Fitch Ratings has assigned a credit rating of 'BBB-' to the $500 million 3.625% senior notes due 2025 issued by DDR Corp. (NYSE: DDR or the company). The notes were priced at 99.260% of their face amount to yield 3.714% to maturity, or 180 basis points over the benchmark rate.
The company expects to use the net proceeds to repay debt under its $350 million term loan, to repay $100 million of the $400 million outstanding under its secured term loan, to repay borrowings under its $750 million unsecured revolving credit facility and for general corporate purposes, which may include the repayment of secured and unsecured debt from time to time.
KEY RATING DRIVERS
DDR's 'BBB-' Issuer Default Rating (IDR) takes into account credit strengths including DDR's improving asset quality via non-core asset sales and re-development, strong expected fixed-charge coverage for the rating, granular tenant roster with select strong credit tenants and improving financial flexibility, featuring a growing unencumbered pool. Balancing these factors is leverage that remains at the higher end of a range Fitch believes is appropriate for the 'BBB-' rating and a low liquidity coverage ratio on a pro forma basis. The company's strong access to capital and limited cost to complete development mitigate near-term liquidity risk.
Improving Asset Quality
DDR continues to execute on its strategic plan, which entails investing in market-dominant power centers in large and supply-constrained markets occupied by retailers that cater to the consumer's desire for value and convenience. Portfolio transformation has been evidenced by a lower asset count of 415 properties currently, down from 621 in 2008, and DDR's goal is reducing the portfolio to approximately 350 assets. The average asset size increased to 275,000 square feet (sf) currently from 190,000 sf in 2008. Fitch views this portfolio transformation favorably because it has resulted in stronger leasing and rental rates. The leased rate is 95.6% currently, up from 92.6% in 2008 and average rent per sf is $13.65 currently, up from $12.34 in 2008.
Strong Leasing Spreads; CapEx Weighs on Effective Rents
Blended leasing spreads on new and renewal leases were 10.2% in 3Q'14, compared to 8.3% growth in 2013, 6.7% in 2012, and 6.1% in 2011. During 3Q'14, new leases were signed at $17.22 per sf and renewal leases were signed at $13.91 per sf. However, capital expenditures continue to weigh on cash flow growth. Capex per square foot represented 4.9% of total face rent for the trailing 12 months (TTM) ended Sept. 30, 2014, up from 3.7% in 2013 and 3.1% in 2012.
Solid Fixed-Charge Coverage
DDR's fixed-charge coverage ratio was 2.3x for the TTM ended Sept. 30, 2014 pro forma for the 2025 senior notes offering and the October 2014 acquisition of 71 shopping centers by a joint venture (JV) formed by DDR and an affiliate of Blackstone Real Estate Partners VII, which DDR funded with proceeds from asset sales. Fixed-charge coverage was 2.3x for 2013 and 2.0x in 2012. Growth in organic and redevelopment EBITDA were the primary contributors to the improvement. Under Fitch's base case whereby the company generates 3% same-store net operation income (SSNOI) growth in 2015 (due to positive releasing spreads and minor improvements in occupancy) followed by a slight moderation in 2016, fixed-charge coverage would be in the low-to-mid-2x range over the next 12-to-24 months, which would be strong for the 'BBB-' rating.
In a stress case not anticipated by Fitch in which SSNOI declines by levels experienced in 2009, fixed-charge coverage would remain just above 2x, which would still be adequate for the 'BBB-' rating. Fitch defines fixed-charge coverage as recurring operating EBITDA including recurring cash distributions from unconsolidated entities less recurring capital expenditures and straight-line rent adjustments, divided by total interest incurred and preferred stock dividends.
Granular Tenant Base
DDR has limited tenant concentration and quality credit tenants including TJX Companies (3.2% of base rent in 3Q'14), Bed Bath & Beyond (2.8%), Wal-Mart Stores, Inc. (Fitch IDR of 'AA' with a Stable Outlook at 2.7%), PetSmart (2.6%) and Kohl's Corporation (IDR of 'BBB+' with a Stable Outlook at 2.3%) and no other tenant exceeds 2% of base rental revenues.
