Fitch Affirms Associated Estates Realty's IDR at 'BBB-'; Outlook Stable
NEW YORK -- November 6, 2013
Fitch Ratings has affirmed the following credit ratings of Associated Estates
Realty Corporation (Associated Estates, NYSE and NASDAQ: AEC):
--Issuer Default Rating (IDR) at 'BBB-';
--$350 million unsecured revolving credit facility at 'BBB-';
--$150 million senior unsecured term loans at 'BBB-';
--$150 million senior unsecured notes at 'BBB-'.
The Rating Outlook is Stable.
In addition, Fitch has assigned 'BBB-' ratings to the company's $45 million
4.29% senior unsecured notes due 2020 and $55 million 4.94% senior unsecured
notes due 2024. The company currently has a total of $250 million of senior
unsecured notes outstanding.
KEY RATING DRIVERS
The 'BBB-' IDR reflects favorable multifamily fundamentals resulting in
sustained fixed-charge coverage appropriate for the 'BBB-' rating, improving
access to capital (unsecured private placements and term loans, follow-on
common equity, revolver recast), and adequate liquidity. Fitch views favorably
Associated Estates' focus on improving asset quality, but there is related
execution risk with respect to non-core asset sales and development lease up.
Credit concerns include elevated leverage for the 'BBB-' rating for a
multifamily REIT that is expected to decline, as well as a concentrated
unencumbered property pool due to the company's small size. However, the
company's 2.0x unencumbered asset coverage of unsecured debt is adequate for
the 'BBB-' rating.
SOLID FIXED-CHARGE COVERAGE
Fixed-charge coverage was 2.8x in 3Q'13 pro forma for the issuance of $100
million of 4.29% senior notes due 2020 and 4.94% senior notes due 2024, a
$115.1 million equity offering, proceeds from $315 million of dispositions,
the repayment of five mortgage loans for $129.3 million, $372.8 million of
asset acquisitions, the assumption of $28 million of mortgage debt and
repayment of certain unsecured line of credit borrowings. Coverage was 2.6x
for the trailing 12 months ended Sept. 30, 2013 compared with 2.5x in 2012 and
2.1x in 2011. Fitch defines coverage as recurring operating EBITDA less
recurring capital expenditures divided by total interest incurred.
Improving rent rollover rates, offset by moderating occupancy, are resulting
in solid fixed-charge coverage. Rental rates on new and renewal leases
increased by 3.2% during the third quarter of 2013 (3Q'13). Despite difficult
comparisons from 2012, leasing momentum continued after new and renewal
spreads of 3.9% in 2Q'13 and 2.2% in 1Q'13. Occupancy has come under slight
pressure, however. Period-end same-community physical occupancy declined to
95.8% as of Sept. 30, 2013, down sequentially from 96.6% as of June 30, 2013
and year-over-year from 97.2% as of Sept. 30, 2012.
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.
SMALL SIZE BUT IMPROVING ACCESS TO CAPITAL
Despite its recent growth, AEC remains substantially smaller than most of its
multifamily REIT peers, with gross undepreciated assets of approximately $1.7
billion, a total market capitalization of approximately $1.6 billion, and an
equity market capitalization of approximately $752 million as of Sept. 30,
2013. 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.
During 2013, the company demonstrated improved access to capital including via
the issuance of four series of unsecured private placements and also recast
its unsecured credit facility, extending the maturity date from Jan. 12, 2016
to June 15, 2017 and reducing the interest spread and facility fee across the
pricing grid. In addition, the company used proceeds from its above-mentioned
forward-funded equity offering to repay a portion of $129.3 million secured
debt obligations on Oct. 1, 2013, which Fitch views favorably.
Liquidity coverage is adequate at 1.5x (defined as liquidity sources divided
by uses) for the period from Oct. 1, 2013 to Dec. 31, 2015. Sources of
liquidity include unrestricted cash, availability under AEC's unsecured
revolving credit facility pro forma for post-quarter-end transactions, and
projected retained cash flows from operating activities after dividends and
distributions. Uses of liquidity include debt maturities as well as projected
recurring capital expenditures and cost-to-complete development.
