Fitch: Realty Income's 'BBB+' IDR Unaffected by Amended Merger Agreement
NEW YORK -- January 9, 2013
The announcement that Realty Income Corporation (NYSE: O) and American Realty
Capital Trust, Inc. (NASDAQ: ARCT) signed an amendment to the previously
announced merger agreement does not affect Realty Income's credit ratings,
according to Fitch Ratings.
The amended terms include a cash consideration of $0.35 per share or
approximately $55.5 million in addition to the original consideration of
0.2874 Realty Income shares for each ARCT share. Realty Income also announced
an expected annual dividend rate of $2.17 per share, an increase of $0.35 per
share. In Fitch's opinion, existing holdout ARCT shareholders' desire for a
higher dividend payout contributed to the revised terms, and these terms will
not materially change pro forma credit metrics. Fitch expects the transaction
to close under the amended terms; however, Realty Income's Issuer Default
Rating (IDR) would be unaffected if the merger is not consummated.
Fitch currently rates Realty Income as follows:
--$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.
The portfolio on a pro forma basis remains geographically diversified and will
have lower tenant concentration and lower 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. Liquidity and access
to capital remain strong. Offsetting these credit strengths is elevated
leverage compared with recent periods, though leverage remains consistent with
the 'BBB+' rating and Stable Outlook.
Pro forma for the October 2012 bond offerings and ARCT acquisition, Realty
Income will own 3,263 properties (compared with 2,838 in 3Q'12) across 49 U.S.
states and Puerto Rico, protecting bondholders from possible regional
supply-and-demand imbalances. In addition, the portfolio will include 44
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.
Both tenant concentration and tenant credit risk will decrease pro forma for
the transaction. The top 15 tenants will comprise 42% of pro forma revenue
compared with 47% in 3Q'12. The largest 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
Pro forma, the weighted average remaining lease term will increase to 11.4
years from 11.0 years in 3Q'12. Moreover, the ARCT portfolio is 100% occupied,
increasing Realty Income's occupancy to 97.7% pro forma from 97% in 3Q'12. The
higher occupancy enhances 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 $511.9 million at a
weighted average coupon of 5.2% and the 2018 and 2022 bond offerings, fixed
charge coverage will improve to 3.0x compared with 2.7x for the trailing 12
months ended Sept. 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
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 the
portfolio to 2,838 properties across 44 tenant industries in 3Q'12 from 630
properties across five industries in 1994. Fitch views integration risk as
negligible as ARCT's net lease portfolio is similar to Realty Income's from a
net lease structure and property quality perspective.
Leverage remains elevated compared with recent periods, but appropriate for
the rating. Pro forma for the amended terms of the ARCT transaction and the
2018 and 2022 notes issuance, net debt to recurring operating EBITDA is 5.7x
compared with 5.7x as of Sept. 30, 2012 and 5.4x in 2011.
Under Fitch's base case that is predicated on contractual rent humps, leverage
would remain between 5.0x and 6.0x 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 exceed 6.0x, which would be weak for
Pro forma liquidity coverage is 3.7x for the period from Oct. 1, 2012 to Dec.
31, 2014, which is strong for the 'BBB+' rating. Liquidity coverage was 3.2x
as of Sept. 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, and projected retained
cash flows from operating activities pro forma for an increase in the
annualized dividend to $2.17 per share) 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 4% of total
debt maturing in 2013, 1.4% in 2014, and 8.3% in 2015.
Fitch anticipates that the company's adjusted funds from operations payout
ratio will remain in the mid-to-high 80% range; AFFO payout was 87.3% for
year-to-date ended Sept. 30, 2012.
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 2.2x pro forma compared
with 2.4x in 3Q'12. The covenants under the company's credit agreement and
bond indenture are not expected to limit Realty Income's financial
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
--Fitch's expectation of fixed-charge coverage sustaining above 3.0x (pro
forma fixed charge coverage is 3.0x);
--Fitch's expectation of leverage sustaining below 4.0x (pro forma leverage is
--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 2.2x).
The following factors may result in negative momentum in the ratings and/or
--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
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit
Analysis' (Dec. 13, 2012);
--'Recovery Rating and Notching Criteria for Equity REITs' (Nov. 12, 2012);
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Criteria for Rating U.S. Equity REITs and REOCs' (Feb. 27, 2012).
Applicable Criteria and Related Research:
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit
Recovery Ratings and Notching Criteria for Equity REITs
Corporate Rating Methodology
Criteria for Rating U.S. Equity REITs and REOCs
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