Growing Unencumbered Asset Pool
The company grew annualized unencumbered net operating income (NOI) to $445 million currently from $252 million in 2009, and the percentage of consolidated NOI derived from unencumbered assets increased to 66% currently from 49% in 2009. As of Sept. 30, 2014, the company's unencumbered assets (3Q'14 annualized unencumbered NOI divided by a stressed 8% capitalization rate) covered pro forma net unsecured debt by 1.9x, which is weak for the rating. The company's goal for 2015 is to repay secured mortgages with unsecured paper, which should enhance financial flexibility; however, Fitch expects unencumbered asset coverage to remain just below 2.0x.
Somewhat High Leverage for Rating
Leverage was 7.5x as of Sept. 30, 2014 pro forma for the 2025 notes offering and Blackstone joint venture acquisition, down from 8.2x in 2013 and 7.8x in 2012. Leverage was skewed upward for full-year 2013 due to the timing of the company's October 2013 acquisition of a portfolio of 30 power centers previously owned by JV with Blackstone Real Estate Partners VII L.P. for $1.46 billion.
Fitch projects that leverage will approach 7.0x over the next 12-to-24 months principally due to EBITDA growth, which would be appropriate for the 'BBB-' rating. In the above-mentioned stress case not anticipated by Fitch, leverage would exceed 7.5x, which would be more consistent with a 'BB+' rating. Fitch defines leverage as net debt to recurring operating EBITDA including recurring cash distributions from unconsolidated entities.
Liquidity Coverage Impacted Negatively by 2015 Debt Maturities
Liquidity coverage is 0.8x for the period Oct. 1, 2014 to Dec. 31, 2016. Fitch defines liquidity coverage as sources divided by uses. Liquidity sources include unrestricted cash (pro forma for the 2025 notes offering and Blackstone JV acquisition), availability under the company's unsecured revolving credit facilities, and projected retained cash flows from operating activities. Liquidity uses include pro rata debt maturities, projected recurring capital expenditures and remaining cost to complete development. DDR has heavy 2015 debt maturities, when 17.5% of pro forma debt matures.
If 80% of secured debt maturities are refinanced through Dec. 31, 2016, liquidity coverage would improve to 1.2x; however, Fitch does not view this as a likely scenario, since the company intends to continue unencumbering the portfolio.
Mitigating liquidity risk is DDR's strong access to capital. In addition to the 2025 notes issuance, in November 2013, DDR issued $300 million aggregate principal amount of 3.50% senior unsecured notes due January 2021 to repay mortgage debt assumed from the acquisition of assets from another JV with Blackstone. The company also selectively accessed the mortgage debt market in 2014, on its Plaza Escorial property located in Puerto Rico, for example.
The company's adjusted funds from operations (AFFO) payout ratio was 63.0% in 3Q'14, up from 61.2% in 2013 and 57.0% in 2012 and reflective of internally generated liquidity of over $130 million annually. In January 2015, the company raised its common stock dividend to an annualized rate of $0.69 per share compared with an annualized rate of $0.62 per share previously.
Active Redevelopment Pipeline
Cost-to-complete to development represented 1.3% of undepreciated assets as of Sept. 30, 2014, up slightly from 2009-2011 levels but still below 3.5% as of year-end 2007. The company's five development projects are located in Chicago, IL, Orlando, FL, Seabrook, NH, New Haven, CT and Kansas City, KS, and are expected to be completed by year-end 2015.
DDR has eight redevelopment projects underway and has identified approximately $635 million of active and redevelopment opportunities. The company could potentially grow the redevelopment pipeline to $1 billion. For example, the company redeveloped Brookside Marketplace in Chicago, IL adding Ross Dress for Less, Panera Bread and Pier 1 Imports through development and T.J. Maxx through small shop consolidation, generating an unlevered cash- on-cost of 10.3%. These improvements should improve asset quality and cash flow growth as DDR generally targets an unlevered cash-on-cost in excess of 10%.
