FITCH AFFIRMS HIGHWOODS PROPERTIES' IDR AT 'BBB-'; OUTLOOK STABLE
Oct 2 (Reuters) - (The following statement was released by the rating agency)
NEW YORK, October 02 (Fitch) Fitch Ratings affirms the following credit ratings of Highwoods Properties, Inc. (NYSE: HIW) and its operating partnership, Highwoods Realty Limited Partnership, (collectively Highwoods, or the Company): Highwoods Properties, Inc. --Long-term IDR at 'BBB-'; --Preferred stock at 'BB'. Highwoods Realty Limited Partnership --Long-term IDR at 'BBB-'; --Unsecured revolving credit facility at 'BBB-'; --Unsecured term loans at 'BBB-'; --Senior unsecured notes at 'BBB-.' The Rating Outlook is Stable. The ratings affirmations reflect Highwoods' improved asset portfolio that is well-positioned in its core markets, a granular, strong credit quality tenant base, and manageable lease expiration and debt maturity schedules. These strengths are tempered by challenging office operating fundamentals in many of these markets, which have resulted in stagnant same-store NOI growth and difficult leasing conditions. This is evident by elevated capital expenditures and sustained negative cash rent spreads. However, Fitch expects Highwoods' leverage and coverage metrics to remain appropriate for the rating over the next 12-to-24 months. The Stable Outlook considers Highwoods' adequate liquidity and access to capital and solid unencumbered asset coverage of unsecured debt, partially offset by Fitch's expectation of soft property-level fundamentals. The economic recovery remains fragile, with the high unemployment rate continuing to adversely impact business prospects of many of Highwoods' current tenants, and general office space users. Highwoods' portfolio is focused primarily in the Southeast region, with the top four markets represented by Raleigh (16.4% of annualized cash revenue), Atlanta (14.2%), Nashville (13.2%) and Tampa (12.6%). Highwoods' geographic focus, with exposure to some weaker markets with lower barriers to entry, has resulted in same-store NOI declines of 0.6%, 2.9% and 2.8% for 2011, 2010 and 2009, respectively. Operating performance has seen positive momentum more recently, however, with 5.4% growth in first quarter-2012 (1Q'12) and 1.8% in 2Q'12. This was driven by an increase in same-store occupancy, which has seen sustained improvement to 91.4% at 2Q'12 from 89.9% at 2Q'11. Occupancy improvement has been partially offset by continued rent declines. Office cash rollover rents declined 6% in 1Q12 and 6.3% in 2Q'12. This follows significant declines in 2010-2011 that ranged from 5% to 12.4%. Despite the decline, average cash rental rates for all in-place leases improved 2% year-over-year. These results were driven by contractual rent escalators and recent acquisitions and dispositions, which have had a higher net effect on in-place rents. Highwoods' portfolio benefits from solid tenant diversification. The top 10 tenants represent 23.2% of annual base rent (ABR) as of June 30, 2012. In addition, the US Federal Government is the largest tenant, contributing 8.9% as of June 30, 2012 ABR (down from 9.8% as of June 30, 2011). Highwoods also has a well-laddered lease expiration schedule, with an average of 11% of annual base rent expiring in each of the next five years. This should mitigate the impact of further rent declines. From 2006-2011, Highwoods underperformed in comparison to a selected group of office REIT peers by 40bps in same-store NOI performance and 130 bps in occupancy rates. However, Highwoods outperformed its markets on an average NOI basis (as followed by Property & Portfolio Research (PPR)) by nearly 100 bps for the same timeframe. Highwoods competes in markets with more private developers. This enables Highwoods to utilize its stronger liquidity and access to capital to attract and retain tenants. Few of the selected REIT peers own properties in the same markets as HIW. Highwoods has solid fixed charge coverage levels despite same-store NOI deterioration since early 2009. Fixed charge coverage has declined to 2.0x for the twelve months ended June 30, 2012 from 2.2x for full year 2009, but remains appropriate for the 'BBB-' rating. Fitch defines fixed charge coverage as recurring operating EBITDA less recurring capital expenditures, less straight line rent adjustments, divided by interest