Fitch Affirms Corporate Office Properties' IDRs at 'BBB-'; Outlook Stable
NEW YORK -- March 25, 2014
Fitch Ratings has affirmed the following credit ratings of Corporate Office
Properties Trust (NYSE: OFC) and its operating partnership, Corporate Office
Properties, L.P. (collectively COPT, or the company):
Corporate Office Properties Trust
--Issuer Default Rating (IDR) at 'BBB-';
--Preferred Stock at 'BB'.
Corporate Office Properties, L.P.
--IDR at 'BBB-';
--Senior unsecured line of credit at 'BBB-';
--Senior unsecured term loans at 'BBB-';
--Senior unsecured notes at 'BBB-';
--Senior unsecured exchangeable notes at 'BBB-'.
The Rating Outlook is Stable.
KEY RATING DRIVERS
Strong Franchise/Defense-Driven Portfolio
COPT generates 72% of net operating income (NOI) from its strategic tenant
niche, which includes properties occupied primarily by government agencies or
defense contractors. As a result, COPT's assets are generally located near
strategic defense locations (i.e. Fort Meade), which drives geographic
concentration in the Washington, DC and Baltimore region. These strategic
locations drive strong tenant investment in the assets and create tenant
stickiness, as retention rates have averaged 71% since 2007.
Tenant missions also center on R&D and high-tech areas that are critical to
national cyber-security in the United States. Together with COPT's
long-standing relationships with the federal government and contractors, these
strategic locations create meaningful barriers to entry.
Portfolio Realignment Largely Complete
COPT completed its Strategic Reallocation Plan (SRP) commenced in 2011 via the
sale of non-core assets (reduced Baltimore County footprint by 2 million
square feet), exiting the Colorado Springs market, and improving its balance
sheet to levels consistent with an investment grade office REIT. Key remaining
transactions include the expected conveyance of a $150 million portfolio
(based on outstanding CMBS balances) to the special servicer during 2014 and
the redevelopment/expected sale of the company's Blue Bell portfolio. These
transactions will further improve financial flexibility and facilitate capital
recycling in the company's strategic niche properties.
Improved Credit Profile; Addition by Subtraction
The company sold its 15-asset Colorado Springs portfolio for $133.9 million
and conveyed 14 properties to the CMBS special servicer for $146.9 million in
December 2013, reflecting the value of in-place debt and accrued interest.
These transactions drove leverage lower to 6.5x at Dec. 31, 2013. Fitch
anticipates that COPT will convey a separate $150 million portfolio to the
special servicer in 2014 following vacancies by Northrop Grumman and CSC in
April 2014, which will facilitate further de-levering. Fitch is not concerned
about potential franchise risk at this time; however, additional conveyances
would be viewed negatively given the potential for weakened access to mortgage
Appropriate Credit Metrics
Leverage declined to 6.5x at Dec. 31, 2013 from 7.0x and 8.7x during the two
prior years, respectively. Fitch expects leverage will increase to 6.8x in
2014 before declining to the low-6.0x range over the longer term, driven by
low single-digit same-store net operating income (SSNOI) growth and
incremental cash flow from development completions. Projected leverage is
appropriate for the 'BBB-' IDR. Fitch defines leverage as net
debt-to-recurring operating EBITDA.
Fixed charge coverage (FCC) was 2.1x for the trailing 12 months (TTM) ended
Dec. 31, 2013, an increase from 1.8x in 2012 and 1.6x in 2011. Fitch expects
that FCC will approach 2.5x over the next 12-24 months, driven by recurring
operating EBITDA growth and continued access to debt capital at favorable
rates. Projected coverage is relatively strong for the rating. Fitch defines
FCC as recurring operating EBITDA, less recurring capital expenditures and
straight-line rent adjustments, divided by total interest incurred and
Uneven Operating Fundamentals
Defense contractor downsizing drove same-store occupancy 100 bps lower to
89.8% at Dec. 31, 2013 from 90.8% at June 30, 2013. Fundamentals remain uneven
across markets - the Baltimore/Washington Corridor, which makes up 47% of
square feet, has seen encouraging leasing indicators evidenced by positive
cash leasing spreads in 4Q'13. However, Northern Virginia and Greater
Baltimore (collectively 32% of square feet) remain under pressure and have
been characterized by cash rent roll down in the high single digits with
elevated capex requirements. Favorably though, GAAP leasing spreads continue
to be positive across the portfolio and accelerated to 4.6% in 2013. Fitch
expects that occupancy will increase marginally in 2014 as contractors
finalize real estate rationalization plans.
