Fitch Rates Realty Income's $750MM 4.65% Sr. Unsecured Notes Due 2023
'BBB+'; Outlook Stable
NEW YORK -- July 10, 2013
Fitch Ratings has assigned a 'BBB+' credit rating to the $750 million
aggregate principal amount 4.65% coupon senior unsecured notes due 2023 issued
by Realty Income Corporation (NYSE: O). The notes were priced at 99.775% of
par to yield 4.678% to maturity, or 205 basis points over the benchmark
treasury rate. The net proceeds from the offering are expected to be used to
repay borrowings outstanding on the company's unsecured credit facility, and
any remaining proceeds are expected to be used for general corporate purposes,
which may include acquisitions.
Fitch currently rates Realty Income as follows:
--Issuer Default Rating (IDR) 'BBB+';
--$1 billion unsecured revolving credit facility 'BBB+';
--$3.3 billion of senior unsecured notes 'BBB+';
--$609.4 million of preferred stock 'BBB-'.
The Rating Outlook is Stable.
KEY RATING DRIVERS
The ratings are supported by the geographic diversity of the company's
predominantly net leased retail property portfolio, limited tenant
concentration and moderate tenant credit risk. The ratings are also supported
by fixed charge coverage that is appropriate for the 'BBB+' rating and Realty
Income's management team that has been and remains cognizant of maintaining
consistent credit metrics while growing through mergers and acquisitions.
Liquidity and access to capital remain strong for the rating. Offsetting these
credit strengths is leverage that is at the high end of the range that is
appropriate for the 'BBB+' rating pro forma for the second quarter of 2013
(2Q'13) acquisitions and the bond offering. Furthermore, the company's track
record of investing outside of net lease retail is somewhat limited within the
context of Realty Income's long history.
DIVERSE NET LEASE PORTFOLIO
As of March 31, 2013, Realty Income's portfolio consists of 3,525 properties
across 49 U.S. states and Puerto Rico, protecting bondholders from possible
regional supply-and-demand imbalances. In addition, the portfolio includes 46
tenant industries, and top segments based on 1Q'13 revenues were convenience
stores (12%), casual dining and quick service restaurants (10.5%), and
theaters (6.7%). These top segments include non-discretionary real estate and
signal investment granularity that Fitch views favorably. Industry expansion
is consistent with Realty Income's strategic plan to be less concentrated in
net lease retail.
IMPROVING TENANT CREDIT
The company's top 15 tenants comprised 42.6% of 1Q'13 rent, which is somewhat
concentrated. The top three tenants at March 31, 2013 were FedEx at 5.7% of
rent, L.A. Fitness at 4.5% and Family Dollar at 3.5%. Acquisition activity in
2012 and year-to-date has focused on properties leased to investment-grade
rated tenants (64% in 2012 and 72% in 2013 year-to-date) thereby improving the
overall tenant credit quality. The company's weighted average lease duration
is long at 11.1 years, signaling durability of cash flow that supports the
ratings. Cash flow coverage of rent has improved in recent years and was solid
at approximately 2.5x in 1Q'13.
SOLID FIXED-CHARGE COVERAGE
Pro forma for 2Q'13 acquisitions and the unsecured bond offering, fixed charge
coverage is solid for the rating at 2.7x, compared with 2.9x in 1Q'13 and 2.6x
in 2012. 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 is predicated on 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.
FORWARD-LOOKING STRATEGIC PLANNING
Realty Income has a long track record of growth since its formation in 1969,
having increased the portfolio to 3,525 properties across 46 tenant industries
in 1Q'13 from 630 properties across five industries in 1994. The original
initiatives of generating monthly income from retail properties leased on a
long-term triple-net basis (1969 to 1994) evolved towards being attuned to
portfolio diversity as well as focusing on cash flow coverage and underwriting
(1997 to 2007). Following the recession, the company concentrated on improving
tenant credit and pursued new industries while re-underwriting and ranking the
Realty Income's strategy currently centers on owning mission-critical real
estate net leased to stronger credit tenants, with a preference for services
over goods. The company owns both discretionary and non-discretionary retail
as well as non-retail. However, its experience owning non-retail such as
distribution (10.6% of 1Q'13 revenue), office (4.6%), agriculture (3%),
manufacturing (2.5%) and industrial (0.2%) properties is somewhat limited.
STRONG LIQUIDITY AND ACCESS TO CAPITAL
Liquidity coverage pro forma for the bond offering is strong at 9.7x for the
period from April 1, 2013 to Dec. 31, 2014. Fitch defines liquidity coverage
as sources of liquidity (unrestricted cash, availability under the unsecured
revolving credit facility pro forma for the bond offering, and projected
retained cash flows from operating activities after dividends and
distributions) divided by uses of liquidity (debt maturities and projected
recurring capital expenditures). Longer term, debt maturities were manageable
as of March 31, 2013 with 0.7% maturing in 2013 followed by 1.8% in 2014 and
8.1% in 2015.
Contingent liquidity weakens slightly pro forma for the bond offering as
unencumbered asset coverage of unsecured debt declines to 2.2x from 2.5x at
1Q'13 (assuming a stressed 8% capitalization rate). The company intends to
further unencumber the portfolio when prepayment penalties on secured debt
assumed as part of the American Realty Capital Trust, Inc. (ARCT) transaction
in January 2013 become less onerous. In addition, the covenants under the
company's revolving credit facility agreement and bond indenture do not
restrict Realty Income's financial flexibility.
Fitch anticipates that the company's adjusted funds from operations (AFFO)
payout ratio will remain in the mid-to-high 80% range (81.9% in 1Q'13),
indicative of the company's ability to generate some internal liquidity
despite its emphasis on predictable and growing dividends.
ELEVATED LEVERAGE FOR THE RATING
Pro forma for 2Q'13 acquisitions and the bond offering, net debt to recurring
operating EBITDA is 6.0x compared with 5.4x in 1Q'13 and 6.6x in 2012.
Leverage was skewed upward in 2012 due to the incurrence of debt prior to the
close of the ARCT transaction. 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 the rating.
PREFERRED STOCK NOTCHING
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 credit metrics and the quality
of the portfolio 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 2.7x);
--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:
--Criteria for Rating U.S. Equity REITs and REOCs (Feb. 26, 2013);
--Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit
Analysis (Dec. 13, 2012);
--Recovery Ratings and Notching Criteria for Equity REITs (Nov. 12, 2012);
--Corporate Rating Methodology (Aug. 8, 2012).
Applicable Criteria and Related Research:
Criteria for Rating U.S. Equity REITs and REOCs
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit
Recovery Ratings and Notching Criteria for Equity REITs
Corporate Rating Methodology
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Sean Pattap, +1 212-908-0642
Fitch Ratings, Inc.
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