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Fitch Affirms Highwoods Properties' IDR at 'BBB-';; Outlook Stable

^{Published on 2011-10-26 10:06:17 - Market Wire}
 

NEW YORK--([ BUSINESS WIRE ])--Fitch Ratings has affirmed the following ratings for Highwoods Properties, Inc. (NYSE: HIW) and Highwoods Realty Limited Partnership (collectively, Highwoods):

Highwoods Properties, Inc.

--Issuer Default Rating (IDR) at 'BBB-';

--Preferred stock at 'BB'.

Highwoods Realty Limited Partnership

--IDR at 'BBB-';

--Unsecured revolving credit facility at 'BBB-';

--Senior unsecured notes at 'BBB-'.

The Rating Outlook is Stable.

The affirmations reflect the company's credit strengths, including manageable debt maturity and lease expiration schedules, and a granular tenant base. Offsetting these strengths are operating fundamentals in Highwoods' markets, which remain weak and will likely be soft in the near- to medium term. However, the company's leverage and coverage metrics are expected to remain appropriate for the rating over the next 12-24 months. The Stable Outlook considers these expected soft property-level fundamentals, offset by Highwoods' adequate liquidity and unencumbered asset coverage of unsecured debt appropriate for the 'BBB-' rating.

The economic recovery remains fragile, with the high unemployment rate continuing to adversely impact business prospects of many of Highwoods' current or potential tenants. Highwoods' portfolio is focused primarily in the Southeast region, with the top four submarkets represented by Raleigh (16.5% of the annualized cash revenue for the six-months ended June 30, 2011), Atlanta (14.8%), Tampa (14.4%) and Nashville (13.2%).

The company's geographic focus, with exposure to some weaker submarkets with limited barriers to entry, has provided limited growth in recent quarters; however, occupancy is trending positively which should result in improving same property NOI results. Highwoods reported a -2.8% and -2.9% cash same property NOI decline in 2009 and 2010, with occupancy rates of 88.8% and 89.5%, respectively. For the six months ended June 30, 2011, the company reported a cash same property NOI decline of -1.4% and occupancy of 90.1%.

Fundamentals remain challenging for Highwoods. Office cash rollover rents have steadily fallen, with declines averaging approximately 10% in 2010 and declines of -7.5% and -5% in 1Q'11 and 2Q'11, respectively. Despite this decline, average cash rental rates for all in place leases has moderated to a decline of -0.4% as of June 30, 2011 as compared to -0.8% for the same period in 2010. The company is relatively small and large lease signings in certain markets could be skewed rent numbers.

Since 2006, Highwoods has underperformed a selected group of office REIT peers by approximately 50 basis points (bps) in same-property NOI performance and 230 bps lower in occupancy rates. However, Highwoods has outperformed its markets on a NOI and occupancy basis, as followed by Property & Portfolio Research (PPR), by almost 260 bps since 2006. Highwoods competes in markets with more private developers and tends to be a leading landlord in its markets. Few of the selected office REIT peers own properties in the same markets as Highwoods.

Highwoods' portfolio benefits from tenant diversification with the top 10 tenants representing 24.7% of annual base rent as of June 30, 2011. The U.S. Federal Government is the largest tenant, contributing 9.8% of June 30, 2011 annual base rent (ABR). In addition, the company has a fairly even distribution of lease expirations, with an average of 9% of ABR expiring in each of the next 10 years.

The company has strong fixed charge coverage levels despite its weak markets and occupancy and NOI deterioration since early 2009. Fixed charge coverage has declined to 2.0x for the 12 months ended June 30, 2011 from 2.3 times (x) at Dec. 31, 2009 but remains appropriate for the 'BBB-' rating. Fitch expects the company to maintain fixed charge coverage around 2.0x during the forecast period. Fitch defines fixed charged coverage as recurring operating EBITDA less recurring capital expenditures (tenant improvements and leasing commissions) less straight line rent adjustments, divided by interest expense, capitalized interest, and preferred dividends.