Informed Demand Mitigates Development Risk
COPT's growth strategy centers on new development given informed demand from
the U.S. Government for new space requirements. The pipeline totaled $287
million at Dec. 31, 2013 and was 78% pre-leased to both government agencies
and defense contractors supporting these entities. The cost to complete the
pipeline is modest at 3% and despite potential growth toward 5%, Fitch expects
development risk will continue to be mitigated by COPT's unique relationships
that provide implicit pre-leasing. The company remains well-positioned to
capture future demand from cyber-driven growth, which should offset weakness
in regional markets and potential future downsizing from defense contractors.
COPT leased approximately 900,000 square feet of first-generation development
and redevelopment space in 2013, which follows a record 1.2 million of square
feet in 2012.
Adequate Financial Flexibility
COPT has a strong liquidity profile with total sources of liquidity covering
total uses of liquidity by 2.3x for the Jan. 1, 2014 to Dec. 31, 2015 period,
strong for the rating.
Fitch defines liquidity coverage as sources of liquidity divided by uses of
liquidity. Sources of liquidity include unrestricted cash, availability under
the unsecured revolving credit facility, and projected retained cash flow from
operating activities after dividends. Uses of liquidity include pro rata debt
maturities, expected recurring capital expenditures, and remaining development
Financial flexibility is also supported by improved access to capital (the
company issued $600 million of unsecured notes in 2013 at a 4.3% weighted
average interest rate) and a growing unencumbered asset pool, which covered
net unsecured debt by 2.2x at Dec. 31, 2013 using a stressed 9% capitalization
Conservative AFFO Payout Ratio
COPT's AFFO payout ratio was 70% in 2013, which allows the company to generate
approximately $45 million of internal liquidity to fund growth and repay debt.
Fitch expects the company to increase the dividend over the next 12-24 months;
however, Fitch expects the AFFO ratio will remain below 80%.
The following factors may have a positive impact on COPT's ratings and/or
--Fitch's expectation of net debt-to-recurring operating EBITDA sustaining
below 6.0x (leverage was 6.5x as of Dec. 31, 2013);
--Fitch's expectation of fixed-charge coverage maintaining above 2.5x
(fixed-charge coverage ratio was 2.1x for the TTM ended Dec. 31, 2013);
--Fitch's expectation of unencumbered asset coverage of net unsecured debt
(UA/UD) maintaining above 2.5x (coverage was 2.2x as of Dec. 31, 2013).
The following factors may have a negative impact on the company's ratings
--Fitch's expectation of leverage sustaining above 7.0x;
--Fitch's expectation of fixed-charge coverage sustaining below 1.8x;
--Fitch's expectation of UA/UD sustaining below 1.8x;
--Material macroeconomic weakness affecting the defense industry, such that a
larger portion of COPT's portfolio would consist of standard suburban office
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Rating U.S. Equity REITs and REOCs (Sector Credit Factors) (Feb. 26, 2014);
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit
Analysis' (Dec. 23, 2013);
--'Recovery Ratings and Notching Criteria for Equity REITs' (Nov. 19, 2013);
--'Corporate Rating Methodology' (Aug. 5, 2013).
Applicable Criteria and Related Research:
Recovery Ratings and Notching Criteria for Equity REITs
Corporate Rating Methodology: Including Short-Term Ratings and Parent and
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit
Rating U.S. Equity REITs and REOCs (Sector Credit Factors)
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS.
PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK:
HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING
PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND
METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF
CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL,
COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM
THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER
PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS
OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN
EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER
ON THE FITCH WEBSITE.
Reinor Bazarewski, +1-212-908-0291
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
Steven Marks, +1-212-908-9161
Sean Pattap, +1-212-908-0642
Media Relations, New York
Sandro Scenga, +1 212-908-0278
Press spacebar to pause and continue. Press esc to stop.