Fitch Rates Associated Estates' $150MM Senior Unsecured Notes 'BBB-';
NEW YORK -- January 24, 2013
Fitch Ratings has assigned a credit rating of 'BBB-' to the $150 million
issuance of senior unsecured notes by Associated Estates Realty Corporation
(Associated Estates; NYSE/NASDAQ: AEC). The notes were offered in a private
placement and consisted of $63 million eight-year notes with a yield of 4.02%
and $87 million 10-year notes with a yield of 4.45%. Proceeds from the
issuance were used to repay borrowings under the company's unsecured credit
facility, including amounts borrowed in December to repay two mortgages
totaling approximately $33.6 million.
Fitch currently rates Associated Estates Realty Corporation as follows:
--Issuer Default Rating (IDR) 'BBB-';
--$350 million senior unsecured revolving credit facility 'BBB-';
--$150 million senior unsecured term loan 'BBB-';
--$150 million senior unsecured notes 'BBB-'.
The Rating Outlook is Stable.
The 'BBB-' IDR reflects favorable multifamily fundamentals resulting in
sustained fixed-charge coverage appropriate for the 'BBB-' rating, the
company's primarily acquisition-driven increase in size which incrementally
lessens asset concentration, and accelerated leverage reductions via follow-on
common stock offerings. The rating action takes into account credit concerns
including an increased development pipeline that hampers liquidity, as well as
heavy 2013 debt maturities. However, mitigating this concern are the company's
continued improvement in access to capital and good contingent liquidity as
measured by solid unencumbered asset coverage of unsecured debt.
FAVORABLE PROPERTY FUNDAMENTALS
Improving occupancy and rent rollover rates are resulting in solid
fixed-charge coverage. Strong demand and muted new supply in AEC's submarkets
have led to same-community physical occupancy of 97.3% as of Sept. 30, 2012,
up from 94.8% as of Sept. 30, 2011. Rental rates on new and renewal leases
increased by 4.4% in the third quarter of 2012 (3Q'12). Despite difficult
comparisons from 2011, leasing momentum continued after new and renewal
spreads of 5% in 2Q'12 and 2.2% in 1Q'12. Fixed-charge coverage was 2.5x in
3Q'12 pro forma for the bond offerings, compared with 2.8x in 3Q'12 and 2.1x
in fiscal year (FY) 2011. Fitch defines fixed-charge coverage as recurring
operating EBITDA less recurring capital expenditures divided by total interest
Fitch anticipates that positive leasing spreads will continue in the near term
due to favorable supply-demand dynamics in AEC's submarkets. For the next
12-to-24 months, Fitch projects that fixed-charge coverage will remain in the
2.5x to 3.0x range due to organic growth and incremental NOI from acquisitions
and development, which is appropriate for a 'BBB-' rating.
In a stress case whereby same-store NOI declines are similar to those
experienced by AEC in 2009, fixed-charge coverage would remain in the mid-2.0x
range in the near term, which would be weaker for the 'BBB-' rating for a
multifamily REIT of AEC's size. In a more adverse case than anticipated by
Fitch, fixed-charge coverage could approach 2.0x, which could place pressure
on a 'BBB-' rating.
EXPANSION IMPROVES ASSET QUALITY
AEC's roots are in the Midwest, though recent acquisitions in other
multifamily markets have broadened the company's geographic footprint. Key
purchases over the past year were in greater Dallas, TX and Raleigh, NC, with
capitalization rates ranging from the low 5% range to the mid 6% range.
Moreover, AEC is selectively targeting submarkets with proximity to
transportation and employment hubs while shedding older assets in Western
Michigan, Duluth, GA, and Columbus, OH.
SMALL SIZE LIMITS CAPITAL ACCESS
Despite its recent growth, AEC remains substantially smaller than most of its
multifamily REIT peers, with gross undepreciated assets of approximately $1.5
billion, a total market capitalization of approximately $1.5 billion, and an
equity market capitalization of approximately $750 million as of Sept. 30,
2012. The company's smaller size may limit capital markets access, given that
REIT-dedicated investors may not be able to acquire a meaningful investment in
the company's securities.
The company's small size also results in certain assets contributing
materially toward results. AEC's top-five assets contribute approximately 25%
of total NOI and the top 10 assets contribute approximately 40% of total NOI,
highlighting asset concentration risk.
