

Over the past few years, Colonial has curtailed its development pipeline, thus reducing overall risk to bondholders. Construction-in-progress and land held for development represented 8.5% of total assets as of June 30, 2011, compared with 8.3% and 7.5% as of Dec. 31, 2010 and Dec. 31, 2009, respectively, and down from a peak of 16.5% as of Dec. 31, 2007. Moreover, the amount remaining to be spent on active development projects was just $61.1 million, or 1.9% of total assets at June 30, 2011, compared to a high of $573.1 million, or 12.9% of total assets at Dec. 31, 2006.

The company's fixed charge coverage ratio (defined as recurring operating EBITDA including Fitch's estimate of recurring cash distributions from partially-owned entities less recurring capital expenditures less straight line rent adjustments, divided by interest expense, capitalized interest and preferred dividends) was 1.6x for the trailing 12 months ended June 30, 2011, an improvement from 1.5x and 1.4x in 2010 and 2009, respectively. Recent positive momentum continues, as fixed charge coverage was 2.0x in 2Q'11. Fitch projects fixed charge coverage will sustain above 2.0x over the next 12-to-24 months, which would be appropriate for a higher IDR. In a more adverse case than anticipated by Fitch, fixed charge coverage could decline to below 1.5x, which is more consistent with a rating of 'BB+'.

The company's incurrence of secured debt has rendered bondholders more structurally subordinated. The company accessed the GSE market during the financial crisis of 2008-2010 and as such, secured debt as a percent of total debt has risen to a level of 40.8% as of June 30, 2011, up from just 5.9% at Dec. 31, 2008. That being said, neither the company's secured debt covenant nor other covenants in Colonial's credit agreements limit its financial flexibility.

Likewise, the unencumbered pool has decreased in size and provided less contingent liquidity. Applying a 7.5% capitalization rate to 2Q'11 annualized unencumbered NOI, unencumbered assets divided by unsecured debt results in a ratio of 1.8x, which is adequate for the 'BB+' rating.

Separately, many of the markets in the Sunbelt region in which Colonial is focused have limited supply constraints and barriers to entry that have led to cycles of overbuilding.

As part of its ongoing strategy, Colonial seeks to dispose of additional commercial assets to reduce its overall exposure to 10% of assets from approximately 20%. In addition, the company seeks to sell older multifamily assets and reinvest the proceeds into newer assets with lower recurring capital needs and better growth profiles. The result of both of these portfolio recycling strategies is the sales of assets with higher cash flow yields and the reinvestment into lower yielding assets, which is dilutive in the near term.

The two-notch differential between Colonial's IDR and the rating on its $50 million 7.25% series B cumulative redeemable perpetual preferred units is consistent with Fitch's criteria for corporate entities with an IDR of 'BB+'. Based on Fitch's criteria report, 'Rating Hybrid Securities', dated Dec. 29, 2009, these preferred units are deeply subordinated and have loss absorption elements that would likely result in poor recoveries in the event of a corporate default.

The following factors may result in an upgrade of the IDR to 'BBB-':

--If the company's fixed-charge coverage ratio sustains above 2.0x (for the 12 months ended June 30, 2011, fixed-charge coverage was 1.6x);

--If the company's leverage ratio sustains below 8.25x (as of June 30, 2011, the company's leverage, defined as net debt to recurring operating EBITDA, was 8.8x on a LTM basis, but 8.2x based on annualized 2Q'11 EBITDA);

--More geographical diversification across the multifamily portfolio into markets with above-average NOI growth characteristics.

The following factors may result in negative momentum on the ratings and/or Rating Outlook:

--If the company's fixed-charge coverage ratio sustains below 1.5x;

--If the company's leverage ratio sustains above 9.0x;

--A sustained liquidity coverage ratio below 1.0x.

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

Applicable Criteria and Related Research:

--Treatment of Hybrids in Corporate and REIT Credit Analysis 9July 11, 2011);

--Recovery Rating and Notching Criteria for Equity REITs (May 12, 2011);

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

--Corporate Rating Methodology (Aug. 16, 2010);

--Parent and Subsidiary Rating Linkage (July 14, 2010);

--Rating Hybrid Securities (Dec. 29, 2009).

Applicable Criteria and Related Research:

Treatment of Hybrids in Corporate and REIT Credit Analysis

[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=642132 ]

Recovery Rating and Notching Criteria for Equity REITs

[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=628490 ]

Criteria for Rating U.S. Equity REITs and REOCs

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

Corporate Rating Methodology - Amended

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

Parent and Subsidiary Rating Linkage Criteria Report

[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=534826 ]

Rating Hybrid Securities

[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647091 ]

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