expense, capitalized interest, and preferred dividends. Leverage (measured as net debt to trailing twelve months recurring operating EBITDA) was 6.1x as of June 30, 2012, compared with 6.7x and 5.4x at Dec. 31, 2011 and 2010, respectively. Highwoods has made ample progress in de-levering since executing debt-financed acquisitions in Pittsburgh and Atlanta in late 2011. Leverage is appropriate for the 'BBB-' rating and is expected to remain so during the forecast period. Highwoods uses a prudent combination of asset sales, common equity and unsecured debt to finance growth and repay debt maturities. Fitch views Highwoods' elevated adjusted funds from operations (AFFO) payout ratio as a credit concern given it has paid out more than 100% of AFFO in common dividends since 2010. Highwoods maintained the dividend level through the downturn while also electing to pay the common dividend entirely in cash, rather than utilize a combination of cash and stock. Additionally, difficult leasing conditions in HIW's markets have led to elevated recurring capital expenditures, which have pressured AFFO. This high payout limits Highwoods' ability to generate internal liquidity. In turn, it will result in Highwoods needing to draw on its credit facility or source other forms of liquidity to fund a portion of the common dividend. An AFFO payout ratio in excess of 100% is inconsistent with an investment-grade rating and could have negative rating implications. The Stable Outlook reflects Fitch's view that Highwoods' credit metrics will remain in an acceptable range for a 'BBB-' rating. The Outlook also takes into account Fitch's expectation that Highwoods will maintain adequate liquidity and appropriate coverage of unsecured debt by unencumbered assets. Sources of liquidity (unrestricted cash, availability from Highwoods' unsecured revolving credit facility, projected retained cash flows from operating activities after dividends and distributions) divided by uses of liquidity (pro rata debt maturities and projected recurring capital expenditures) result in a liquidity coverage ratio of 1.0x for the period from July 1, 2012 through Dec. 31, 2014. If Highwoods refinanced 80% of its secured debt due in the period, its liquidity coverage would be a strong 2.2x. In addition, Highwoods has a well-laddered debt maturity schedule with no unsecured debt maturities until the revolver in 2015. However, this facility may be extended at Highwoods option to 2016. Highwoods has historically maintained strong coverage of unsecured debt by unencumbered assets. The implied value of unencumbered assets (calculated as unencumbered NOI divided by a stressed capitalization rate of 9%) covered unsecured debt by 2.1x as of June 30, 2012. Fitch deems this adequate for a 'BBB-' rating, though it has fallen since 2009 (when it was approximately 2.9x). The two-notch differential between Highwoods IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB-'. Based on Fitch research on 'Treatment and Notching of Hybrids in Nonfinancial Corporates and REIT Credit Analysis' dated December 15, 2011, these securities are deeply subordinated and have loss absorption elements that would likely result in poor recoveries in a corporate default. Fitch does not anticipate positive rating momentum over the near term. That said, the following factors may result in positive momentum on the ratings or Rating Outlook: --Fitch's expectation of fixed-charge coverage sustaining above 2.25x (fixed charge coverage was 2.0x for the 12 months ended June 30, 2012); --Fitch's expectation of leverage sustaining below 5.5x (leverage was 6.1x as of June 30, 2012); --Fitch's expectation of unencumbered asset coverage of unsecured debt sustaining above 2.5x (implied unencumbered asset value calculated as annualized unencumbered property NOI dividend by a 9.0% capitalization rate); --Demonstrated consistent access to the unsecured bond markets; --Maintaining a healthy liquidity surplus. Conversely, the following factors may precipitate negative momentum on Highwoods' ratings and/or Outlook: --Fitch's expectation of fixed charge coverage declining below 1.75x; --Fitch's expectation of leverage increasing above 6.75x; --A sustained decline in unencumbered asset coverage of unsecured debt below 2.0x; --An AFFO payout ratio exceeding 100%.
(Reporting By Joan Gralla)