LEVERAGE APPROPRIATE FOR RATING
A follow-on common stock offering of $87.2 million in June 2012 and capital
raises via ATM programs have funded acquisitions and development. Net debt to
recurring operating EBITDA was 7.7x in 3Q'12 compared with 7.1x in 2Q'12 and
8.3x in FY2011.
Under Fitch's base case projections, AEC's leverage will sustain in the 7.0x
to 7.5x range over the next 12-to-24 months as the company grows earnings via
acquisitions and development while funding such activity with approximately
45% debt and 55% equity. In a stress case whereby same-store NOI declines are
similar to those experienced by AEC in the 2009 period, leverage would sustain
around 8.0x, which would be more appropriate for a 'BB+' rating. In a more
adverse case than anticipated by Fitch, leverage could sustain above 8.5x in
the near term, which would be weak for a 'BB+' rating.
DEVELOPMENT CONSTRAINS LIQUIDITY
AEC's development pipeline consists of two active projects in Dallas and
Bethesda, MD, as well as two future projects in Dallas and Los Angeles. Draws
on the company's $350 million unsecured revolving credit facility to fund
these projects weakened liquidity coverage to 1.2x (defined as liquidity
sources divided by uses) for the period from Oct. 1, 2012 to Dec. 31, 2014.
However, pro forma for the private placement offerings, liquidity coverage
improves to 1.7x. Sources of liquidity include unrestricted cash, availability
under AEC's unsecured revolving credit facility, and projected retained cash
flows from operating activities after dividends and distributions. Uses of
liquidity include debt maturities and projected development, and recurring
Debt maturities are heavy in 2013, however, totaling 21.1% of total debt as of
Sept. 30, 2012. Assuming an 80% mortgage refinance rate on upcoming secured
debt, liquidity coverage would improve to 4.8x, but Fitch views this scenario
as unlikely as the company endeavors to continue unencumbering the portfolio
via equity offerings and unsecured debt.
GOOD CONTINGENT LIQUIDITY
Third quarter 2012 annualized unencumbered NOI divided by a stressed
capitalization rate of 7.5% covered unsecured debt by 2.9x, which is strong
for a 'BBB-' rating. Pro forma for the repayment of mortgage debt on select
assets with the private placement unsecured bond offerings, unencumbered asset
coverage is 2.1x, which is adequate for a 'BBB-' rating.
Unencumbered NOI represented 58% of 3Q'12 NOI and Fitch anticipates
unencumbered NOI increases to 74% on a pro forma basis, compared with 45% in
2011 and 34% in 2010. This positive trend is indicative of the company's
commitment toward growing its unencumbered pool, to the benefit of unsecured
LIMITED UNSECURED-BORROWER TRACK RECORD
The private placement bond offerings improve the company's unsecured-borrower
track record, building on recent transactions including the upsizing of the
unsecured term loan to $150 million from $125 million. In addition, the
covenants in AEC's unsecured debt agreements do not restrict financial
The Stable Outlook reflects that the 'BBB-' rating is not likely to change in
the near-to-medium term. Fitch anticipates that AEC will continue growing in a
measured manner via acquisitions and development while maintaining
fixed-charge coverage in the 2.5x-to-3.0x range and leverage in the 7.0x to
7.5x range over the next 12-to-24 months.
WHAT COULD TRIGGER A RATING ACTION
Fitch does not anticipate positive rating momentum in the near term. However,
the following factors may result in positive rating and/or Outlook momentum:
--Undepreciated assets sustaining above $2 billion (undepreciated assets were
approximately $1.5 billion as of Sept. 30, 2012);
--Fitch's expectation that fixed-charge coverage sustains above 3.0x given the
company's size (3Q'12 fixed-charge coverage was 2.5x pro forma);
--Fitch's expectation that leverage sustains below 7.0x given the company's
size (as of Sept. 30, 2012 leverage was 7.7x based on 3Q'12 annualized
recurring operating EBITDA).
The following factors may result in negative rating and/or Outlook momentum:
--Fitch's expectation that fixed-charge coverage ratio sustains below 2.0x;
--Fitch's expectation that leverage sustains above 8.0x;
--A base case liquidity coverage ratio that excludes the impact of refinancing
activities sustaining below 1.0x (pro forma liquidity coverage is 1.7x).
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:
--'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.
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