NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has assigned a 'BBB+' rating to the $350 million aggregate principal amount 2.00% coupon senior unsecured notes due 2018 and $450 million aggregate principal amount 3.25% coupon senior unsecured notes due 2022 issued by Realty Income Corporation (NYSE: O).
The 2018 notes were priced at 99.910% of par to yield 2.017% to maturity, or 140 basis points over the benchmark treasury rate. The 2022 notes were priced at 99.382% of par to yield 3.323% to maturity, or 170 basis points over the benchmark treasury rate. The net proceeds from the offering will be used to repay borrowings outstanding on the company's unsecured credit facility, and any remaining proceeds will be used for general corporate purposes, which may include additional property acquisitions.
Fitch currently rates Realty Income as follows:
--Issuer Default Rating (IDR) 'BBB+';
--$1 billion unsecured revolving credit facility 'BBB+';
--$2.6 billion senior unsecured notes 'BBB+';
--$609.4 million preferred stock 'BBB-'.
The Rating Outlook is Stable.
Following the Sept. 6, 2012 announcement by Realty Income that it agreed to acquire American Realty Capital Trust, Inc. (NASDAQ: ARCT) in a $2.95 billion transaction, Fitch affirmed Realty Income's 'BBB+' IDR. The portfolio on a pro forma basis remains geographically diversified and will have lower tenant concentration and tenant credit risk. Cash flow visibility and fixed charge coverage will increase as a result of the ARCT portfolio's longer lease duration and 100% occupancy. In addition, Realty Income's management team has been cognizant of maintaining consistent credit metrics while growing through mergers and acquisitions. Offsetting factors include a slightly higher leverage ratio - albeit at a level that remains consistent with the 'BBB+' rating and Stable Outlook - as well as a weaker though still strong near-term liquidity position. Liquidity has improved pro forma for the 2018 and 2022 bond offerings.
Pro forma for the bond offerings and ARCT acquisition, Realty Income will own 3,263 properties (compared with 2,762 in 2Q'12) across 49 U.S. states and Puerto Rico, protecting bondholders from possible regional supply-and-demand imbalances. In addition, the portfolio will include 45 tenant industries pro forma, compared with 38 in 2Q'12. The industry expansion is consistent with Realty Income's strategic plan to be less concentrated in net lease retail.
Tenant concentration will decrease and tenant credit risk will decline pro forma for the transaction. The top 15 tenants will contribute 42% pro forma compared with 48.5% in 2Q'12. Top tenants will be FedEx at 6% of rent, AMC Theatres at 3.8%, L.A. Fitness at 3.7%, Diageo at 3.6%, and Walgreens at 3.2%. Cash flow coverage of rent was solid at approximately 2.5x in 2Q'12 and approximately 75% of the tenants in the ARCT portfolio are rated investment grade.
Pro forma, the weighted average remaining lease term will increase to 11.4 years from 11.1 years in 2Q'12. Moreover, the ARCT portfolio is 100% occupied, increasing Realty Income's occupancy to 97.7% pro forma from 97.3% in 2Q'12, enhancing cash flow stability absent tenant bankruptcies.
Fixed charge coverage will improve pro forma. Assuming minimal additional G&A expense, the assumption of mortgage debt of approximately $526 million at a weighted average coupon of 5.2% and the 2018 and 2022 bond offerings, fixed charge coverage will improve to 2.9x compared with 2.7x for the trailing 12 months ended June 30, 2012, and 2.8x in 2011. Fitch defines fixed charge coverage as recurring operating EBITDA less straight-line rent adjustments less recurring capital expenditures divided by total interest incurred and preferred dividends.
Fitch's base case projection reflects contractual base rent increases, which should result in coverage sustaining around 3.0x over the next 12-to-24 months; this is consistent with a 'BBB+' rating. In a stress case not anticipated by Fitch in which tenant bankruptcies similar to the Friendly's bankruptcy in 2011 reduce annual rent by approximately 5%, fixed charge coverage would remain above 2.5x and remain appropriate for a 'BBB+' rating.
