TEXT-Fitch:Mack-Cali's multifamily acquisition near-term credit neutral
(The following statement was released by the rating agency)
Oct 11 - Mack-Cali Realty Corporation's (NYSE: CLI; Mack-Cali) agreement to acquire, Roseland Partners, L.L.C (Roseland), a multifamily owner / operator / developer is a near-term credit neutral event as the transaction's small size will not meaningfully impact credit metrics, according to Fitch Ratings. The potential for and implications of overreaching by acquiring and developing later in the multifamily cycle is a longer-term credit concern.
Fitch expects CLI will grow the multifamily segment from its current size (the Roseland acquisition and one joint venture development) to become a larger component over time as a way to offset weak suburban office fundamentals and monetize its land bank. The multifamily sector currently benefits from a multitude of factors including strong demand, low supply and above average liquidity. Fitch would view overly ambitious acquisition and development volumes negatively as the sector may face a more challenging operating environment going forward.
On Oct. 9, 2012, Mack-Cali agreed to acquire the real estate development and management business of Roseland for an aggregate consideration of up to $135 million. Roseland owns interests in six multifamily properties (1,769 units), nine in-process multifamily developments (2,149 units), land (developable up to 5,980 apartment units) and interests in other developments and commercial real estate assets. The majority of the interests are located in the Northeast.
The ratings reflect Mack-Cali's strong fixed charge coverage, low leverage and granular tenant base. Credit concerns include the lack of geographic diversification, exposure to markets with weak fundamentals and the potential to overreach through the multifamily expansion and weaker liquidity. Absent deleveraging equity offerings, Fitch expects Mack-Cali's metrics to weaken going forward though remain consistent with the rating.
Fixed charge coverage was 2.5 times (x) for the trailing 12 months (TTM) ended June 30, 2012, compared with 2.3x and 2.5x during 2010 and 2009, respectively. Fitch projects fixed charge coverage will weaken to 2.2x through 2014 as the challenging operating fundamentals result in declining revenues and will not benefit materially pro forma for the acquisition (pro forma). Fitch defines fixed charge coverage as recurring operating EBITDA less Fitch's estimate of routine capital expenditures less straight-line rent adjustments, divided by total interest incurred and preferred stock distributions.
Mack-Cali's leverage is relatively low for the rating category at 4.8x for the TTM ended June 30, 2012 and 5.2x pro forma. Fitch expects the company will fund the acquisition through the revolving credit facility. Leverage was 5.1x and 4.8x as of Dec. 31, 2010 and 2009, respectively. Fitch projects leverage will approach 6.0x through 2014, assuming the challenging operating environment continues to negatively impact recurring operating EBITDA and the company incurs additional debt to fund its development expenditures.
Mack-Cali's liquidity coverage is strong for the rating (pro forma) at 2.1x through 2013 but weakens materially through 2014 to 0.9x as a result of $335 million of secured and unsecured debt maturities. Liquidity coverage is defined as sources of liquidity (unrestricted cash, availability under the company's unsecured credit facility, and retained cash flows from operating activities after dividend payments) divided by uses of liquidity (debt maturities, projected routine capital expenditures and development commitments).
Unencumbered asset coverage of unsecured debt is solid for the rating at 2.5x (based on a stressed 9% capitalization rate) as of June 30, 2012, and the majority of Mack-Cali's assets are unencumbered providing ample contingent liquidity.
Mack-Cali's solid credit metrics are partially offset by the challenging leasing environment resulting from the geographic concentration in suburban office markets that have weak fundamentals. Same-store net operating income (SSNOI) declined 3% in 2011, the second straight year of decline (-7% in 2010). Further, operating fundamentals were worse than the reported results imply, as SSNOI was positively impacted by a one-time tax reversal.
Economic headwinds, high unemployment, high market vacancies and a continued migration by tenants from suburban office to central business districts have diminished the company's ability to maintain occupancy and drive rental growth. As such, Fitch projects SSNOI will decline an additional 4% in each of the next two years which results in the deteriorating leverage and coverage metrics. A material deviation in strategy, a worsening in fundamentals beyond Fitch's base expectations, or a sizable acquisition without sufficient equity could cause the deterioration in metrics to accelerate.
The company's projected funds from operations after deducting recurring capital expenditures and straight line rents, or adjusted funds from operations (AFFO), are expected to approach and later exceed dividend distributions through 2014. This will place pressure on the company's ability to generate internal liquidity. An AFFO payout ratio in excess of 100% could have negative rating implications.
The Stable Outlook reflects Fitch's expectation that leverage and coverage metrics will stay within levels appropriate for the 'BBB' IDR but notes the expected deterioration. Management remains committed to maintaining conservative credit metrics and would enact measures to offset higher leverage, if necessary, consistent with management's track record. Additionally, the company's solid liquidity position and unencumbered assets mitigate refinance risk.
Although Fitch does not anticipate positive ratings momentum in the near-to-medium term, the following factors may result in positive momentum on the rating and/or Outlook:
--Sustaining positive same-store net operating income growth for several consecutive quarters;
--Net debt to recurring operating EBITDA sustaining below 4.5x (leverage was 5.4x as of June 30, 2012 pro forma);
--Fixed-charge coverage sustaining above 2.7x (coverage was 2.5x for the trailing twelve months ended June 30, 2012);
--Maintaining a liquidity coverage ratio above 2.0x.
The following factors may result in negative momentum on the rating and/or Outlook:
--Leverage sustaining above 6.0x; --Fixed-charge coverage sustaining below 2.0x; --A sustained liquidity shortfall;
--A deviation in strategy or a transaction effected on a non-leverage neutral basis;
--A dividend payout ratio exceeding 100% of AFFO.
Fitch currently rates CLI and Mack-Cali Realty, L.P. (collectively, Mack-Cali) as follows:
Mack-Cali Realty Corporation:
--Issuer Default Rating (IDR) 'BBB';
Mack-Cali Realty, L.P. : --IDR 'BBB';
--Unsecured revolving credit facility 'BBB';
--Senior unsecured notes 'BBB'.
The Rating Outlook is Stable.