Debt maturities are mild pro forma for post-quarter-end transactions, with no
additional 2013 maturities, followed by 5.2% of pro forma debt maturing in
2014, and 2.4% in 2015. Assuming an 80% mortgage refinance rate on upcoming
secured debt, liquidity coverage would improve to 2.0x, but Fitch views this
scenario as unlikely as the company plans to continue unencumbering the
The company's AFFO payout ratio was 73.1% in 3Q2013, compared with 62.8% in
2012 and 78.2% in 2011, all of which are indicative of moderate organic
PORTFOLIO UPGRADE HAS EXECUTION RISK
The company is expected to stagger asset purchases and sales from 4Q2013
through 4Q2014 to improve asset quality and broaden a footprint in
higher-growth markets such as Raleigh, Charlotte and Dallas. Acquisitions
total $372.8 million across the southeast, mid-Atlantic and Texas and include
newer vintage assets. The company is targeting dispositions of $315 million
across assets in the southeast and mid-Atlantic regions. Assets targeted for
disposition have an average age of 18 years.
Acquisition cap rates of 5.5% are below expected disposition cap rates ranging
from 6% to 6.5%, diluting near-term earnings. In addition, Fitch sees lease-up
risk associated with certain to-be acquired assets and existing development
projects. The company also holds land in San Francisco, CA, Los Angeles, CA
and Monrovia, CA. Cost-to-complete development is manageable and represented
7.2% of gross asset value as of Sept. 30, 2013, up from 3% as of year-end 2012
and 0.5% as of year-end 2011.
ELEVATED LEVERAGE FOR 'BBB-' EXPECTED TO DECLINE
Net debt to recurring operating EBITDA was 8.1x as of Sept. 30, 2013 pro
forma, compared with 7.9x in FY12, 8.3x in FY2011, and 8.8x in FY2010.
De-levering common stock offerings and at-the-market program equity issuance
have improved the overall leverage trajectory. Development activity funded by
revolving credit facility borrowings increased leverage in 3Q2013.
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 primarily with asset
In a stress case whereby same-store NOI declines are similar to those
experienced by AEC in the 2009 period, leverage would revert towards 8.0x;
leverage sustaining above 8.0x 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.
GROWING BUT CONCENTRATED UNENCUMBERED POOL
As of Sept. 30, 2013 pro forma for the forward-funded equity offering and
repayment of five mortgage loans, unencumbered NOI represented 73.4% of total
NOI, up from 59.3% in 2012 and 44.2% in 2011. This growing pool benefits
unsecured creditors and provides contingent liquidity appropriate for the
Third quarter 2013 pro forma annualized unencumbered NOI divided by a stressed
capitalization rate of 8% covered unsecured debt by 2.0x, down from 2.7x on a
comparable basis from 3Q2012, and adequate for a 'BBB-' rating. Recent private
placement issuance and borrowings on the revolving credit facility to repay
secured debt maturities and fund acquisitions and development caused the
The unencumbered pool is somewhat concentrated with the top 10 unencumbered
properties by NOI contributing a large portion of pro forma unencumbered NOI.
The Stable Outlook reflects that the 'BBB-' rating is not likely to change in
the near-to-medium term. Fitch anticipates that Associated Estates will
continue to invest in younger assets in higher growth markets and reduce
secured debt levels. Fixed-charge coverage in the 2.5x-to-3.0x range and
leverage in the 7.0x to 7.5x range is appropriate for a smaller multifamily
REIT at the 'BBB-' level.
The following factors may result in positive rating and/or Outlook momentum:
--Improved granularity in the unencumbered asset pool;
--Fitch's expectation that fixed-charge coverage sustains above 3.0x given the
company's size (3Q'13 fixed-charge coverage was 2.8x pro forma);
--Fitch's expectation that leverage sustains below 7.0x given the company's
size (as of Sept. 30, 2013 pro forma leverage was 8.1x, however leverage is
expected to approach to the low-to-mid 7x range over the next 12 months).
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 1.5x).
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--Corporate Rating Methodology (Aug. 5, 2013);
--Criteria for Rating U.S. Equity REITs and REOCs (Feb. 26, 2013);
--Recovery Ratings and Notching Criteria for Equity REITs (Nov. 12, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and
Criteria for Rating U.S. Equity REITs and REOCs
Recovery Ratings and Notching Criteria for Equity REITs
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Fitch Ratings, Inc.
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Sendhil Selvaraj, +44 (0) 207 682 7218
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