Puerto Rico Exposure
Puerto Rico accounts for 8.6% of DDR's annualized base rent. In July 2014, Fitch downgraded the ratings for the Commonwealth of Puerto Rico debt to 'BB-' from 'BB', following the February 2014 downgrade to 'BB' from 'BBB-'. The Rating Outlook is Negative. The Commonwealth has repeatedly demonstrated its focus on bolstering the fundamentals of its general credit, including through continued progress in closing the general fund budget deficit and limiting exposure to public corporation shortfalls. The Commonwealth's economy has been in recession since 2006. Despite economic weakness, DDR's portfolio in Puerto Rico has performed well with blended rents psf up 7.5% from 2009 to 2013, spurred by demand from relationship tenants.
Chief Executive Officer Separation Announcement
On Jan. 2, 2015, DDR announced that Daniel B. Hurwitz and DDR's Board of Directors finalized a mutually agreed upon separation agreement whereby Hurwitz will remain an employee of the company until Feb. 14, 2015; however, Hurwitz relinquished his role as CEO and Director of DDR, effective Dec. 31, 2014. David J. Oakes is President and Chief Financial Officer, a position he assumed on Jan. 1, 2013. Under the current executive team, DDR continues to execute on various elements of DDR's strategic plan to improve portfolio quality, engage in transactions such as acquisitions and dispositions, and improve portfolio operations and balance sheet metrics.
Preferred Stock Notching
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 'BBB-'. Based on Fitch research titled 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis', 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.
Stable Outlook
The Stable Outlook centers on Fitch's expectation of leverage around 7.0x, which is appropriate for the rating; fixed-charge coverage in the mid-2x range, which is strong for the rating; and weak liquidity coverage for the rating (offset by a growing unencumbered pool).
RATING SENSITIVITIES
The following factors may have a positive impact on DDR's ratings and/or Outlook:
--Fitch's expectation of leverage sustaining below 6.5x is the primary factor for positive momentum on the ratings and/or Outlook, since this metric is more consistent through interest rate cycles (pro forma leverage is 7.5x);
--Fitch's expectation of growth in the size and quality of the unencumbered pool with unencumbered assets (unencumbered NOI divided by a stressed capitalization rate of 8.0%) to net unsecured debt of 2.5x is another important positive (this metric is 1.9x pro forma);
--Fitch's expectation of fixed-charge coverage sustaining above 2.3x is a less meaningful ratings sensitivity for positive momentum as it is less consistent through interest rate cycles (pro forma fixed-charge coverage is 2.3x).
The following factors may have a negative impact on DDR's ratings and/or Outlook:
--Fitch's expectation of leverage sustaining above 7.5x;
--Fitch's expectation of fixed-charge coverage sustaining below 2.0x;
--Base-case liquidity coverage sustaining below 1.0x (this ratio is 0.8x pro forma from Oct. 1, 2014 to Dec. 31, 2016).
Fitch currently rates DDR Corp. as follows:
--Issuer Default Rating (IDR) 'BBB-';
--$815 million unsecured revolving credit facilities 'BBB-';
--$350 million senior unsecured term loans 'BBB-' (Fitch expects to withdraw this rating upon repayment);
--$337.1 million senior unsecured convertible notes 'BBB-';
--$2.4 billion senior unsecured notes 'BBB-';
--$350 million preferred stock 'BB'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'2015 Outlook: U.S. Equity REITs' (Dec. 16, 2014);
--'Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis' (Nov.
25, 2014);
--'Recovery Ratings and Notching Criteria for Equity REITs' (Nov. 18, 2014);
--'Corporate Rating Methodology' (May 28, 2014);
--'Rating U.S. Equity REITs and REOCs: Sector Credit Factors' (Feb. 26, 2014).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
Rating U.S. Equity REITs and REOCs (Sector Credit Factors)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=737957
2015 Outlook: U.S. Equity REITs (Capital Access Underpins Disciplined Growth)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=828828
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=968995
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