Leverage (net debt to recurring operating EBITDA) was 5.9x for the 12 months ending June 30, 2011, compared with 5.5x as of both Dec. 31, 2010 and 2009. Leverage remains appropriate for the 'BBB-' rating and is expected to remain so during the forecast period. Recent acquisitions in Atlanta and Pittsburgh will likely cause an increase in leverage for full year 2011 to approximately 6.9x as the company utilized its credit facility to fund these partial-year acquisitions. Fitch expects the company to raise equity and unsecured debt to term out a portion of the credit facility balance. In addition, improvements in EBITDA should result in leverage falling back into the low to mid-6x range. This range is appropriate for the 'BBB-' rating.

The Stable Outlook reflects Fitch's view that Highwoods maintains adequate liquidity and will maintain appropriate coverage of unsecured debt by unencumbered assets.

The company's liquidity coverage ratio is adequate. The company has only secured debt maturing over the next three years after refinancing its credit facility and term loan in 2011. Sources of liquidity (unrestricted cash, availability from the company's unsecured revolving credit facility, projected retained cash flows from operating activities after dividends and distributions) divided by uses of liquidity (pro rata debt maturities, development expenditures, and projected recurring capital expenditures) result in a liquidity coverage ratio of 0.6x for July 1, 2011 through Dec. 31, 2013. If Highwoods refinanced 80% of its secured debt due in 2012 and 2013, the company's liquidity coverage would be 1.3x.

The company has a well laddered debt maturity schedule with no major debt maturities until 2016 when its term loan and three secured mortgages mature.

The company has historically maintained strong coverage of unsecured debt by unencumbered assets. Unencumbered assets (calculated as annualized unencumbered NOI divided by a capitalization rate of 9%) covered unsecured debt by 2.3x as of June 30, 2011, which is adequate for a 'BBB-' rating. Fitch expects this metric to fall towards 2.0x during the forecast period, which would be on the weak end for the rating category. However, the covenants in the company's credit agreements do not limit financial flexibility.

The company's cash flows after deducting recurring capital expenditures and straight line rents and adjusting for other non-cash items, defined as adjusted funds from operations (AFFO), have been exceeded by common and preferred unit distributions during 2010 and the last 12 months ending June 30, 2011, placing pressure on the company's ability to internally generate liquidity. The AFFO payout ratio will likely remain high well into 2013. Absent other mitigating circumstances, a prolonged AFFO payout ratio in excess of 100% could have negative rating implications.

The two-notch differential between Highwood's IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB'. Based on Fitch's criteria report 'Rating Hybrid Securities' dated July 28, 2011, these preferred securities are deeply subordinated and have loss absorption elements that would likely result in poor recoveries in the event of a corporate default.

Fitch does not anticipate positive rating momentum over the near to medium term. However, the following factors may affect ratings and/or Rating Outlook.

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

--Maintaining a healthy liquidity surplus;

--Maintaining a fixed charge coverage ratio above 2.4x (for the 12 months ended June 30, 2011, fixed charge coverage was 2.0x. Coverage was 1.9x pro forma for recent acquisitions);

--Net debt to recurring operating EBITDA remaining below 6.0x (for the 12 months ended June 30, 2010, leverage was 5.9x. Leverage was 6.9x pro forma for recent acquisitions);

--Demonstrated access to the unsecured bond markets.

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

--Maintaining fixed charge coverage below 1.8x;

--Maintaining leverage above 6.5x;

--A sustained decline in unencumbered asset coverage below 2.0x (as defined as the annualized unencumbered property net operating income divided by a 9% capitalization rate).

Additional information is available at '[ www.fitchratings.com ]'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

Applicable Criteria and Related Research:

--Corporate Rating Methodology, Aug. 12, 2011.

--Parent and Subsidiary Rating Linkage, Aug. 12, 2011.

--Rating Hybrid Securities, July 28, 2011.

--Treatment of Hybrids in Corporate and REIT Credit Analysis, July 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.

Applicable Criteria and Related Research:

Corporate Rating Methodology

[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647229 ]

Parent and Subsidiary Rating Linkage

[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647210 ]

Rating Hybrid Securities

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

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 ]

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