Realty Income has a long track record of growth, having increased to 2,762 properties across 38 tenant industries in 2Q'12 from 630 properties across five industries in 1994. Fitch views integration risk as negligible, since ARCT's net lease portfolio is similar to Realty Income's from a net lease structure and property quality perspective.
Leverage will increase slightly pro forma. Under the terms of the $2.95 billion transaction, Realty Income will issue 45.6 million new common shares whereby each ARCT share will be converted into 0.2874 Realty Income common shares. The assumption of $526 million of mortgage debt associated with the ARCT transaction and 2018 and 2022 notes results in net debt to recurring operating EBITDA of 5.2x compared with 4.8x as of June 30, 2012.
Under Fitch's base case that is predicated on contractual rent humps, leverage would remain around 5.0x over the next 12-to-24 months, which would remain appropriate for the rating. In a stress case tenant bankruptcy scenario not anticipated by Fitch, leverage could approach 5.5x, which would still be adequate for the rating.
Pro forma liquidity coverage is 6.5x for the period from July 1, 2012 to Dec. 31, 2014, which is strong for the 'BBB+' rating. Liquidity coverage was 6.7x as of June 30, 2012. Fitch defines liquidity coverage as sources of liquidity (unrestricted cash, availability under the unsecured revolving credit facility pro forma for the bond offering and ARCT transaction, projected retained cash flows from operating activities pro forma, an increase in the annualized dividend to $1.94 from $1.81 previously) divided by uses of liquidity (debt maturities and projected recurring capital expenditures).
Upcoming debt maturities are manageable through 2015 on a pro forma basis, with minimal maturities for the remainder of 2012 followed by 4% of total debt maturing in 2013, 1.4% in 2014, and 8.3% in 2015.
Contingent liquidity weakens slightly pro forma for the bond offerings and ARCT acquisition. The company intends to further unencumber the portfolio when prepayment penalties on ARCT secured debt become less onerous. However, unencumbered assets (calculated as unencumbered property NOI at a stressed capitalization rate of 8%) cover unsecured debt by 2.6x pro forma compared with 2.9x in 2Q'12. The covenants under the company's credit agreement and bond indenture are not expected to limit Realty Income's financial flexibility.
The two-notch differential between Realty Income'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', available on Fitch's web site at 'www.fitchratings.com', 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.
The Stable Outlook reflects Fitch's view that there is limited integration risk associated with the transaction, Realty Income's M&A track record is solid, and credit metrics will remain consistent with the rating.
The following factors may result in positive momentum in the ratings and/or Rating Outlook:
--Fitch's expectation of fixed-charge coverage sustaining above 3.0x (pro forma fixed charge coverage is 2.9x);
--Fitch's expectation of leverage sustaining below 4.0x (pro forma leverage is 5.2x);
--Fitch's expectation of unencumbered assets-to-unsecured debt sustaining above 3.0x (pro forma unencumbered NOI divided by a stressed 8% capitalization rate to unsecured debt was 2.6x).
The following factors may result in negative momentum in the ratings and/or Rating Outlook:
--Fitch's expectation of fixed-charge coverage sustaining below 2.5x;
--Fitch's expectation of leverage sustaining above 6.0x;
--Tenant bankruptcies resulting in a weakening of the company's credit metrics.
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. 8, 2012;
--Recovery Ratings and Notching Criteria for Equity REITs, May 3, 2012;
--Criteria for Rating U.S. Equity REITs and REOCs, Feb. 27, 2012;
--Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis, Dec. 15, 2011.
Applicable Criteria and Related Research:
Corporate Rating Methodology
Recovery Ratings and Notching Criteria for Equity REITs
Criteria for Rating U.S. Equity REITs and REOCs
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis
Sean Pattap, +1-212-908-0642
One State Street Plaza
New York, NY 10004
Britton Costa, +1-212-908-0524
Michael Paladino, CFA, +1-212-908-9113
Sandro Scenga, New York, +1 212-908-0278
Source: Fitch Ratings